A peak into our models

Published on July, 30th 2021 Market and research
Winter in... Coming?
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Frank TRIVIDIC

Deputy Chief Investment Officer

[Invest. Pro.] Intended for Professional Clients in accordance with MIFID.

Written by Frank Trividic, Deputy Chief Investment Officer at Seeyond, on July 2021

 

Following a logical period of consolidation and concerns about Covid-19, market sentiment should gain traction again. Equity fundamentals remainsolid and treasury yields too low to challenge economic momentum and risk appetite. 

The revenge of Developed Markets?

We have seen significant improvement in Equity fundamentals over the last 3 months. The main positive drivers were Economic Growth (stabilizing at a high level, especially in the US and Europe) and Valuations (lower long-term yield offsets higher stock prices). Micro factors (Earnings Momentum and Revisions) continue to support investors’ sentiment, while Inflation remains – in theory - the major fundamental risk for Global Equity markets. Geographically speaking, Eurozone takes the lead, followed closely by the US with the biggest positive jump (due to increasingly sustainable Economic Growth). Last in line, EM have the weakest fundamentals, which is consistent with a more fragile situation after the Covid crisis.

Chart 1: Evolution of equity market fundamentals over 3 months

 Chart 1: Evolution of equity market fundamentals over 3 months

Source:  Seeyond proprietary models as of 2nd July 2021

Sovereign Bonds in the Middle of the Field

This quarter saw a large andlogical consolidation in long term yield increase. Cheaper valuations and extreme short positioning fueled this movement. Doubts about the sanitary situation  and therefore economic reopening strengthened the trend. We are now in the middle of the field where Valuations (especially marginally steeper yield curves) are just compensating Economic Growth and Risk Aversion factors. Considering geographical breakdown, US Treasuries continue to benefit from better valuations, while European Government Bonds clearly look less attractive.

Chart 2: Evolution of core sovereign bond fundamentals over 3 months 

Chart 2: Evolution of core sovereign bond fundamentals over 3 months

Source:  Seeyond proprietary models as of 1st July 2021

We believe the current situation is a perfect mix of late 2009 and mid 2017 (see Chart 3). After a strong increase in long term yields due to economic recovery (in both Activity and Inflation), a consolidation occurred due to doubts on economic momentum. Like in 2010 and 2017, these issues should vanish in the coming months. Fears about the Delta Variant and its potential impact on economic seem exaggerated. US job market will strengthen with the end of unemployment benefits, while the trend on inflation should stay firm. Lack of US treasury supply will reverse, concern about debt ceiling will ease and the FED will soon – before year end - communicate on tapering. 

Chart 3: US 10Y yield and US economic momentum

Chart 3: US 10Y yield and US economic momentum

 Source: SEEYOND, Bloomberg as of 30th June 2021 – ISM: Institute for Supply Management 

What Next?

Investors are less positioned on the reflation trade. Concerns about the economic recovery should subside. The FED will try to anchor market forecasts on short term interest rate while announcing timid tapering of asset purchass. European equities should benefit from an improving Covid situation, further economicreopening, a dovish ECB and cheaper valuations.

We expect a rebound of the reflation theme, with strongest return from European cyclical and cheap sectors. Emerging markets should stay under pressure – in relative to DM - while Chinese authorities are more focused on the internal imbalance than on economic momentum. US long term yields should see new highs, leading for a new phase of yield curve steepening. Dollar should weaken against European currencies, while strengthening against emerging currencies. 

   

This article has been provided for information purposes only to professional clients as defined in the MiFID Directive. It must not be used for retail investors. The provision of this material or reference to specific sectors or markets in his article does not constitute investment advice or a recommendation or an offer to buy or sell any security. Investors should consider the investment objectives, risks, and expenses of any investment carefully before investing. Views expressed in this article as of the date indicated are subject to change and there can be no assurance that developments will transpire as may be forecasted in this article.