Market Risk Outlook - Higher Conviction, Less Downside
Risk assets have maintained the positive momentum we reported in our previous Societe Generale Market Risk Outlook in October 2019, with equities back to historical highs on the back of upward surprises in global manufacturing and consumer/business confidence. In essence, the widely held view that there is (still) no alternative to equities for now is, according to our strategists, holding true.
This cross-asset publication seeks to help you navigate our key calls across the different asset classes in today’s economic environment. We discuss multiple risks to both the upside and downside by asset class.
Our Societe Generale Asia economists and equity strategists point out that the COVID-19’s impact could potentially be deeper and wider than the SARS episode in 2003 due to China’s economic rise over the past 17 years and its weight in global growth, trade and tourism, and given the fact that we are in a different risk environment now. For now, the market seems to be ignoring this, but as our Chief Economist points out here, the key question is whether this epidemic will go global, and hence become a pandemic.
The one sector that has failed to maintain positive momentum in the past three months is commodities. By mid-January, global market participants took in the full measure of potential impacts from the coronavirus outbreak in China. Measures taken by individuals or authorities to avoid the virus from spreading (i.e. reduced travel, idle factories and lower domestic consumption) dramatically cut oil consumption forecasts and prices dropped. The lost demand will not be retrieved. The outbreak has completely overshadowed several other bullish developments that occurred over the month across the entire commodity complex. Indeed, every complex within commodities was hit with the noticeable exception of gold.
Market Risk Outlook
In the report, for each covered asset class, we present succinctly our base case and risk scenarios:
- Equities: Despite the positive momentum, we maintained our bearish call on equities. Upside risk: The start of a fourth mini-cycle (no recession) in a context in which EPS growth is not being downgraded anymore could push the S&P 500 higher. Downside risk: A serious acceleration of the trade war, bad-deal Brexit, a China hard landing and the coronavirus turning into a pandemic would hit equities globally.
- Rates: Our US-based SG rates strategists see the 10y Treasury yield lower. Upside risk: Lower yields would stem from a failure to contain the coronavirus, which would exacerbate the downturn in global growth. Downside risk: Yields would likely move higher should we see a continuation of robust consumer spending and employment data. EUR rates: Rangy EUR rates is the baseline scenario from our Euro rates strategists, who see no room for a sustained move up or down in EUR rates in 2020.
- Credit: Our credit strategists have a bearish outlook given the high level of balance sheet leverage in the US and a deceleration in GDP growth, which should lead to an acceleration in defaults. Their model forecasts a rise in US speculative-grade defaults to between 7% and 10% by end-2020. Upside risk: US growth staying stable. Downside risk: In addition to the base case of weak US growth, European spreads coming under pressure due to European political risk.
- Forex: Our FX strategists’ base case is an appreciating EUR/USD with downside risks considerably greater than upside. Downside risk: Weaker euro on the back of a worsening of the coronavirus situation. Upside risk: Slower US growth than we forecast. USD/JPY: The base case is for further gains against the Japanese currency. GBP/USD: Our strategists see a gain against the US dollar with an upside risk on the back of a ‘good’ trade deal. The downside is a function of three factors: 1) weakness in Europe; 2) a positive turnaround in the US economy; and 3) a weaker Chinese yuan.
- Emerging markets: Our strategists expect Chinese rates to decrease with the coronavirus outbreak posing asymmetric downside risks to CGB yields and is a function of disruptions to Chinese manufacturing.
- Crude oil: Our commodity strategists expect Brent prices to trend slightly lower. Upside: OPEC+ sharpening cuts on the back of even weaker demand stemming from the coronavirus. Downside: Worsening of the coronavirus and demand destruction that OPEC+ cannot manage.
- Copper: The base case is for rising prices on the back of an anticipated deficit. Upside: Strong European stimulus package channelled to copper-intensive renewable energy infrastructures. Downside: Limited, as prices are near the 90th percentile of costs.
- Gold: We maintain our moderately bullish forecasts for gold. Upside: Geopolitical tensions escalating to full-blown confrontations, would incentivise investors to purchase gold to cover their portfolios’ risks against the resulting instability. Downside: Should the gold price and EM currency relationship be restored, gold prices will drop to restore the equilibrium.
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We exhibit our base case price forecasts within specific time horizon, as well as conviction levels and price impacts for each scenario. The upside and downside risks to our growth forecast are also discussed in detail.
About Societe Generale Cross-Asset Research
Societe Generale Cross-Asset Research is composed of more than 200 Analysts, Strategists, Economists and Quant, combining their expertise into ‘Research-based’ and innovative solutions suited to client’ needs: fundamental studies and expert views, investment ideas and long-term strategies, trade ideas and tactical baskets, thematic and systematic indices, quant solutions. On top of its established UK and Western European base, Societe Generale Cross-Asset Research benefits from a global coverage thanks to its presence in the US and in Asia (Hong Kong, Singapore, Tokyo and Bangalore) and Societe Generale local networks in Eastern Europe.
This editorial contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of Societe Generale. This interview is dedicated to institutional and professional investors and is not deemed to be seen and used by retail investors for investment purpose. The viewers shall consult their own financial advisers to make their own appraisal.