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Market Outlook Q3 - The macro picture: Managing growth divergence

We have asked Julius Baer’s opinion leaders about how they see the third quarter of 2020 and where they believe investors can find the best opportunities in the current environment. Download the Investment Guide (link below) to find out more.

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The coronavirus pandemic has resulted not only in a huge health crisis, but also in enormous economic damage. As we exit the crisis mode, we observe large and widening divergences among regions, countries and sectors. The overall broad-based policy response, combined with a slowing infection rate, points to an earnings recovery ahead. Whilst the different growth prospects provide opportunities for investors, they also present risks.

Economic activity is back

Policymakers around the world are now taking action to combat the recession. Governments and central banks have already announced massive support measures to help cushion the blow from the virus. We are convinced that central banks will use all their available policy options to limit the economic fallout. As monetary easing cannot do it alone, coordinated action with more expansionary fiscal policies is crucial to avoid a global depression.

Growing divergence

We enter Q3 2020 with a strong tailwind from US fiscal stimulus as well as progress in the containment of the coronavirus in China, Europe and the USA. While the spread of the virus is a global phenomenon, the policy responses and the economic outlook vary on a national level. The difference in fiscal response and the depth of the economic shock will translate into growing divergence across regions and sectors.

US dollar has several benefits

The US dollar should still benefit from the structural outperformance of US assets and its safe-haven quality in times of market volatility. We expect the US dollar to remain strong versus most emerging market currencies, as the US government’s growth stimulus dwarfs the stimulus measures in the emerging economies. Progress made in terms of setting up fiscal support in the Eurozone brings the euro on a par with the US dollar. The chances of a growth rebound in the US and in Europe are rising.

Low-grade corporate bonds

The US Federal Reserve’s zero interest rate policy in conjunction with the strong fiscal boost and the outlook for an economic recovery in the second half of the year argue in favour of credit risk. From our perspective, we focus on the BBB/BB segments of the US corporate bond market as we see limited downside and expect credit spreads to compress towards the historic mean.

US equities are driving the growth

In the post Covid- 19 global economy, we expect the US to emerge as one of the relative winners and the Eurozone likely to become a laggard. US stocks should gain due to broad-based fiscal and monetary support. The US market benefits from being over-exposed to growth sectors in the technology and internet space, which further profit from trends towards digitalisation and home office working. We still like the information technology sector as it continues to generate market-leading earnings growth whilst valuations are far from excessive.

Cyclical stocks

Positive earnings revisions normally occur following recessions, and cyclical companies are the main driver of upside revisions in earnings. Therefore, we currently like cyclical sectors such as financials, materials and industrials where we see tangible upside in absolute terms but also relative to the rest of the market.

Chinese equities

China was the first major economy to exit lockdowns, but data up to the end of May shows a slightly less robust recovery than anticipated, and localised coronavirus clusters are precipitating strident containment measures. More monetary policy support is therefore to be expected, as well as continued investment in both ‘old’ and ‘new’ infrastructure. We therefore prefer domestic-oriented quality stocks.

Political instabilities

Politics remain on the radar when it comes to risk and remain a source of volatility. The coronavirus-induced recession in the US, together with racial protests have put the election outlook back on the front page. Latest surveys show that presidential approval has slid significantly lower. As a result, US-China rivalry is likely to heat up further. In Europe, fragmentation risks seemed to diminish when European Union leaders agreed to a rescue package, but we think that the level of collaboration could again experience setbacks.

Download the Investment Guide

The crisis has revealed some of the conceptual shortcomings in politics and economics and shown our vulnerability to such shocks. For investors, it is important to learn from what we have seen and prepare for the future.

To download the Investment Guide, please enter your e-mail address below and you will receive a download link via e-mail.