Rough seas but favourable winds

Markets tend to be keen and quick to price-in worst-case scenarios when bad news occurs, and then take time to climb the wall of worries, which makes for a bull market. In the second half of this year, we expect markets to continue pricing in a combination of falling virus cases, rising PMIs, and continuing fiscal injections - this time with no early austerity - while central banks buy the equivalent of new issuance (and probably more) for longer. And, if the Fed is reluctant to go to negative rates, will it prefer to buy equity ETFs to facilitate balance-sheet repair instead, in case another market rout were to develop? Such a cocktail could push risk premia into lower territory.

There are clear risks in the background, from an L-shaped cyclical outlook to a second wave, overly leveraged corporate balance sheets, structural weaknesses in some emerging markets, fast-increasing state capitalism with interference on dividends and buybacks, the US-China trade dispute and swings in market sentiment. After the strong rally from the mid-March lows, we recommend “only” a balanced allocation (45% fixed income including cash, 45% equities), but we buy the laggards in each compartment. With the Fed already at zero and reluctant to go to negative rates, we can no longer use US treasuries as portfolio protection, which makes it difficult to protect the equity portion - except via the 10% yen exposure.

We strongly reiterate that credit spreads could continue to fall (we're “only” halfway through their fall, in our view), dragging down EM sovereign credit spreads, capping equity volatility in the near term, and buoying some cheaper, less-secure equity segments (value and some leveraged companies - but no zombies - as opposed to growth and quality) and the laggards (Japan and Euro area equities). Curve steepening should continue to perform at the longer end of the sovereign bond markets. In the euro area, strong and credible policy action leads us to allocate an even higher weight to the currency (euro up by 2pp to 40.5%, USD down 3pp to 30%), but also to equities, while we keep longs for carry in the periphery bonds - especially in Italy.

We continue to like the positive asymmetry on many commodities (10%, +1 point) after their price collapse: supply is under some control (voluntarily for OPEC+, or forced due to bankruptcies) while demand is recovering, as highlighted by rising PMIs and China's recovery. We prefer commodities to inflation-linked bonds (-5 points to zero). We also further raise our allocation to commodity-related sectors in equities (Metals & Mining and Oil & Gas).

We stay put on EM FX exposure, highlighting three prerequisites to a sustained rally: 1) reduced COVID-19 stress, i.e. a firm drop in new cases; 2) sustained normalisation of commodity prices; and 3) a convincing reset of the global supply chain/trade, which would signal a return to long-term economic growth.

In coordination with Societe Genéeale’s strategists on all asset classes, and using quantitative, positioning and behavioural tools detailed in the report, our analysts come up with an asset allocation geared to further pricing of a recovery in a context of heavy liquidity injections.The report develops:

• Investment calls based on key themes such as “Gearing to a mini-cycle”; “Social distancing is here to stay”; “Search for yield to continue”; “How to deal with a heavy political agenda?; “State capitalism gaining momentum”; “Widening gap between EM and China”.
• An editorial on the market outlook and the way to position, including:  “Liquidity aplenty: hold on to credit”; “Equities – gear for another upside leg”; “Constructive asymmetry on commodities”; “Patience required on EM assets”; “Asset allocations for the main risk scenarios”; “ESG in the time of COVID-19”.
• Economic scenario forecasts
• Quantitative portfolio construction tools

If you are an existing client, click here for direct access to the report

Find out more about our independent research 

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.

Disclaimer
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.