The rapid rebound from the Covid-19-driven market meltdown last March has convinced many investors that what we endured was a bull market stumble — not a bear market rally.
Even the U.S. economy’s worst performance since the Depression, record national debt, rising bankruptcies, soaring Covid-19 deaths, and insurrectionists storming the Capitol, haven’t been able to stop this bull.
In addition to markets setting record highs, signs of speculative excess are all over: the GameStop saga, huge gains in cryptocurrencies, the surge in day-trading, and penny stock and SPAC booms.
All this raises the question: are investors being sufficiently objective or letting excess exuberance get the best of them?
Steven Fleming, a principal and U.S. leader of PwC’s Business Recovery Services practice, argues that in spite of ongoing federal stimuli, the financial distress that lies ahead will be even greater than last year. “Companies that bolstered liquidity through capital raises,” explains Fleming, “now must manage higher debt service and more levered balance sheets in the face of continued operation uncertainty and a challenging earnings and cash flow environment. And he cautions these underlying challenges haven’t yet had time “to trickle through the economy.”
It is precisely this kind of uncertainty that worries Marc Sbeghen, a former portfolio manager at the venerable Banque Privée Edmond de Rothschild and cofounder of Swiss-based Iteram Capital, who believes investors need a Plan B. He further warns, “We simply don’t know the depth in which vaccination will penetrate societies nor the impact variant strains of Covid-19 might have on vaccine efficacy and future government policy.”
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For additional perspective, RIA Intel looked beyond U.S. borders to see what European-based global allocators make of the U.S and various foreign markets, and where they see compelling opportunity.
Admittedly, continental bias exists. European sentiment has been shaped by GDP contraction that was significantly worse than what the U.S. experienced in 2020. The European fiscal response to the crisis has been far less aggressive than the federal government’s (though they maintain a more robust safety net for its citizens). The continent is not home to any of the global tech leaders that have primed U.S. equity returns and may continue doing so over the near term. And nominal interest rates have been negative across virtually the entire yield curve. One can actually finance a home purchase in Denmark with a 20-year mortgage at a fixed rate of 0%.
The takeaway from various European allocators is clear. They cautiously see opportunity in developed markets supported by strong monetary and fiscal intervention, with a tilt toward value stocks if the recovery accelerates. They seem to have even more enthusiasm for Asian emerging markets as part of the global recovery play. They believe U.S. investors can benefit from foreign exposure because many anticipate the continued weakening of the greenback, which would enhance dollar-based returns.
But they also see plenty of risk globally because there’s never been such a schism between rising markets and stumbling economies, which will likely suffer from increasing business failures and the long reach of the pandemic. This holds especially true in the U.S.
Many European allocators are concerned U.S. markets are heading down an Olympic ski jump propelled by unprecedented levels of government-sourced liquidity and strong faith that the ramp up of Covid-19 vaccinations will make for a clean take off.
They also fear that investors may be ignoring or downplaying the debris the pandemic is leaving in its wake and as well as the uncertainty related to the vaccine’s rollout, its effectiveness, and extent to which people trust it.
The big question is whether the U.S. will stick the landing, come down with a minor wobble or wipe out like the skier in the opening of ABC’s Wide World of Sports.
One thing is probable — volatility will increase, likely tracing the parabolic paths of the ski jumper.
That kind of rosy outlook — underpinned by an assumed return toward normalcy — largely echoes investor expectations being reported for 2021. After such a trying year, one can’t blame folks for wanting to see a bright side.
One concern with this sentiment, however, is the market seems downright sanguine, having netted more than 18% in 2020. That would be a terrific year under normal conditions reflecting a booming economy, which is far from where we are.
Driving these gains was a flood of liquidity unleashed by unprecedented levels of government, fiscal, and central bank stimulus, paltry bond yields across the yield curve, and passage of President Biden’s additional $1.9 trillion relief package.
However, something is already happening to these benign expectations. And the canary in the coal mine may be seen across the Atlantic in Germany.
The link between the German and U.S. economy may be more on the nose than most would expect. Germany is the economic engine that drives Europe — a major financial, manufacturing, service, and population center. It’s the U.S. in concentrate.
In 2020, after suffering its worst recession since World War II, Germany ended the year contracting less than anticipated with GDP having fallen -5% — significantly better than the European Union’s contraction of -7.6%.
But at the end of January, the German government slashed its 2021 growth forecast from +4.4% to +3%, driven in part by the second lockdown the country imposed late last year and is expected to keep in place at least through most of the first quarter of 2021. This has sent business confidence tumbling to a six-month low.
Sbeghen’s Iteram Capital is a $400 million Geneva-based alternative investment specialist created by former investment executives of Banque Privée Edmond de Rothschild. Iteram’s flagship absolute return vehicle gained 9.5% net in 2020 and has generated net annualized returns of 5.6% over its first five years in business. He too expects double-digit market gains in 2021 — neutrally weighting U.S. exposure, underweighting Europe, and being more optimistic about Asian emerging markets.
Sbeghen thinks commodities should benefit from a nascent recovery, especially industrial metals such as copper (used in electrical cables), nickel (batteries), and tin (battery anodes). Countries supplying these metals, including Australia and Chile, should benefit.
With health-care providing essential services and products for aging Baby Boomers, Sbeghen thinks this sector should remain a core holding. Innovation is also driving genetics and bio-informatics — key computational support in discovering effective drugs and vaccines — including against Covid-19.
He cautions investors about the lack of substantial agency rerating of sovereign and corporate debt. “It’s as if these key guard rails are saying, ‘Hey, as long as countries and companies can access capital markets, nothing has really changed,’” posits Sbeghen.
But what concerns him most is investors seem largely to be “risk on” with little consideration that things may not play out as hoped.
“Most forecasts are based on a happy scenario where the vaccines are successfully rolled out and the threat of shutdowns are finally lifted off most economies,” explains Sbeghen. “We simply don’t know this,” he says.
Sbeghen thinks investors should be more cautious, having exposure to non-directional strategies like global macro and multi-strategy. He suggests holding more cash, being in more liquid investments to enable prompt selling, reducing leverage, reducing riskier investments, and holding long-dated government bonds, which have proven to be effective portfolio insurance. During the first eight months of 2020, 30-Year U.S. Treasurys returned 25%. Despite a second half rally, these bonds ended the year up 18%.
Tilo Wendorff, managing director of Absolute Returns at the $20 billion German Alternative Investment Manager Prime Capital, is also being more cautious and directionally more flexible. He plans to increase his Global Macro exposure from 14% to 25% and reduce his more aggressive equity market neutral and relative value exposure from 60% to 50%.
“We had a very good 2020, with net returns of more than 10%,” notes Wendorff, which was several percentage points higher than the firm’s annualized gains of 6.8% since its inception in 2007, driven primarily by independent alpha.
“But there are some very dark clouds around us,” Wendorff told RIA Intel, “including the likelihood of widespread bankruptcies that, if realized, will seriously disrupt future growth.”
Instead of seeing expensive stocks, markets setting record high after record high, negative interest rates, and intense credit compression that doesn’t differentiate risk, investors are acting willfully ignorant of what all this may mean, Wendorff asserts. “For us, global macro’s ability to quickly shift key trend exposure from long to short, makes it an insurance policy.”
While he’s cautiously optimistic for 2021, Berthelemy, too, is keenly aware of the bifurcation between economic and market performance, and the eventual impact that extensive bankruptcies and capital destruction may have.
“With U.S. corporate leverage now running at 84%,” Berthelemy said, “I think there’s clear risk in how long cheap rates can sustain many businesses and the eventual effects it may have on equities. The tools that global macro managers have at their disposal can enable them to react to sudden shifts in sentiment and outlook.”
While Berthelemy is optimistic about U.S. 2021 GDP growth hitting 5%, he thinks European shares might outperform because the continent was hit harder last year than the states. Eurozone GDP fell -7.6% whereas the U.S. contraction was less than half that. A key reason he likes Europe’s more traditional businesses: monetary and fiscal policy will reflate economies, which should benefit value shares more than growth stocks, whose torrid price appreciation he expects to slow this year.
Like Iteram’s Sbeghen, Berthelemy thinks Covid-19 may remain a material risk if vaccines can’t be sufficiently rolled out and prove effective on evolving strains. “This scenario,” he says, “would put pressure on risk assets, likely giving a boost to growth over value shares as cyclical sectors will continue to underperform.”
Berthelemy sees limited downside this year, believing central bank and government stimulus will prevent a sharp market sell-off if Covid remains virulent. A market retreat to June 2020 levels is his worst-case scenario. Such a drop would take the S&P 500 about 20% lower.
A more upbeat outlook comes from the $70 billion, Switzerland-based global alternative asset manager LGT Capital Partners.
The independent 22-year-old management firm, owned by the Princely Family of Liechtenstein, is maintaining a pro-growth posture in 2021. “We believe the unprecedented support and stimulus measures by central banks and governments will overcome the damaging effects wrought by the pandemic,” asserted Pascal Pernet, head of client solutions.
And with the Democrats having taken control of the U.S. government, he sees this “mandate adding even more fuel to the already highly expansionary fiscal and monetary policy regime. This will act as a reflationary force that supports the case for a lasting bull market.”
Relying on an extensive range of external managers, LGT CP is maintaining its significant equity exposure, along with high-quality private equity positions, insurance-linked strategies, and alternative risk premia (factor-based) investing to help generate diversified uncorrelated returns.
Sharing a similar sentiment expressed by other allocators, LGT CP is focused on the technology sector in the Far East, especially with firms that have strong balance sheets. In spite of the uncertainty about the West’s future trade relations with China post pandemic, LGT CP sees compelling opportunities being created from China’s recent regulatory changes. And the firm thinks Northern Asia will enjoy more robust economic growth primed by its relatively virus-free recovery.
A tactical shift LGT CP is making from its strategic allocation is based on reflationary global policies. It’s significantly reducing its weighting in investment-grade bonds. It’s also paring back its still bullish stance on gold, which is based on fears of monetary debasement.
Luxembourg-based global asset manager Candriam, a subsidiary of New York Life Investments with assets of more than $169 billion, shares LGT CP’s optimism. Its global head of multi-assets, Nadège Dufossé, is “confident fiscal and monetary policy accommodation will outlive the coronavirus and prolong the rebound.”
Candriam’s flagship Multi Asset Income Strategy, which has netted annualized returns over the past five years of 3.75%, climbed 12% in 2020.
In anticipating a material pickup in economic activity, Dufossé sees an opportunity in rotating into “economically-sensitive small- and mid-cap shares and value sectors, such as banks where she believes there’s ample room for re-rating. She cautions an expected steepening of the yield curve may be restrained by central banks buying longer-term bonds.
Like many, she shares continued optimism for emerging market equity and local currency bonds, especially if the projected weakening of the dollar continues.
Dufossé’s biggest takeaway from the pandemic is affirmation of human ingenuity to confront crises. “We are shifting to a more risk-on stance,” she explains, “because of governments’ and businesses’ capacity to solve problems and correct errors which sustains our hope going into 2021.”
She cautions “the key risk to our central scenario is the race between vaccination and the spreading of new virus variants, which could make vaccination less effective and delay recovery.”
The private bank, which has $339 billion in assets under management, recommends underweighting government and investment-grade bonds because of low yields and yield compression that has already squeezed out most capital gains. It’s most keen on Asian emerging market hard currency debt and equities because this region is particularly benefitting from the revival of global trade and earnings ahead of other markets.
While Deutsche Bank sees further upside for U.S. stocks, it questions the rapid macro recovery story, an issue it sees more pronounced in Europe, where the bank thinks pre-pandemic GDP growth levels won’t be achieved until the end of 2022. This in turn may hold back European equities, particularly if Europe is unable to use fiscal stimulus to increase economic activity.
Michael Petry, head of hedge funds at Danske Bank in Copenhagen, specializes in fixed income. He expects the yield curve will begin steepening this year, turning nominal rates from negative to positive, especially along the long end as European economies begin to recover from the pandemic. This suggests the end to both the government and corporate bond market rally.
With $3 billion in assets under management, Petry’s flagship product — Danske Bank Invest Hedge Fixed Income Strategies — has enjoyed a 10-year annualized rate of return of 12.3%. It rose 9.96% last year.
What particularly concerns Petry is the massive debt piling up in Europe and the U.S. and the subsequent cost of additional financing. “We might see central bank quantitative easing slowing in the second half of 2021,” Petry tells RIA Intel, “and this might collide with greater investor concerns about debt quality, which could collectively push yields higher.” These two events could shock the debt market, cycling prices lower and rates higher. Petry thinks the Mediterranean economies are most vulnerable to such a scenario.
The $153 billion Geneva-based wealth manager Union Bancaire Privée (UBP) published a cautious forecast for this year titled “A Brave New World.” With the government response to the pandemic shifting from monetary to fiscal stimulus, Group CIO and Co-CEO of Asset Management Michaël Lok thinks investors must focus on politics and risk management.
While UBP sees renewed growth fueling investment opportunities, stretched global equity valuations, especially in the U.S., haven’t been this high since before the tech bubble burst in 2000. “We don’t expect multiple reratings to be a significant driver of stocks this year,” Lok says. “The upcoming earnings recovery will be patchy,” he adds, “as some sectors may see permanent damage in the decade ahead from the new world that is taking shape.”
Further, compression of government and corporate bond yields reduces room for further capital appreciation. And a rising yield curve could trigger bond losses. Accordingly, UBP believes active thematic investing is key to achieving positive returns in equities and credit.
With that in mind, Lok emphasizes the need to hedge long-bias exposure with options and futures, structured products, and both credit and equity long-short strategies.
Lok expects U.S. investors may see a weakening dollar boost foreign investment returns. He believes the dollar bear market, which started last March, will continue through this year “due to a worsening U.S. current account deficit and domestic political forces.” He expects the greenback to depreciate against the euro, Swiss franc, the Chinese yuan, and the Japanese yen. However, he anticipates the dollar to hold against emerging market currencies.
Eric Uhlfelder has covered global capital markets for 25 years, wrote the first book on the advent of the euro post currency unification, and has earned a National Press Club award.
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