Turbulence ahead, risk-taking more selective

Chief Investment Officer's team
11 July 2021
Turbulence ahead risktaking more selective
H1-2021 ended well, but H2 starts with volatility and dispersion

AT A GLANCE

  • H1-2021 ended well, but H2 starts with volatility and dispersion
  • This should continue, fueled by uncertainties on the virus, growth, inflation and policy responses
  • We remain constructive but have made some tactical adjustments

The first half of the year was one of the best on record for risk assets, especially for stocks and listed real estate from developed markets. Let’s be clear: the easiest part of the year may already be behind us.

At this level of valuations, markets will be sensitive to a trio of key questions. Will the current rise in infections derail growth? Will the current spike in inflation persist? And how will policy support evolve?

We do not have definite answers, but a scenario. On the virus front, we consider that hospitalizations matter much more for the economy than headline infections, and to that extent, we find comfort in data from the most vaccinated areas: the vaccines seem to work perfectly well in avoiding the most severe cases. With regards to inflation, we keep on believing the spikes are transitory, but acknowledge that it may last longer than we initially thought. As a result, both growth and inflation support the idea that interest rates are too low. Finally, we do not expect an imminent and material change in policy support, especially on the monetary side. The US should talk about tapering, but not start it in the coming months. The ECB has just shifted to a more dovish inflation target, and no country in Europe can afford a higher cost for their sovereign debt. Finally, China just announced a 50 basis points cut in its RRR, to support to growth, credit and signal flexibility.

Against this backdrop, we have adjusted our tactical asset allocation. We have downgraded High Yield to Neutral (from Overweight), and reinvested half of the proceeds into EM Debt. The other half has been spread between cash, as we expect volatility ahead, and hedge funds, for the asymmetrical returns. We remain overweight equities, especially in DM. Stay safe.

Cross-asset Update

Emerging market performance has been uninspiring year to date, the MSCI EM Index is up a meagre 2% for the year, with China pursuing a more balanced growth model the main drag on the benchmark. Chinese equities as measured by the MSCI gauge are in negative territory by more than 5% and investors are wondering when they will start to see some light at the end of the tunnel. US equities may be expensive indeed, but continue to make new highs, while Chinese stocks go nowhere, pushing impatient momentum traders to keep on piling on expensive stuff. Our clients should not invest following these behavioral biases and we hold the view that they will be rewarded for patience.

Stock market weakness reflects Beijing deliberate policy decision to curb credit growth starting from late last year in order to avoid economic instability. The credit impulse, the ratio of total credit growth to GDP, peaked in November and has been falling ever since, driving a slowdown phase across the whole economy. The Chinese wariness of overstimulating activity sits in stark contrast with the absolute intention to ‘go big’ in America and this to an extent accounts for the difference in performance in favor of US equities. Also, in the past few months the Chinese authorities tightened regulations in a number of sectors, with interventions in data security, against monopolies and in favor of decarbonization. While in the long run these measures improve the structure of the economy, in the shorter term they may have had somewhat of a dampening effect and concerned investors. Indeed, the service PMI, a key measure of business confidence, fell significantly in June, but that should reflect temporary factors related to a virus outbreak and subsequent local restrictions, as well as to chip shortages.

Beijing is well aware of the state of the economy and the People Bank of China cut its Reserve Requirement Ratio by 0.5% in a bid to support activity via increased accommodation. The most likely source of demand remains government-led investments - exports have already peaked this year with the shift in the foreign economies to service-driven recoveries not helping Chinese manufacturers and households consumption at times hampered by local lockdowns improving slowly. This combination of factors should urge the government to increase investments in the second half, so extrapolating current economic and market weakness would not be appropriate in our view. Also, sequential growth in the US is expected to moderate significantly starting from Q4, so comparables for China should start to improve.

With Chinese policy more market-friendly by late H2 investors should be taking notice.



Fixed Income Update

What a fascinating couple of weeks this have been! The US Treasury curve has bull-flattened significantly with the 10-year dipping below 1.25% and 30-year printing 1.85% intraday last Thursday, raising questions as to whether the reflation trade is about to end. Treasury yields have come up from their lows to end 11-15 bps higher at the close of the week. The core CPI-adjusted US 10-year real yield ended the week at a four-decade low -2.20%. The Fed’s hawkish turn and recent mixed macro data are behind the rally, but fundamentals cannot entirely explain the phenomenon. Though the growth trends in the US have peaked, they are expected to remain extremely strong throughout 2022, and the Fed will not even think about tightening if unemployment rates stay stubbornly above 4%. Moreover, the recently released FOMC meeting minutes confirmed that the Fed is less hawkish than what the Dot Plots had portrayed. We have revised our year-end 10-year Treasury yield estimates to 1.75%. Hence, we remain short duration and advise clients to take duration exposure in tranches when the 10-year nominal yields move upwards of 1.45% at the least.

The market tends to become nervous whenever there are sharp drops in the US Treasury yields. The last couple of weeks were not exceptions. Spreads widened by 5-10 bps across sub-asset classes. The bullish rally in yields, however, mitigated the effects. All the asset classes were in the green except Asian High Yield that returned -0.5% last week. The asset class has given up two-thirds of its YTD returns, highlighting the perils of chasing yields and being concentrated in a single asset class. The upcoming summer times could lead to higher volatility. Clients should be reasonable with risk cutting excess leverage and allocating a portion of the portfolio to safe-haven asset classes.

In our latest TAA meeting held last week, we booked profit in our overweight to High Yield asset class. Even though the asset class fundamentals remain strong, valuations are expensive. High-Yield spreads have compressed by 65 bps which has helped the segment to be the best performer in Fixed Income and mitigate the effect of rising yields. There might be another 5-10 bps of spread compression left on the table, but it seems prudent to be neutral on the asset class. We increased our overweight in the Emerging Market Debt, which is the only segment to have current spreads near the historical medians. Though we must admit the long duration of the asset class poses a risk to our view. Fundamentally, the segment offers value. In addition, the only major hawkish central bank PBOC has cut its reserve ratio. This could signal a pitstop for the ongoing credit tightening and effort to spur growth. This move should be positive for the onshore China IG segment. We have been advising clients to have some portfolio allocation since it provides higher diversification benefits within emerging markets.



Equity Update

The first half of 2021 has seen global equities gain 12.3%, a number we had thought was a good return for the whole year. We analyse the various factors that drive equity returns to see what the rest of the year holds for equity performance. Developed markets have continued their outperformance into July with service sector activity picking up. In both the U.S. and Europe domestic leisure activities and travel is recovering – the last hurrah of recovery. In the US it is back to 80% of pre pandemic levels. The U.S. equity markets finished out a volatile week positively, increasing the weekly winning streak to three. Financials led returns, with Technology close behind as 10 year Treasuries yields seesawed, ending the week at 1.39%. This move fits in with our view to be agnostic to growth and value strategies as the strategy shift is going to continue. European markets gained in tandem with the U.S. and have mirrored US returns this year. The positive performance of DM equities came despite the potential impact of the spreading Delta coronavirus variant in the world, as hospitalizations are fewer. The technology sector shrugged off President Biden's executive order aimed at cracking down on anticompetitive practices among U.S. businesses. Asian markets however had a negative week, with China equities down 4.3% as further crackdown on China companies specially those listing in the US led to a broader market sell off.

Our positioning going into the second half of 2021 is to remain overweight equities as monetary policy is still favourable and low interest rates are there for some time, strong inflows into equities continue with excess savings created by the huge fiscal stimulus and most importantly earnings growth of 30 to 50% across EM to DM economies mitigates valuation worries. We think the trajectory is still positive but definitely more volatile as seen last week. Our higher conviction on developed markets continues as they have a growth premium on both economic and earnings growth over emerging markets. Earning season kicks off next week in the US and expectations are for S&P 500 companies to grow EPS y/y by 62%, following Q1 where earnings grew by 52% y/y/. Within DM however, our tactical call is Europe on more attractive valuations and EPS growth expectations at 45% for 2021 compared to 37% for the US. European companies are a good way to position cyclically as they have a larger beta to the global recovery as 60% of revenue comes from overseas.

We think emerging markets performance awaits another quarter to pick up, as the economic recovery should follow the West. More significantly affecting China equities are regulatory issues and a US economic blacklist of 34 China entities adding to strained US-China relations. We have shifted our overweight Asia positioning to EMEA which should perform in synch with European equities. We continue our tactical overweight on the UAE. Oil prices are supportive of government revenue, trading volumes are improving, policies to encourage white collar expats is working as seen in the real estate end user volume growth. The Dubai real estate sector performance has lagged the broader market and this gap should narrow once the Dubai developers reinstate dividends. With improving cash flows this looks imminently possible.



Written by:

IMPORTANT INFORMATION

This document is prepared by Emirates NBD Bank (P.J.S.C) (“the Bank” or “Emirates NBD”), licensed and regulated by the Central Bank of the UAE (“Central Bank”) and the Securities and Commodities Authority of the UAE (“SCA”) and subject to regulation, supervision and control of the Central Bank and SCA, having its head office at Baniyas Road, Deira, PO Box 777, Dubai, United Arab Emirates. This document may be distributed and/or made available by the Bank and its affiliates and subsidiaries, including Emirates NBD Capital KSA CJSC (“ENBD Capital”) (through its website, its branches or through any other modes, whether electronically or otherwise).

Emirates NBD and its affiliates, subsidiaries and group entities, including its shareholders, directors, officers, employees and agents are collectively referred to Emirates NBD Group.

Any person (hereinafter referred to as “you”, “your”) who has received this document or have access to this document shall acknowledge and agree to the following terms.

Reliance

Data/information provided in this document are intended solely for information or illustrative purposes and are not designed to initiate or conclude any transaction.

This publication may include data/information taken from stock exchanges or other third-party sources from around the world, which Emirates NBD reasonably believes to be reliable, fair and not misleading, but which have not been independently verified. The provision of certain data/information in this publication may be subject to the terms and conditions of other agreements to which Emirates NBD is a party. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. Emirates NBD or any member of Emirates NBD Group makes no representation or warranty and accepts no responsibility or liability for the sequence, accuracy, completeness or timeliness of the information or opinions contained in this publication. Nothing contained in this publication shall be construed as an assurance by Emirates NBD that you may rely upon or act on any information or data provided herein, without further independent verification of the same by you.

The contents of this document are prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors, including those relevant to the determination of whether a particular investment activity is advisable. Emirates NBD does not undertake any obligation to issue any further publications or update the contents of this document. Emirates NBD may also, at its sole discretion, update or change the contents herein without notice. Emirates NBD or any member of Emirates NBD Group does not accepts no responsibility whatsoever for any loss or damage caused by any act or omission by you as a result of the information contained in this publication (including by negligence).

References to any financial instrument or investment product in this document are not intended to imply that an actual trading market exists for such instrument or product. Certain investment products mentioned in this document may not be eligible for sale in some jurisdictions, and they maynot be suitable for all types of investors. The information and opinions contained in this publication is provided for informational purposes only and have not been prepared with any regard to the objectives, financial situation and particular needs of any specific person, wherever situated. If you wish to rely on or use the information contained in this publication, you should carefully consider whether any investment views and investment products mentioned herein are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You should also independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professional advisers or experts.

Confidentiality

This publication may be provided to you upon request (and not for distribution to the general public), on a confidential basis for informational purposes only, and is not intended for trading purposes or to be passed on or disclosed to any other person and/or to any jurisdiction that would render the distribution illegal.

Solicitation

None of the content in this publication constitutes a solicitation, offer, recommendation or opinion by Emirates NBD to buy, sell or trade in any security or to avail of any service in any jurisdiction. This document is not intended to serve as authoritative legal, tax, accounting, or investment advice regarding any security or investment, including the profitability or suitability thereof and further does not provide any fiduciary or financial advice. This document should also not be used in substitution for the exercise of the prospective investor’s judgment.

Third Party

This publication is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. It is the responsibility of any person in possession of this publication to investigate and observe all applicable laws and regulations of the relevant jurisdiction. This publication may not be conveyed to or used by a third party without the express consent of Emirates NBD or its affiliates, subsidiaries or group entities distributing this document. You should not use the data in this publication in any way to improve the quality of any data sold or contributed by you to any third party.

Liability

Notwithstanding anything to the contrary set forth herein, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from this publication including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. Under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of this publication, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business.

This publication does not provide individually tailored investment advice and is prepared without regard to the individual financial circumstances and objectives of person who receive it. The appropriateness of an investment activity or strategy will depend on the person’s individual circumstances and objectives and these activities may not be suitable for all persons. In addition, before entering into any transaction, prospective investors should: (i) ensure that they fully understand the potential risks and rewards of that transaction; (ii) determine independently whether that transaction is appropriate given an investor’s investment objectives, experience, financial and operational resources, and other relevant circumstances; (iii) understand that any rates of tax and zakat or any relief in relation thereto, as may be referred to in this publication may be subject to change over time; (iv) consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment; (v) understand the nature of the investment and the related contract (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk; and (vi) understand any regulatory requirements and restrictions applicable to the prospective investor

Forward Looking

Past performance is not necessarily a guide to future performance and should not be seen as an indication of future performance of any investment activity. The information contained in this publication does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Risk

Data included in this publication may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records. The use of this publication is at the sole risk of the investor and this publication, and anything contained herein, is provided "as is" and "as available." Emirates NBD makes no warranty of any kind, express or implied, as to this publication, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Investment in financial instruments involves risks and returns may vary. The value of investment products mentioned in this document may neither be capital protected nor guaranteed and the value of the investment product and the income derived therefrom can fall as well as rise and an investormay lose the principal amount invested. Investment products are subject to several risks factors, including without limitation, market risk, high volatility, credit and default risk, illiquidity, currency risk and interest rate risk. It should be noted that the value, price or income of securities denominated in a foreign currency may be adversely affected by changes in the currency rates. It may be difficult for the investor to sell or realise the security and to obtain reliable information about its value or the extent of the risks to which it is exposed. Furthermore, the investor will not have the right to cancel a subscription for securities once such subscription has been made. Prospective investors are hereby informed that the applicable regulations in certain jurisdictions may place certain restrictions on secondary market activities with respect to securities.

Before making an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment. In receiving this publication, the investor acknowledges it is fully aware that there are risks associated with investment activities. Moreover, the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described in this publication and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with the investor.

Intellectual property

This publication has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and such others. All present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall, as between the investor and Emirates NBD, at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties.

Except as specifically permitted in writing, you should not copy or make any use of the content of this publication or any portion thereof or publish, circulate, reproduce, distribute or offer this publication for sale in whole or in part to any other person over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet or construct a database of any kind. Except as specifically permitted in writing, you shall not use the intellectual property rights connected with this publication, or the names of any individual participant in, or contributor to, the content of this publication, or any variations or derivatives thereof, for any purpose. This publication is intended solely for non-commercial use and benefit, and not for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. By accepting this publication, you agree not to use, transfer, distribute, copy, reproduce, publish, display, modify, create, or dispose of any information contained in this publication in any manner that could compete with the business interests of Emirates NBD. Furthermore, you should not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you, except as otherwise provided with Emirates NBD’s prior written consent. You shall have no ownership rights in and to any of such items.

IMPORTANT INFORMATION ABOUT UNITED KINGDOM

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the London branch of Emirates NBD Bank (P.J.S.C) which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority in the UK. Some investments and services are not available to clients of the London Branch. Any services provided by Emirates NBD Bank (P.J.S.C) outside the UK will not be regulated by the FCA and you will not receive all the protections afforded to retail customers under the FCA regime, such as the Financial Ombudsman Service and the Financial Services Compensation Scheme. Changes in foreign exchange rates may affect any of the returns or income set out within this publication.

IMPORTANT INFORMATION ABOUT SINGAPORE

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the Singapore branch of Emirates NBD Bank (P.J.S.C) which is licensed by the Monetary Authority of Singapore (MAS) and subject to applicable laws (including the Financial Advisers Act (FAA) and the Securities and Futures Act (SFA). Any services provided by Emirates NBD Bank (P.J.S.C) outside Singapore will not be regulated by the MAS or subject to the provisions of the FAA and/or SFA, and you will not receive all the protections afforded to retail customers under the FAA and/or SFA. Changes in foreign exchange rates may affect any of the returns or income set out within this publication. Please contact your Relationship Manager for further details or for clarification of the contents, where appropriate. For contact information, please visit www.emiratesnbd.com.

IMPORTANT INFORMATION ABOUT EMIRATES NBD CAPITAL KSA CJSC

Emirates NBD Capital KSA CJSC (“ENBD Capital”), whose registered office is at P.O. Box 341777, Riyadh 11333, Kingdom of Saudi Arabia, is a Saudi closed joint stock company licensed by the Saudi Arabian Capital Market Authority (“CMA”) under License number 37-07086 dated 29/08/2007G (corresponding to 16/08/1428H) to deliver a full range of quality investment products and related support services to individuals and institutions in the Kingdom of Saudi Arabia. ENBD Capital is subject to Capital Market Law, and Implementing Regulations in the Kingdom of Saudi Arabia

ENBD Capital’s contact details are T +966 (11) 299 3900 and F +966 (11) 299 3955.

This document may not be distributed in the Kingdom of Saudi Arabia except to such persons as are permitted under the Investment Funds Regulations issued by the Capital Market Authority.

The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. Prospective subscribers of the securities offered hereby should conduct their own due diligence on the accuracy of the information relating to the securities offered. If you do not understand the contents of this document, you should consult an authorised financial adviser.