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December 2020

Barometer: Vaccine a shot in the arm for cyclical stocks

With a Covid-19 vaccine on the horizon, cyclical stocks could stage a recovery.


Asset allocation: vaccine a boost but not a cure-all

There is light at the end of the Covid tunnel.

Rapid progress in the development of a vaccine and the formal start of US President-elect Joe Biden’s transition to the White House have helped boost prospects for the global economy and corporate profits.

That said, investors should not get ahead of themselves. Economic activity, especially in developed economies, is expected to recover only gradually in the coming weeks; Covid cases are still surging in the US and the chance of a third wave of the pandemic in Europe cannot be ruled out.

Because of such risks, we are maintaining our neutral stance on equities and non-investment grade bonds.

Fig. 1 - Monthly asset allocation grid
asset allocation grid

Source: Pictet Asset Management

Our business cycle indicators show the global economy is on track for a strong recovery from the second quarter of 2021 onwards, thanks in large part to an improvement in conditions in the US and China.

The gap in the economic growth rates of emerging and developed nations is widening with developing world industrial production recovering to above pre-Covid levels (see Fig. 2). This differential could grow further if global trade continues to improve and the US dollar resumes its descent.

In the US, a buoyant housing market is leading the recovery, while surprisingly upbeat capital goods orders data point to a rebound in business investment. Corporations – and households – have amassed historically high levels of cash, which they are sure to deploy if their confidence grows.

Developments in Washington, where lawmakers are negotiating the size and scope of the next coronavirus relief programme, will also be crucial.

President-elect Biden’s selection of former US Federal Reserve chair Janet Yellen as Treasury Secretary could pave the way for aggressive fiscal stimulus. Yellen has consistently maintained that interest rates should remain low for longer – a stance that we believe is compatible with ample fiscal stimulus.

We expect that even a scaled-down version of Biden’s stimulus plan would be enough to lift real personal consumption growth to 6.5 per cent in 2021 from current estimates of 5.3 per cent.

Fig. 2 - Emerging leaders
EM vs DM industrial production (100 = 2019 Q4)
EM vs DM industrial production

Source: Pictet Asset Management, CEIC, Refinitiv. Data covering period 01.01.2018 - 01.09.2020.

Our liquidity analysis shows conditions are still positive for riskier assets, albeit less so compared with a few months ago. The volume of global monetary stimulus injected into the financial system as a proportion of GDP has fallen to 18 per cent from an August peak of 29 per cent, as central bank emergency money printing and state-guaranteed credit creation slow.1

Private lending is also stalling. In the euro zone, the European Central Bank’s third-quarter survey showed significant tightening in banks’ credit standards and that demand for corporate loans remained weak.

Valuation signals are flashing red for equities after a recent rally has taken major indices to record highs and pushed earnings multiples for global stocks to above 19, compared with a long-term average of 15.

We expect stocks’ earnings multiples to contract 15 per cent next year, in tandem with a decline in excess liquidity-- or the difference between the rate of increase in money supply and nominal GDP growth. Our analysis indicates an enduring relationship between the two. Still, the contraction in multiples should be offset by what we see as a 25 per cent rise in corporate earnings in 2021.

Bonds are expensive in the main. We believe that will remain the case as central bank policies cap yields; the market is pricing no interest rate hikes at all in the next four years for any of the world’s major economies.

Sentiment and technical readings are marginally positive for both equities and bonds. Equities may have seen a significant USD71 billion in investment flows in the past two weeks, but this comes after a long period in which flows have been lacklustre.


Equities regions and sectors: dialling up cyclicals

While the days in the northern hemisphere are getting ever darker, prospects for equity markets have brightened a little, with the viability of a vaccine now well established and with economists forecasting a synchronised global recovery. Some of that good news is clearly already priced in, and risks remain on both counts. Still, within equity markets, it is the sectors and regions most sensitive to the economic cycle that are likely to do well over the medium term and therefore deserve to take up an increased share of our portfolio.

Industrial stocks are a clear beneficiary – the sector’s fortunes are very closely linked with capital expenditure. Historically, capital spending increases in response to a rise corporate earnings, with a time-lag of some six months. As we expect corporate profits to rise by around 25 per cent in 2021, spending on plant and machinery should grow over the year. US capital expenditure plans – based on the 3-month average of the NIFB and Philadelphia Fed’s capex surveys – are at their highest level since early 2019 (see Fig. 3). We therefore upgrade industrials to overweight. 

Fig. 3 - Industrial spending
Relative performance of global industrial sector versus world equities,  compared to US capex intention surveys
Industrials and capex

Source: MSCI, Refinitiv Datastream, Pictet Asset Management. Data covering period 01.01.2006-26.11.2020.

Persistently strong Chinese economic growth should support the materials sector, while a likely surge in private consumption can be expected to boost consumer discretionary companies. We are overweight both sectors. 

We also see prospects improving for financial stocks, upgrading the sector to neutral. After underperforming the MSCI World index market by some 30 per cent since early 2018, financials is the only equity sector that still looks cheap relative to its 20-year history, according to our model.

Healthcare remains our preferred defensive sector. We are underweight utilities as their earnings growth potential is weak, and are neutral on consumer staples, which will be vulnerable to any further pickup in bond yields.

Our regional allocations also reflect a broad pro-cyclical stance. We retain a preference for Japanese and emerging markets stocks – markets that perform best when global growth accelerates.

Asian emerging market stocks look particularly promising. 

The new Regional Comprehensive Economic Partnership (RCEP) encompassing 15 Asian and Pacific countries underscores the region’s growing economic clout and the potential for a rise in trade and investment within the region.

We have become slightly more optimistic on UK equities, which are trading at relatively low earnings multiples. If a Brexit trade deal materialises, that could prove a big boost.

We are more cautious on the US, where current price-to-earnings ratios (above 22 times based on 12-month forward earnings, versus fair value of 19-20 times) can only be sustained if trend growth is unchanged, profit margins remain above average levels,  and the average bond yield stays at 1 per cent. Given that some long-term valuation metrics also look worryingly high, such as US stocks’ market capitalisation to GDP, we downgrade the US to underweight.


Fixed income and currencies: after the gold rush

After recent weakness the dollar is less overvalued than it was six months ago and should stay relatively stable over the short term (see Fig. 4). We have consequently reduced our position on gold to neutral. This shift is further reinforced by a slowing pace in central banks’ money printing and a  pick-up in global real yields, both of which represent headwinds for the precious metal.

We also continue to like emerging market bonds in local currency, based on the strength of emerging economies relative to their developed market counterparts as the world starts to recover from the Covid-19 crisis and on interest rate differentials between the two blocs. China’s bonds look particularly attractive given that they are trading at a record yield spread to US Treasuries.

Fig. 4 - Tactically oversold
Trade weighted US dollar and deviation from 6-month average
US dollar chart

Source: Refinitiv Datastream, Pictet Asset Management. Data from 30.12.2011 to 20.11.2020.

Elsewhere in fixed income, we are overweight US government and investment grade bonds as they offer higher yields than elsewhere in the developed world. 

Normally at this point of an economic cycle, high yield bonds look attractive relative to equities. They tend to outperform early in a recovery. But this time around, expensive valuations make the high yield market look considerably less enticing. Also, the US administration’s decision to terminate some of the emergency facilities introduced in the immediate aftermath of the pandemic removes a backstop to this asset class - a key reason for their rich valuation so far. 


Global markets overview: equities on fire

Global equities delivered their strongest monthly returns on record in November, posting gains of more than 12 per cent as news of three significant Covid-19 vaccine breakthroughs lifted investor spirits.

Positive results from separate vaccine trials conducted by pharmaceuticals groups Pfizer-BioNTech, Moderna and AstraZeneca raised the prospect of a return to normal economic conditions in 2021 and a strong recovery in corporate profits.

Providing additional fuel to the rally was Joe Biden’s victory in the US presidential election. The widely held view is that a Biden administration will adopt a less confrontational approach to international relations and trade, easing conditions for multi-national companies unsettled by the ‘America first’ policies of the Trump White House.

The market’s record-breaking gains were accompanied by heavy investment inflows into equity funds. According to Bloomberg data, investors shifted some USD54 billion into US listed equity exchange-traded funds in November –an amount bettered only by the USD67 billion taken in January 2018.

Fig. 5 - Record highs
MSCI All Country World Price Index
MSCI world chart

Source: MSCI, Refinitiv Datastream, Pictet Asset Management. Data covering period 01.012018-25.11.2020. 

The pattern of returns suggested investors took vaccine developments as an opportunity to reassess prospects for industry sectors hardest hit by the pandemic . Energy, financial and materials stocks – sectors with among the weakest returns year to date – led the market higher in November with double-digit gains. The technology sector, which has thrived as lockdowns increased demand for digital services, lagged. 

The same pattern could be seen in the returns of individual regional and domestic markets. European markets – which have a greater share of economically-sensitive stocks than their tech-heavy US counterparts – saw gains of as much as 29 per cent in local currency terms. Greek, Italian, French and Spanish stocks each rose by more than 20 per cent compared to the S&P 500’s 11 per cent rally. 

With investors in buoyant mood, gold tumbled. Its 6 per cent plus decline was its worst monthly fall in more than four years. The dollar also fell sharply, ending down by more than 2.5 per cent on a trade-weighted basis. Emerging markets currencies gained most against the greenback, with those of commodity-exporting countries appreciating the most. The Brazilian real rose 8 per cent while the South African rand was up more than 5 per cent.


In brief

Barometer december 2020

Asset allocation

We retain our neutral stance on equities and bonds.

Equities regions and sectors

We turn more cyclical, upgrading industrials to positive and financials to neutral, while reducing allocation to consumer staples.

Fixed income and currencies

We reduce our position on gold to neutral as the dollar temporarily stabilises after recent declines.