Are differing speeds of vaccine roll-out causing an increasing divergence in the speed and extent of economic recovery?
To a large degree, yes, is the view of Maarten-Jan Bakkum, senior emerging markets strategist at NN IP.
He believes the large differences between countries with regard to the pandemic explain some of the differences in equity and fixed income market performance.
“The inability of most emerging market governments to contain the virus has been an important reason for our scepticism about EM recovery prospects and the outlook for EM equities, despite the strong global trade picture, steady upturn in China and rising commodity prices.”
For EM fixed income, he suggests the strong rise in US bond yields might have been a more important factor recently, but also here, the raging pandemic, with its impact on fiscal accounts, political risk and longer-term growth prospects, has been a key reason to be cautious, particularly in the local-currency segment.
Kevin Thozet, member of the investment committee at Carmignac, says that on the rates front, over the first quarter EM fixed income suffered somewhat from the rising rates environment and he expects US rates to stabilise as investors are increasingly pricing in a decent amount of premium relative to the Federal Reserve’s projections for rate hikes.
“As such we see value in hard currency EM debt as well as in forex to capture valuations that are becoming attractive. Yet are somewhat more cautious on the local currency front as some local central banks could turn more hawkish in a context of rising inflationary pressure.”
Emerging market lag
Thozet is cautiously optimistic about emerging market recovery generally. “While there have been some delays, we expect vaccination to pick up in the developed world with emerging markets being the next in line.
“Indeed, while most so-called emerging markets are still lagging on the vaccine roll out front, we expect the pace to pick up as vaccination efforts mature in developed markets and production capacity to be redistributed.”
He maintains a constructive view on emerging market assets. “Our medium-term view is that the policy mix in the US, together with the re-opening of the world economy, is conducive to a lower US dollar, increased global trade and higher commodity prices; all of which are positive for emerging market assets”.
Within developed markets, the growing difference between the US and the Eurozone, not just with regard to the vaccination campaign, but also in terms of the fiscal policy response, has made NN IP more positive about the US economic recovery. It has also made it more wary of an inflation overshoot in the US in the coming months.
This is the main reason, in its multi-asset model portfolio, NN IP has an underweight in US Treasuries, combined with an overweight in German Bunds. “We think 10-year Treasury yields still have the potential to rise further, reflecting the continued strengthening of the US economy, albeit at a more gradual pace,” Bakkum explains.
In global equity markets, the underperformance of emerging markets has been one of the major developments recently, Bakkkum says with the failure to contain the virus in a large part of the emerging world playing an important role.
But he adds that rising US bond yields and the higher regulatory risk in China for monopolistic companies in the fintech and e-commerce sectors also explain some of this underperformance. EM equities have returned 2% year-to-date, compared with 10% for US and 9% for Eurozone equities.
Bakkum explains his current weighting preferences. “We maintain a moderate overweight in equities based on the combination of a strong post-pandemic recovery, solid earnings momentum and supportive economic policy. We have reduced our cyclical bias somewhat by downgrading the energy sector to neutral and upgrading consumer staples from a large underweight to a moderate underweight.”
He has also re-opened a moderate overweight in IT. The sector combines cyclical (semiconductors, hardware) with structural growth (software and services) and, argues Bakkum, scores high on the quality ranking.
He concludes: “An allocation to the broad IT sector fits well with our view that, as we move further along in the business cycle, our exposure to cyclical growth should gradually be supplemented with exposure to more stable, secular growth.”
Mohammed Kazmi, portfolio manager for UBP’s absolute fixed income team, is relatively upbeat on the potential for European growth following the vaccine rollout.
“There has been plenty of pessimism with regards to the European growth story given an initial slow vaccine rollout as well as another wave of covid-19 cases which resulted in lockdowns being extended.
“However, we think we are at an inflection point with regards to European sentiment as the vaccine distribution has begun to meaningfully pick-up, which should allow for Europe to follow the likes of the US and UK and start planning for loosening restrictions in the months ahead.”
He adds: This should provide another boost to the global growth recovery, which has so far been US led, as highlighted by the latest high frequency numbers.”
Kazmi also thinks that investors could be surprised by the length of the global recovery. “Pent up savings that have built up during the pandemic will be drawn-down which will support consumer spending, whilst we see policymakers providing tailwinds to this recovery rather than headwinds, with fiscal support in both the US and Europe continuing”.
As a result, he thinks the risk is that growth will continue to surprise on the upside for a sustained period of time, which could lead markets to price in a more hawkish Fed given that their guidance is outcome based, rather than calendar based.
Therefore, he continues to hold a short duration bias given that growth risks are to the upside, whilst he is positive on credit, continuing to hold overweights across portfolios given this supportive backdrop. “Our preference remains for the higher beta segments of the market such as high yield and Financial AT1s which should continue to benefit from the strong recovery.”
The view at Amundi echoes Kazmi’s cautious optimism towards European markets.
“Even though vaccinations in Europe are progressing at a slow pace and the recovery will be slow, the current earnings season has been positive so far. The cyclical and value features of EU markets should help overcome the economic growth lag. However, we remain focused on stock selection and fundamental analysis and are exploring opportunities in segments linked to the recovery.”
Blanchet argues that the ‘great rotation’, favouring cyclicals vs. defensives and value vs. growth, is demonstrating resilience. But the focus now will be on economic reopening, interest rates and nervousness around overvalued hyper growth stocks.
“As a result, we continue to look for businesses with strong balance sheets. We also believe investors should explore quality cyclical stocks in financials and materials,” he says.