Game of Trillions

Chief Investment Officer's team
17 January 2021
Game of Trillions
President-elect Biden announced $1.9tn fiscal stimulus, and the Fed confirmed it won’t reduce support soon


  • President-elect Biden announced $1.9tn fiscal stimulus, and the Fed confirmed it won’t reduce support soon
  • Markets did not show any euphoria, disturbed by weak retail sales and mixed earnings
  • We made some adjustments to our tactical asset allocation, adding EM vs DM in particular

The key news of last week came once again from Washington: on Thursday, President-elect Joe Biden released details on his $1.9tn economic relief package, which notably includes $1,400 cheques for American individuals – one could call it helicopter money. The same day, the Fed Chairman issued clear statements that the central bank was not going to taper its balance sheet expansion anytime soon, not even talking about hiking interest rates.

This is undoubtedly good news, but the market reaction indicates that it was not unexpected. The world is struggling with the second wave of the virus which is unfortunately worse than the first one from a public health perspective. The global deaths from COVID-19 surpassed 2 million and are still growing. There is an economic cost of course: US retail sales tumbled for a third month in December, and the first releases of the Q4 earnings season from US banks were mixed and the forward looking statements full of uncertainty. The stimulus plan itself faces some opposition from the Republicans in the Senate, and the continuously positive data from manufacturing and industrial sectors is not enough to further boost an already bullish sentiment.

This was a mildly “risk-off” week as a result, especially on developed markets cyclical asset classes. We held our tactical asset allocation committee last Tuesday and adjusted our exposure to bring it closer to our newly reshuffled long-term strategy, basically reducing developed markets in favor of their emerging counterparts. China’s exceptionalism in the current crisis should be confirmed by their quarterly GDP to be released later this week. We remain reasonably positive for 2021 of course: we’ll get through this. Stay safe.

Cross-asset Update

The year is not starting on a strong note for gold enthusiasts, with the yellow metal down 3.6% in the period through Friday. Although some of the key drivers seem to be in place for the uptrend to resume, from plenty of stimulus to expectations of higher inflation, investors have collected losses year-to-date. The economic relief package announced by president-elect Biden on Thursday is not the kind of aid safe-haven assets need right now. Optimism about future market gains continues as governments keep on supporting the economy and help market participants look through the pandemic. With rising inflation expectations driven by a more constructive outlook, bond yields have been rising steadily in the last few months, breaching the 1% threshold on the 10-year tenor in the United States. Gold, offering no yield, has started to underperform and ETFs ended 2020 with two months of outflows in spite of the record year in terms of performance. Confronted with stronger growth and equity valuations still appealing versus bonds and cash, investors have poured money in stocks, shunning more defensive opportunities.

This state of affairs is unlikely to change anytime soon. The problem is that US nominal rates are likely to push higher alongside real rates, as it has been the case so far this year. Money should continue to avoid safe havens, at least until real yields have reached levels more in line with the bullish scenario on the economy currently discounted by markets. The advice to long-only investors is to buy on weakness, in order to accumulate gold preferably below $1,800/oz. At the same time, we are comfortable with our gold overweight position, based on its modest correlation to other assets, lowering overall portfolio volatility and diversifying exposure away from equities an credit.

US dollar bears must have been equally disappointed by gains of 0.9% against DM peers year-to-date. Investors started 2021 positioned very much dollar bearish, given its overvaluation, headwinds from low policy rates, growing federal indebtedness and the expectation that Biden’s fiscal package would further debase the currency via more money printing. While Powell’s recent speech about the tapering of asset purchases being out of the question was reassuring in terms of downward pressure on the dollar, Biden’s large fiscal package could have unexpected consequences. If it proves to be too much of a good thing for the US outlook talk of US exceptionalism, though borrowed from the future, could resurface. Accelerating economic growth well above the global average would make US assets still appealing, including the dollar, especially if Biden’s tax hikes prove to be token with significant fiscal aid to families driving pent-up demand. Although we hold the view that US exceptionalism is still a tail risk for US assets, this year further dollar weakness is likely to come with more bumps along the road than initially assumed.

Biden’s package, while much awaited by Americans in need, for now is not much of a boon for gold bulls and dollar bears.

Fixed Income Update

Reflationary trades are all the rage in the market now with the proposed $1.9 Tn fiscal stimulus news. As we mentioned earlier, we see an upside risk to our Year-End target of the 10-year US Treasury yield. The question is, how well the markets would digest this increase in yields. Our view is that Investment Grade returns this year would be dominated by yield curve movement since there is little to no headroom in credit spreads. However, the situation might be different for Emerging Market and High Yield, where there is some cushion to mitigate increasing yields. For example, the 10-year treasury yield has risen by more than 35 bps since early November. The Investment Grade and High Yield spreads have tightened by 30 and 75 bps at the same time. The Emerging Market spreads have shrunk by 60 bps during that period. This negative correlation, albeit at a lower beta, should continue to be the central theme this year.

The credit indices moved mostly sideways last week without any significant direction. Simultaneously, investor appetite for the longest dated debt instruments has come down significantly. According to Bloomberg, Longer-dated investment-grade bonds have weakened more than the broader market on a total return basis since the end of November, with bonds maturing in 10 years or more down 2.1%. Bonds maturing 30 years and out have accounted for just 6% of volume in 2021, down nearly 12 percentage points from the same period last year in the Investment Grade US credit space. Most of the new issues are between 5-7 year maturities. This trend should reverberate across other sectors of credit as well.

2021 YTD defaults reached four after a total of 226 defaults last year. The trailing 12-month default rate is 5.5%. The US has the highest default rate of 6.6% while Emerging Markets have the lowest default rate of 3.5%.

Weekly Fund flows had a pro-risk tilt within Fixed Income. The asset class received a total of $13.6 Bn. Investors sold Government bond focused funds and put money into Agg type funds and credit-focused funds. Short duration funds generated more investor interest as compared to long-duration ones. Flows into Emerging Market were steady with a decisive tilt towards local currency funds, which garnered two-thirds of the net inflows.

GCC market primary issuance is slowly gaining pace. After Emirates NBD and FAB pricing 5-year senior securities in the first week of January, Oman followed suit last week with a blockbuster three tranche offering. The total order book size was c.$15 Bn resulting in 5x coverage. Books were skewed towards the 10-year bond as the yield curve flattens significantly post that. KSA’s largest bank, the National Commercial Bank, has announced a mandate for the first-ever USD Tier 1 issuance from the Kingdom. It should generate significant investor demand, and we expect this issue to set a new GCC record for the lowest ever Tier 1 coupon priced by a bank.

Equity Update

Weak US retail sales countered by another large stimulus package on its way, upbeat financial earnings with cautionary guidance and rising global COVID cases: were the mix influencing last week’s market movements. Global equities lost slightly over a percent with DM equities down as the main US indices lost 1.5% on the week and European equities close to a percent. Japan was a gainer, though lockdowns there are accelerating. Global sector performance had energy continue its rally with tech and consumer, last year’s winners down on the week, a mirror image of 2020 performance. EM equities ended slightly up with China, Hong Kong and Indian markets leading gains.

The UAE continued its strong performance with the Dubai Index now up over 8% year to date. The UAE economy is showing signs of a recovery with PMI in expansionary territory at over 50 in December, Dubai hotel occupancy rates have recovered to above 70% of pre-covid levels as of November data, December preliminary occupancy rate was only down 10% year/ year. Tourist arrivals are up and the real estate market is seeing interest from expats wishing to buy homes to live in, rather than for speculation or yield with the new investment norms and visa rules. However, the UAE is still seen as one of the top destinations for rental yield which ranges from 4 to 6%, depending on the location. The recent curtailment on new property launches is favourable for investor sentiment as are the low mortgage rates. For the near term we prefer the banking sector as dividend payouts should remain strong and rising yields are favourable.

The current focus for markets is the start of earnings season in the US. Blackrock the world’s largest asset manager grew assets to $ 8.7 trillion with revenue up 13% and net income up 20% with strong inflows into equities and fixed income funds and ETFs. Guidance was for this to continue into 2021. US banks beat earning expectations with JP Morgan once again on top with a 42% rise in 4Q earnings. The bank released $3 bn in provisions which had been set aside during the Pandemic. However, guidance from their CEO Jamie Dimon whilst mostly upbeat had a few caveats including “significant near term uncertainty” causing a few ripples in investor sentiment. Citi and Wells Fargo Q4 earnings too were above estimates but not as strong as JP Morgans. All 3 banks spoke of the positive effect of the vaccines and stimulus on the economy but are looking more to H2 for a recovery.

The stalling of the tech rally and rotation into cyclicals will see its next phase and direction depending on guidance in Dec 20 (Q4 for most) earning updates. S&P 500 tech companies have strong net income margins at above 20% and are one of the few sectors with positive earnings growth in 2020 at c.5% and estimated at 14.5% for 2021. This is lower than the S&P 500 where estimates for earning growth are at 20 to 22% for 2021, but that is skewed by energy coming off negative earnings. Hence a close to 15% earning growth for tech from a positive base is quite commendable. The other sector with consistent 2020/ 2021 earnings growth is healthcare, where we are seeing exceptional investment from governments and the private sector.

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