The beginning of the beginning

Chief Investment Officer's team
14 March 2021
The beginning of the beginning
President Biden’s stimulus plan got final approval with individual payments already on their way


  • President Biden’s stimulus plan got final approval with individual payments already on their way
  • Better virus control and already resilient economies should see stellar quarters ahead
  • Risk assets rallied in the wake of benign inflation numbers

Last week, President Biden’s $1.9 trillion stimulus plan was approved, and individual payments of $1400 immediately started being sent to eligible individuals in the largest “helicopter money” experiment in history. There may be more to come, as discussions have started on a second plan, targeting US infrastructure, with proposals ranging from $2trn to $4trn.

Against such a backdrop, interest rates kept on pushing higher, but their rise was overall reasonable as the CPI release came below expectations for February, drawing an ideal picture alongside strong PMIs. While the Fed sticks to its “patient” stance, the ECB came with a “dovish” surprise as the institution committed to increasing bond purchases to contain the rise in yields. No surprise then that US stocks printed a new all-time high, and that rotation towards the most cyclical segments accelerated: the top 5 sectors of 2021 so far include energy, financials, materials and industrials. Staying within stocks, the GCC has now taken the top spot in the Emerging Regions, up 10% YTD. Developed markets however caught up with their developing peers last week: a stronger US dollar and a recovery in its early stages in the West provides an additional boost in the short-term.

We still hold the view that inflationary pressures will be material but temporary, and that investors are better off in cyclical assets such as stocks and real estate. It is however important to keep in mind that markets are prone to overshooting and that a higher volatility regime may create opportunities across asset classes. We could shortly see irresistible levels to come back on to Treasuries or Gold, and we won’t hesitate to put cash to work, should inflation fears become outsized. Stay safe.

Cross-asset Update

Hardly is the ink dry on the latest US pandemic-relief bill, carrying the impressive tag of $1.9tn, that Joe Biden’s focus is shifting to an infrastructure plan worth between $2 and 4tn, an even more astounding magnitude given that it would see the economy, already recovering much faster than expected, overheat. Commodities and equities would be the greatest beneficiaries of this initiative being most exposed to the reflationary pressures exerted by more public spending. The former are by definition the inputs necessary to make the plan operational, which would further underpin cyclical stocks and translate into stronger earnings growth supporting equities and trumping concerns about higher rates. Bond investors would once more be left with the short end of the stick, as Treasuries still embed little inflation risk at current prices in spite of the recent rise in yields. Although Washington’s initiative is quite extraordinary, real commodity prices and commodity-related stock valuations still show little-to-no premium versus historical averages, as one would expect once markets fully price in the benefits of infrastructure works.

When reworking the Strategic Asset Allocation Templates late last year, we kept in mind the reflationary goals pursued both by central banks, in particular the Federal Reserve, and governments, hence produced strategic portfolios with a more cyclical bias, partially preempting the trends which are starting to unfold today. We increased the share of EM assets, more exposed to the global cycle and correlated with higher price pressures, to reduce higher-quality bonds, no longer offering value following repeated Quantitative Easing programs. We also added to DM HY bonds, in order to make the portfolios less sensitive to the duration risks clouding the horizon of fixed income investors. At the same time, we maintained a capital-preservation constraint limiting downside potential during challenging times. Hence, the clients trusting our judgement would be allocating capital to a mix of assets built on a blend of foresight and prudence, which would most likely help grow capital to an extent, while avoiding harsh drawdowns.

Our tactical positioning, mainly biased towards equity and credit, matched by an underweight in global Treasuries and absolute-return funds, is based on our conviction that the shorter term outlook remains bright and is actually a reflection of a longer reflationary wave. Investors should also be aware that the preference of the authorities for more inflation comes with new risks. Yields are set to rise further, as the gap between their current level, historically very low, and the projections of future economic growth is the largest since 1966 in the United States. On a longer time frame, the strong growth impulse, entirely engineered with public interventions, is nowhere near to being self-sustained. One may wonder what will happen when Mr. Powell dares to communicate that the Fed intends to start the tapering of asset purchases in order to reduce financial stability risks.

Our new SAA, built with new risks in mind, should help mitigate them.

Fixed Income Update

After weeks of dithering, the 10-year US Treasury yield finally closed above 1.6% as of last Friday, driven by the strong US job report and consumer sentiment release, the ramp-up in vaccine roll-outs and the approval of stimulus measures. All the eyes are now on Wednesday's FOMC meeting. We do not anticipate any additional steps to be announced as different Fed officials have maintained a clear line that the rise in yields is a signal of confidence in the economy. The Q&A session would be most important as Chairman Powell addresses investor concerns.

The ECB meeting last week was very dovish. The Governing Council pledged to buy sovereign bonds at a higher pace, though officials indicated that the overall emergency stimulus program size of €1.85 Trillion would not increase. Policymakers agreed that there had been some tightening of financial conditions due to higher yields in recent weeks. JP Morgan estimates that the central bank may increase buying to €80 Bn from the current €60 Bn. The gap between US Treasuries and German Bunds reached its highest point in a year, which could act as a feedback loop to decrease that spread.

With a total return of -4%, the USD IG market is off to its worst start on record. Meanwhile, the primary issuance market remains red-hot. Verizon sold $25bn worth of bonds in a deal that is touted as the largest YTD and the sixth-largest on record on Thursday. The order-books for the jumbo deal peaked at $109bn, which would increase issuer confidence in this crucial sub-sector, still with YTD negative returns. Simultaneously, the US High Yield issuance has crossed $25bn in March and is only $11bn short of printing a record. These massive numbers indicate that rising yields have not affected the funding markets largely, with the occasional deal getting canceled.

Fixed Income weekly Fund flows turned negative for the first time since November 2020, with both IG and HY developed-market and EM-hard-currency bonds affected. Short-duration bond funds also lost a staggering $9bn. The majority of these outflows are ETF-related and are nowhere close to the 2013 taper tantrum levels. Most analysts expect flows to become positive as soon as the bulk of the $21bn sidelined cash is put to work.

GCC markets returned +0.2% last week, with the Oman curve outperforming the rest of the sovereigns. Long-duration bonds had a better week than the short-duration ones. Bank Muscat, the largest bank of Oman by market share, issued 5-year senior notes with 3x order books coverage. The final pricing of 4.75% was wider by c.50 bps to Oman 26s, and the bonds were trading at a premium in the secondary market according to the latest trader runs.

Equity Update

Markets were higher for the week, and year to date global equities are up c.5%, a nice progressive number, not too euphoric or causing pain. Emerging and developed market equities are now at the same level with EM affected by the higher Dollar and China equities losing some of their steam, largely on the backlash of China regulation on big ecommerce, social media and digital payment tech monopolies. US markets are pricing in the impact of President Biden signing a fresh $1.9tn fiscal relief package and expectations for a large infrastructure bill. $1400 stimulus checks flowing into consumer activity, which has already seen growth this year and the savings rate already at 20.5% implies further inflows into equities. The S&P 500 rose 2.6% last week, is at a new high and at 5.3% year to date is slightly outperforming global equities and the Eurozone at 3%. The Nasdaq gained 3.1% last week but tech is under performing and the cyclical rotation has continued into March with energy, financials and industrials leading sector returns. It was another volatile week, but a positive one, as the shift continued from growth to value stocks and those that stand to benefit as the economy progresses to a post-pandemic environment. This is amid the recent spike in bond yields and quick COVID-19 vaccine rollouts. Much debate on the proposed vaccine passport with Qantas for it and as Singapore Airlines initiates IATA’s travel pass mobile app for digital health verification on some flights.

In the UAE, focus remains on increasing tourist activity and supporting expat inflows with the new 20-year plan for Dubai with more beaches as well as nature reserves. The target is to increase population by 76%. The week saw telecom stocks rally and a small uptick in real estate. The Dubai Index is in line with global equity performance, the Abu Dhabi Index is up 14% YTD. KSA equities are in line with oil gains up 10% YTD.

Widespread immunization, accommodative Central bank policy and savings will support the global economic recovery, although new COVID-19 strains remain a concern. However, this is a double edged sword and the massive fiscal support and excess savings risk overheating the economy, however we are still some way away from inflation targets for the Fed and ECB. The next Fed meeting will provide important direction. Stronger corporate earnings remain the dominant catalyst for equity performance at least for now.

Rising yields are behind the recent weakness in technology shares, as the 10-year yield is often used as the risk-free rate in the discount rate in formulas to calculate the future value of stocks, and many technology companies are expected to make a greater proportion of their profits in later years: the high growth expectation. Higher yields, though aid banks by making lending more profitable and reflect expectations for faster economic growth, from the boost in business activity. With the 10-year yield already at 1.6% we are moving our technology overweight to neutral and moving industrials up from neutral to overweight. We have been overweight financials for some time and see continued out performance from them. On the energy front we are neutral, though oil is hovering near $70. We would add to ESG themes, as that remains a focus for the govt. and private sector.

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