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SystematicEdge Monthly Market Overview December 2020

Market Context: Strong equity and credit market momentum despite most of the world being in the eye of the Covid storm.

Global Macro: 

As the latest wave of the Covid-19 pandemic continues to weigh heavily on major western economies, equity and credit markets seem to ignore the lasting economic impact of the pandemic for the years to come and are not pricing in the possibility that the pandemic might last longer than expected. This rally of risky assets implies that investors are taking into account the following three main anticipations: 1) Investors expect rates to remain low in the coming years. We believe it is a fair assumption as most central banks pledged not to raise short-term interest rates in the next three years and potentially intervene if long-term interest rates rise too much, using a curve control mechanism. 2) Investors expect governments around the world to implement stronger fiscal stimulus measures and help corporations and individuals. 3) Investors expect the recently developed vaccines to result in global virus immunity some time in 2021. We remain cautious about the global economic outlook in 2021 as economic indicators, such as GDP and unemployment, may temporarily worsen, while Covid-19 new infections and deaths may keep rising, thus delaying the recovery. As such, the market sentiment could turn negative at some point in 2021 if the pandemic lasts longer than expected, amid vaccine deployment challenges and potential virus mutations, and if governments fail to deliver on their stimulus promises. On the plus side, the Brexit withdrawal agreement negotiated between the UK and the EU will minimize the economic impact of the Brexit, thus removing an important source of uncertainty overhang in Europe.

Financial Markets: 

With a Democratic US congress, we anticipate further fiscal stimulus in the US and subsequently the continuation of the US dollar bearish trend as well as a rise in long-term US interest rates, which will be favorable to banks. Moreover, the Biden administration is expected to increase taxes on the wealthiest, reverse part of Trump’s corporate tax breaks, and address the issue of global Tech corporations using tax shelters abroad. The Nasdaq 100 Index has doubled over the past two years, as Tech stocks reached their highest valuations since the dot-com era. The US dollar fell to its lowest level since April 2018 during the last trading day of 2020, representing a drop of almost 13% from its high in March. The USDRMB rate broke its 6.50 support on the last day of 2020 and its downward trend continues, driven by rapidly increasing foreign investments in Chinese bonds and stocks (see graph below).

Equity: Month to date the S&P 500 rallied 3.5%, Euro Stoxx 50 +0.6%, Hang Seng +3.4%. Fixed Income: 10-year US yield rose 8bps in December to 0.92%. Emerging market government bonds gained 1.9% in USD and 3.2% in local currencies. High-yield corporate bonds went up 1.0% in EUR and 1.5% in USD. Currencies: USD further weakened in December: EUR +2.0%, CNY +0.7%, AUD +4.2%; safe haven JPY +0.7%, CHF +2.1%. Commodities: Oil prices continued to rise in December while gold prices rebounded: WTI Oil +7.9%, Gold +7.3%.

Risks:

  • Covid-19: Given new restrictions across Europe and the US following the new wave of infections, we see increasing near-term downside risk to the world’s economic growth outlook.
  • Profit-taking pressure: Equity markets have rallied since November 2020, fueled by a bullish consensus. We thus anticipate increased volatility from profit taking in early 2021.
  • Bankruptcy wave: The number of bankruptcies has been rising amid the economic recession and could worsen in the coming months.
  • Tech bubble: Tech stocks remain under pressure, given the highest valuations since the dot-com era and high market concentration, while the Biden administration is expected to take a much stronger stance on the tax and anti-trust treatment of Tech companies.
  • US-China tensions: US-China trade frictions remain strong, with increasing tension around Taiwan and the South China Sea. Meanwhile, the US government pushed for the delisting of Chinese Tech companies from US stock exchanges in an effort to curb the companies’ US investor funding.

Opportunities:

  • Greater China is exiting the pandemic ahead of western countries. China’s GDP is expected to increase over 8% in 2021. We favor the Hang Seng China Enterprise Index (HSCEI) to gain exposure to the Chinese stock market as Hong Kong H-shares trade at a 30% discount to their mainland counterparts, the widest gap in a decade. Moreover, the delisting of Chinese stock in the US is benefiting the Hong Kong market amid increasing inflows to the SEHK (Stock Exchange of Hong Kong).
  • Quality stocks in the financial sector in the US, Europe, Hong Kong, and Japan: Following the US election and Democrats’ congressional win, investors are positioning themselves for higher long-term rates in the US and more generally the end of rate cuts. This is positive for the banking and insurance sectors where valuations continue to look attractive and we believe falling loan-loss provisions for banks will support accelerating earnings growth. We expect stocks of well-capitalized quality banks to pay an above-market dividend yield contingent on their central bank’s green light.
  • The Oil & Gas sector partly recovered in 2020, yet still trades at half the book value of the market, its lowest level since 1928.