Our View

Recovery ahead

10.08.2021

Dr. Felix Brill · Dr. Thomas Gitzel · Bernhard Allgäuer · Harald Brandl · Jérôme Mäser

Reading time: 9 Min

Companies are reporting results above projections, but are trying to steer investors' expectations in a more realistic direction. Most markets have weathered this well so far, as well as uncertainty about regulatory intervention in China or higher inflation rates. This shows: The economic recovery is on track despite stumbling blocks.

One number, and everything is different. The monthly US nonfarm payrolls showed a rapid increase in jobs in July and pushed the unemployment rate down by half a percentage point to 5.4 %. Investors found this such good news that they suddenly forgot concerns about economic risks. At least that is what the immediate market reaction suggests.

In situations like these, it is worthwhile not to get caught by the hectic pace of the markets. For the risks have not simply disappeared. Nor have we thrown away our "green recovery" scenario because of this news. In our view, the recovery remains on track.

The equity markets may continue to rise in this environ-ment, even if the air has become thinner in terms of valuations. We interpret the resilience of recent weeks as a good sign and remain invested according to the strategic allocation. On a regional level, we continue to prefer Europe.

In our view, the decline in bond yields is only temporary. The positive economic outlook and the signals of the US Federal Reserve to reduce securities purchases speak for rising yields in the coming months. Therefore, we remain underweight in government bonds.

However, after the recent price decline, we are increasing the gold allocation. We appreciate not only the diversification properties of gold, but also see the gold price well supported by negative real interest rates and a weak dollar in the longer term.

Tactical Positioning

Weighting

Our View on the Portfolio

Economic recovery on track
Europe is favourite among equity markets
Chinese bonds as a supplement
Gold for diversification

Risk of interest rate rises
High stock market valuations
Uncertainty around China following growth figures and regulatory intervention

Our View on the Economy

The two main risks are back

Two possible bumps for the recovery are reappearing. One is the increasing number of Coronavirus cases. The rapid spread of the Delta variant calls once again for restrictions, especially in travel. On the other hand, the shortage of certain goods continues to weigh on the manufacturing sector. The lack of semiconductors in particular does not seem to be quickly resolved. It seems to be more a structural phenomenon than a temporary one. Against this backdrop, it is no wonder that early economic indicators are giving way – although at high levels. In the autumn and winter months we will see a return to a normal economic environment. Thus, the catch-up driven high growth rates of late will soon start to fade. However, the economic recovery is set to continue, as the risks of recession are currently low.

Services sector benefits from catch-up demand
Economic recovery intact
Central banks keep their expansionary monetary policy stance for now

Supply shortages slow economic recovery
Delta variant of the Coronavirus makes travel restrictions necessary again
A return to normality will not stop the industrial sector but it will slow it down

Our View on Monetary Policy

Fed starts to prepare tapering

The U.S. central bank, the Fed, has recently held back on monetary policy readjustments. However, policy makers announced that they had come closer to reaching the goals of price stability and maximum employment. At the same time, this means that tapering, i.e. a reduction in securities purchases, is getting a little closer. According to Fed Chairman Jerome Powell, the members of the Open Market Committee have been looking very specifically at exit options. It is thus clear that the course has been set for an end to the ultra-expansive monetary policy. But it will probably be several months before the Fed actually starts tapering. The end of the year could be a likely starting point for the reduction of securities purchases.

Fed prepares tapering, but there will be no abrupt change of course
ECB has launched its new monetary policy strategy and makes clear that there will be no rate hikes for the foreseeable future

Difficult discussion about the right amount of monetary policy measure intensifies
The monetary policy shift could lead to rising nervousness in financial markets

Our View on Government Bonds

Yields in retreat

Recently, the yields on government bonds on both sides of the Atlantic have been mostly declining. In the government bond markets, the economic recovery seems not to be trusted completely. At the same time, fears of a sustained rise in inflation appear to have subsided. The picture of a temporary rise in inflation drawn by central banks is now widely accepted. If the economic recovery continues over the next two years, there is little doubt in our view that yields will be on the way to higher levels. After the rapid rise on the long end of the interest rate curve earlier this year, the current consolidation has been strong, but not unusual. As we stick to our positive outlook for the economic recovery, we continue to expect higher yields going forward.

ECB makes clear that it does not move away from ultra-expansive monetary policy
In the eurozone, ECB purchases benefit peripheral bonds

Fed opens door to tapering bond purchases in the second half of 2021
Rising public debt will weigh on government debt ratings
Government bonds come with a high interest rate risk

Our View on Corporate Bonds

Topsy-turvy world: yields down, spreads up

The Fed is preparing markets for the eventual reduction of bond purchases (tapering). This would be a first step towards normalising monetary policy. Typically, credit spreads fall during an economic recovery while government bond yields rise. At the moment, however, it is exactly the opposite: If the Fed withdraws and allows markets to take over again, bond prices should move to the fundamental value. In the case of spreads, a compensation of 2 to 3 percentage points above the current level would be appropriate. For government bonds, too, higher yields would be justified given the inflation concerns. A withdrawal by the Fed would thus be a double whammy for corporate bonds. But whether the Fed can implement its plan will depend on how markets are responding. Market turmoil could quickly lead to a re-evaluation by the Fed.

Monetary policy normalisation cannot be easily implemented
The ECB clarifies that ultra-expansionary monetary policy will stay even longer

Fed mentions November as a possible date for first tapering
Returning to a normalised monetary policy threatens losses from higher spreads and higher returns
Corporate bonds are exposed to increased interest rate risk (duration) due to low interest rate level

Our View on Equities

Strong equity markets, but the air is getting thinner

Equity markets in the US and Europe have so far been relatively unphased by a more difficult business environment. Supply bottlenecks and cost pressure are the most important factors when assessing the outlook for corporate earnings in the second half of the year. Earnings growth rates are no longer supported by base effects when compared to the previous year. While the manufacturing sector enjoys full order books, specially hard-hit industries such as aviation, gastronomy, hotels and tourism remain under stress. However, the strong performance of equity markets have driven valuations higher. These are also challenged by the homemade correction of Chinese equities. Accordingly, we see elevated risks for higher short-term volatiliy in other markets as well.

Full order books in manufacturing sector
Low interest rate environment continues to support equity markets
Very good earnings in the first half provide a solid basis for the rest of the year

Regulatory action leads to price corrections in the Chinese stock market
High fundamental valuations
Expect lower earnings growth in the second half

Our View on US Equities

Looking for added value

The US equity market has been driven to new highs by strong earnings growth. The fundamental valuation stands at extreme levels, which, without an additional acceleration in corporate profits, increases short-term risks. The most important driver of the market, the technology-driven growth segment, is experiencing increasing resistance for various reasons (such as taxes and antitrust discussions). Cost pressures and increased investment expenditure suggest a slowing earnings growth in the second half of the year. This leads to a situation where risk premiums in other regions such as Europe appear more attractive for investors.

Strong economic growth with an increasingly better looking labour market
Senate has passed the important stimulus package by US President Joe Biden

High fundamental valuations reduce risk premia for investors
Earnings growth of technology sector slowing
Relative attractiveness compared to other regions sinks

Our View on Alternative Investments - Gold

The dollar as a spoiler

Just like the half-year results currently determine what is happening in the stock markets, the latest World Gold Council report shows the trend in gold demand. It has remained stable year-on-year thanks to the recovery in the jewellery sector and higher central bank purchases. The price of gold itself recently benefited only to a limited extent from lower yields. For in periods of higher inflation and the prospect of a more restrictive monetary policy, the US dollar takes the lead. The stronger greenback reduces purchasing power and thus holds back gold. But the current level of yields argues for higher gold prices and so we see the latest sell-off as a buying opportunity to increase protection in the portfolio with a view to high valuations in the equity markets and risks of a setback.

Price weakness and expensive stock markets justify higher weight
Central bank purchases support demand
Low interest rates provide opportunity dividend
Protection against higher inflation rates

Stronger USD reduces purchasing power
Headwinds if bond yields rise
Prospects for more restrictive monetary policy have a negative effect

Our View on Currencies

No weakness of the greenback for the time being

When economic risks return to the fore, defensive currencies are in demand. These include in particular the US dollar and the Swiss franc, but also the euro. Within this triangle, preference is given to the US dollar and the franc. Risk-sensitive foreign currencies lose against these three currencies. So emerging market currencies, as well as the Swedish krona or the Australian dollar, are experiencing weakness. As long as the global recovery continues in the medium to long term, the current period is only an intermezzo in a broader trend that speaks for a weaker dollar.

Defensive currencies are currently in demand, including the USD, the CHF and the EUR
The EUR has weakened against the CHF and USD, but is stronger against most other currencies

High-beta currencies like the SEK, which sensitively react to risk-on and risk-off, currently lose
Emerging market currencies are currently not able to strengthen against the leading currencies

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Find past publications here:

Our View in July 2021

Our View in June 2021

Our View in May 2021

Important legal advice

This documentation was produced by VP Bank AG (hereinafter the bank) and distributed by the companies of the VP Bank Group. This documentation does not constitute an offer or an invitation to purchase or sell financial instruments. The recommendations, estimates and statements contained therein reflect the personal views of the relevant analyst of VP Bank AG at the time of the date stated on the documentation and can be changed at any time without prior notice. The documentation is based on information that is considered reliable. This documentation and the assessments or assessments made therein are prepared with the utmost care, but their accuracy, completeness and accuracy cannot be guaranteed or guaranteed. In particular, the information contained in this documentation may not include all relevant information on the financial instruments covered or their issuers.

For more important information on the risks associated with the financial instruments in this documentation, the proprietary business of the VP Bank Group or the management of conflicts of interest in relation to these financial instruments, and for the distribution of this documentation, see www.vpbank.com/legal_notes

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