Lombard Odier chief investment officer Stéphane Monier expects economies will likely return to a slow-growth, low-inflation environment with high debt and low-to-negative interest rates, after an initial spurt in activity in the second half of 2020.
After an unprecedented economic shock and rally in financial markets due to the coronavirus in the first half, Monier foresees a ‘square root’-shaped economic recovery over the next six months with a steep renewal in activity followed by a tailing-off as some sectors take longer to resume, particularly leisure, hospitality and tourism.
He also believes that Covid-19 accelerated four structural trends that have been changing the and therefore present investment opportunity.
These four trends are the world’s inescapable dependence on technology, the ongoing profound demographic changes, the continuing rise of China and the need to decarbonise quickly.
“The second half of the year will be dominated by the US presidential election as well as the evolution of the Covid-19 pandemic. As the US race unfolds and candidates unveil their programmes, we’ll be able to better assess the impact on financial markets,” Monier said.
“Asset allocations capable of managing more volatility will be crucial. The following 10 investment ideas are designed to help portfolios weather foreseeable, and less predictable, developments.”
The first conviction he outlined was the need to keep exposure to risk assets and to stay invested, or risk missing out the best days of the market.
“The sharp recovery following the pandemic-induced fall underlined the importance of staying invested in equities,” Monier said. “Investors should now make sure that they hold enough risk assets in their portfolios. In the circumstances, there is no substitute for preparing tactical responses to the inevitable surprises that will demand changes to portfolio risk profiles.”
Performance of global equities since 23 Mar 2020
Source: FE Analytics
This leads to his second conviction, which is to add defensive allocations. He said portfolios need defensive assets in the event of unwanted volatility and these can include US Treasury bonds, gold, Japanese yen or put options on equity indices.
Lombard Odier’s third conviction was the attractiveness of investment grade credit. Due to the asset class being directly supported by central bank backstops, he said it will continue to be an attractive area to generate yield compared to sovereign debt.
The opportunity to identify attractive high-yield fixed income given that defaults are already largely priced in was the firm’s fourth conviction. Monier said certain BB and B rated credit looks attractive, but transport, retail, leisure, US energy and emerging world debt outside of Asia should be avoided.
The fifth conviction was that sustainable equity growth, healthcare and information technology will outperform in 2020. That being said, Monier believes that due to the strength of the rally during the first half of the year, investors should still expect lower equity returns in the second half.
“We favour corporate stocks with sustainable growth prospects and resilient balance sheets, such as information technology and healthcare, which should outperform value stocks. We also like utilities that are working on sustainable solutions, offering attractive opportunities as state spending trickles down into infrastructure projects,2 he said.
“Post Covid-19, we expect the government spending splurge to increase investments in medical infrastructure and treatments. Medical technology, including tracking, testing and monitoring tools will all benefit. Information technology stocks more widely have excellent post-pandemic growth prospects, including in areas such as the internet’s physical architecture and security.”
The sixth conviction highlighted by the Lombard Odier chief investment officer was around Asian equities within emerging markets.
Due to China and Asia’s quicker return to economic and industrial activity, it makes for an attractive investment, he said. It will also be buoyed by the large fiscal and infrastructure spending taking place on telecommunications, power, transport and IT. He pointed out that China looks like it is heading towards a V-shaped recovery, driven by strong domestic demand.
Lombard Odier’s seventh conviction was the stability that real assets offer in turbulent markets.
In a slow-growth, low-rate environment, infrastructure should see support from government-backed investments, and real estate in high quality residential and logistics properties stand out in the US, Swiss and European market. Monier also said that private equity should not be overlooked, due to its additional portfolio diversification, exposure to the real economy and potential for enhanced returns.
The eighth investment conviction was a weaker US dollar. He anticipates that with activity recovering, the US dollar will be weaker compared to other G10 currencies, which are undervalued. He cited their exposure to China’s business cycle and generally favourable balance of payments, highlighting the Euro, Japanese yen and the Australian dollar specifically.
Monier’s ninth investment conviction was the volatile outlook for sterling. He said that the hit to the UK economy as a result of the pandemic in addition to the lack of Brexit progress means that the risk of a no-deal has risen and volatility for sterling will be likely. He believes that this will see the pound will get worse before they get better.
The tenth and final investment conviction Monier revealed was around the strength of particular emerging currencies against the US dollar.
While investors should remain selective, he said currencies with lower debt levels, decent external balances, and exposure to improving eurozone growth or China will do well. He highlighted the Czech koruna, Israeli shekel, Indonesian rupiah, Korean won, Taiwanese dollar and Chilean peso in particular.