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Chief Investment Officer's team, 03.01.2021
Let us start by wishing you a very healthy, happy and prosperous new year for you and your beloved. Please be sure that all the Wealth Management teams at Emirates NBD will keep on working hard to contribute to the prosperous side of things.
To that extent, 2020 was against many odds a great year for financial markets. The brutality of the economic shock was unprecedented, but so were the responses. From Central Banks to Governments, and including crucially, frontline workers and scientists, everything was done to limit the magnitude and duration of the damages from this historical pandemic.
Financial markets were supported by the collapse in interest rates. They reflected it in higher valuation multiples, which apply to strongly recovering earnings for 2021 as vaccinations have now started everywhere. We have been extremely active in our tactical asset allocation in 2020, and are delighted to announce that our cautious, moderate and aggressive profiles have all delivered double digit returns last year: +11%, 12% and 13% respectively, in round numbers.
We enter 2021 with a reasonably optimistic stance. We expect a year of coupon-clipping in fixed income, and of capital appreciation in stocks. But if anything, 2020 has accelerated major shifts in financial markets which cannot be ignored for the long-term. This is why we have reshuffled our Strategic Asset Allocation by adding more Emerging Markets than ever, for their better fundamentals and expected returns.
We will formally issue our 2021 Outlook later this month but give you a glimpse at our new SAA in the following pages. Stay safe.
Our new Strategic Asset Allocation (SAA)
At the end of last year we went through the exercise of reassessing our Long-Term-Capital-Market-Assumptions, that is the return-risk profile expected in the next ten years for major asset classes. This non-judgmental, mostly quantitative exercise gave us an unambiguous outcome: the collapse of interest rates as well as the high valuation multiples for risk assets, especially in developed markets, have changed the investment landscape for the long-run. Sources of returns are scarcer, while potential risks have not vanished.
The bedrock of our Strategic Asset Allocation is capital preservation at a given horizon. We aim at delivering the best possible returns while limiting the risk of loss over respectively 3, 5 and 7 years for our Cautious, Moderate and Aggressive profiles. Our relative goal is also simple to express: we want to make a difference with our international competitors in difficult times, with a better protection, while not being distanced too much when markets are buoyant. We have managed so far to deliver on this promise since we reshuffled our asset allocation process back in 2018. Having said that, for the coming decade, we had to make some changes -again.
We hold the view that risk assets are borrowing returns from the future by means of ever-larger, hence most likely unsustainable, central bank interventions and through ever-growing indebtedness. One way or the other, assuming that they will be eventually delivering in line with the longer term record seems to be naïve, especially in developed markets which also show limited growth looking forward. With regards to defensive assets, most of them offer little value, sometimes negative, especially, again, in developed markets.
Emerging Markets are the answer. In order to keep a low probability of loss on a given horizon while maintaining decent expected returns, we have skewed allocations towards EM debt and stocks. We haven’t changed the overall weight of asset class categories (cash, bonds, stocks, alternatives) but have increased the proportion of emerging versus developed. We also keep an important portfolio share in alternative assets.
According to our calculations, a cautious profile should be able to achieve on average a return of 3.3% yearly enduring a market volatility of 5.1%. For a moderate profile, those numbers become 4.4% and 7.6%, and for an aggressive one 5.5% and 10.2% respectively.
This new SAA has been approved by our internal committees, and implemented on December 31st. As per process, our Tactical Asset Allocation, which is the actual recommended positioning of portfolios, is reviewed every month and hasn’t been changed since early December. This is why our current relative positioning, after the quarterly rebalancing of our SAA, shows a large overweight in Developed Market stocks, for example: we haven’t added to them in absolute, but their weight in the SAA, our relative reference, has decreased. We will review our TAA on January 12th .
Fixed Income Update
As this is the first weekly of the year, we will focus on the broad brush strokes rather than last week's events in this edition. The events of 2020 have shaped up how 2021 is going to unfold for the fixed-income investors. Both rates and bond yields are at or close to all-time lows across the sub-asset classes in the fixed income space. The Fed’s total balance sheet is at an eye-popping $7.4 Tn. Unprecedented levels of monetary and fiscal policy support are in place. Most of the major economies have approved vaccines and have started mass vaccination programs. Investors face increasing inflation expectations, a weakening dollar, and fledgling economic growth in 2021. The real challenge for the investors is how to generate decent returns given this backdrop.
We believe hunt-for-yield to continue as more than 80% of investment-grade bonds yield less than 1%. Emerging Market and High yield bonds should continue their strong performance next year. Default rates should be stable as the financing conditions have eased considerably. ESG issuance has increased, and the momentum should continue in 2021. Emerging Market primary issuance should outstrip the previous years, with MENA sovereigns leading the region's bandwagon. Some of the more attractive sectors would be the Chinese property sector, Asian HY, and LatAm GREs.
The 10-year Treasury yield ended the year at 0.91%, a full percentage point down from the December 2019 level while hitting an all-time low of 0.51% in August 2020. We have a year-end fair-value of 1.2% for the benchmark yield. The low rates and increasing yields should make developed market Govt bonds unattractive for returns and unsuitable for risk mitigation.
Bloomberg Barclays benchmark IG index OAS spreads closed at 93 bps last. The corresponding yield of 1.23% achieved on 31st Dec 2020 is the lowest ever yield for the benchmark. Consequently, this asset class will be less attractive to investors in 2021. IG issuance in 2021 should be lower than in 2020.
The spreads in HY asset class have compressed by more than 790 bps during the last months, generating excellent returns. The extensive policy support, flattening default rates, and benign financing conditions should lead to hunt-for-yield and consequently inflows into the asset class. We think HY asset class would provide the highest chance of capital appreciation to the investors.
The OAS spreads for the Bloomberg Barclays EM Bond index trades firmly below 300 bps. This would be a year of clipping the coupons in this asset class rather than capital appreciation. Higher economic growth deferential should allow EM sovereigns to easily tap the primary markets in 2021, with MENA IG sovereign issuers leading the way.. Investors would do well to participate in the primary markets where we can expect higher issuance concession from the one-off new issuers.
2020 and December ended with broad gains across most major global equity indices, supported by the US stimulus package, Brexit negotiations concluded and a demonstrable global vaccine rollout. We start 2021 with hopes of an economic recovery helped by strong fiscal and monetary support. We expect equities to continue gaining as economies revert to pre COVID levels and a low interest rate regime. Corporate earnings growth is expected to be strong and profits back to 2019 levels, which should mitigate the high valuations. However, the health crisis has taken its toll on economic growth and the new UK virus variant has led to increased lockdowns. Challenges remain and expect some pullbacks. Tech regulation is now a global concern as is cybersecurity with the increased use of the internet and accelerated digital migration. 2020 has been an unusual year and the extreme March sell off led to US equities losing 25% in 3 weeks. Global travel and airlines sector lost 70% of their revenue from Feb to Dec. All global markets were in correction territory. The equity rally from April is not an anomaly and this is a normal post-recession market. Also the rally began broadening in November, cyclicals are outperforming, yields are rising and the US Dollar is weakening, trends likely to continue this year.
Global equities were up 16.2% in 2020, with most major equity indices positive, barring the UK. The Hang Seng Index ended the year flat though China tech companies partially recovered from the crackdown from China’s regulators. EM stocks +18.3% outpaced DM +15.9% and this supports our recent increased OW EM positioning. In December, EM equities gained 7.4% aided by a weaker Dollar and strong inflows. China led global equity returns consistently as the first economy to return to normal. The GCC ended flat for the year with the Abu Dhabi and KSA indices in the green and the Dubai index slightly negative at -5%. US equity indices continue a decade long rally with the Nasdaq +45% and the S&P 500 +18.4%. Leading global sectors last year were Tech, Consumer Disc., Comm Services and Materials. Laggards with negative returns are Energy, Real Estate and Financials. Tech outshone as online shopping, gaming and cloud use accelerated the shift of companies to a more digital platform. We recommend staying invested in tech but selectively and keeping an eye on the future trends i.e. 5G and EVs. Tesla entered the S&P 500 with a market cap higher than the top 7 auto manufacturers combined, as the shift to EVs accelerated. Apple added close to $ 1 trillion in market cap in 2020 closely followed by Amazon. The NYFAANG index doubled. This has raised concerns from regulatory authorities on not only their monopolistic hold in search, ecommerce and payments, but the data these companies control. Genomic stocks saw the biggest gains in 2020, at over 200%. We continue to like the broader healthcare sector and quality banks in the financial space. Growth +34.0% outperformed Value -1.2%. However, November US elections with a Democratic Biden win buoyed investor sentiment with more visibility on policy and improving global relations and a rotation to cyclical and value stocks.
Written By:Maurice Gravier Chief Investment Officer, MauriceG@EmiratesNBD.com
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Our last weekly publication of 2020
The end of the tunnel?
Adjusting to a clearer 2021 outlook
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