Global Market Perspective Q4 2020: economic and asset allocation views

Risk assets continued to record gains in the third quarter but returns were more modest compared to the previous quarter. The recovery in global activity, hopes of a Covid-19 vaccine and ongoing policy support provided a strong lift to global equities. Although, as the quarter drew to a close, the rally lost steam given the fresh rounds of lockdowns in Europe and a stalemate in the US over the fiscal stimulus package. Even with increasing political uncertainty in the US, however, the S&P 500 led the way thanks to tech. By contrast, the European stock markets suffered losses alongside a stronger euro.

Despite ongoing trade tensions between the US and China, emerging market equity remained one of the strongest performers benefiting from a softer US dollar and recovery in commodity prices. In comparison, bonds were more mixed with credit and emerging market sovereign bonds delivering positive gains, whilst government bond returns were flat.

In terms of our economic forecasts, we have upgraded global growth in 2020 largely driven by a better-than-expected performance in US activity over the second quarter. In 2021, global growth should improve supported by loose fiscal and monetary policy and the arrival of a vaccine at mid-year, which is distributed in the third quarter. Against this backdrop, inflation is expected to remain subdued allowing central banks to keep policy loose. That said, we do see some easing in the pace of quantitative easing (QE) as growth continues through 2021.

On the risks to our central view, we see the W-shape recovery as the greatest concern, which involves the return of the virus leading to a second wave of lockdowns. The overall balance of risks has shifted in a slightly more reflationary direction led by a continued chance of a V-shape recovery.

From an asset allocation perspective, we maintain a positive view on credit given the substantial liquidity provisions by the Federal Reserve (Fed) and European Central Bank (ECB). However, we have rotated some of our credit exposure into equities in the search for a better return potential, as there is less room for credit spreads to tighten further from here. Within equities, we have diversified our quality and growth bias, which is increasingly a consensus trade, by adding some exposure to US small caps. We have also kept our exposure to local emerging market debt and emerging equities.

Meanwhile, government bonds continue to offer little value relative to equities. We believe that the upside to bonds is limited, but the unprecedented level of monetary accommodation by the central banks mean that we are neutral on duration. Moreover, we prefer inflation-linked bonds to nominals given the Fed’s new target on inflation. With bonds proving to be a less effective portfolio hedge, we own currencies such as the Japanese yen to manage cyclical risks in the portfolio.

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Global Market Perspective - Q4 2020 16 pages | 3,967 kb