LGT Private Banking House View – August 2020

Headwinds on financial markets are increasing

The pandemic continues to keep financial markets on tenterhooks, although a certain degree of complacency can be noted, not least due to the 20 trillion dollar stimulus from central banks and governments. For capital markets, however, the headwind has increased in recent weeks, especially when they are exclusively in the optimistic camp. The arguments of the "bulls" are as follows:

• Economies are reopening after the lockdown
• There are first successes on the subject of vaccines
• The rate of change in economic data is steadily improving
• The companies will have an explosion in profits next year due to cost control
• Global central banks provide “infinite“ liquidity
• Financing conditions are supportive
• Interest rates remain low

In contrast to this, the “bears” see the world as follows:

• Covid-19 is not under, but out of control
• The reopening is slowing or has even stalled. This will keep unemployment high for longer and harm consumption
• The existing fiscal stimulus will not be sufficient
• Macroeconomic rates of change are beginning to weaken
• Valuations are at a multi-year high
• US elections cause uncertainty
• The risk of a renewed trade conflict between the US and China has increased

Although the arguments of both sides can be rationally understood, they have an enormous scope for interpretation with regard to validity on the time axis and the extent to which this public information is already priced in by capital markets.

Short-term increase in headwinds

We remain constructive in the medium-term, but in the short-term we expect some headwinds for capital markets. We see the following three challenges at the center:

• The consequences of the corona crisis will occupy the economies and thus capital markets much longer than is currently expected. In this situation, the media plays a key role: in particular, the short-term risk of dramatic headlines should not be underestimated.
• The resurgence of the trade conflict between Washington and Beijing comes at an extremely inopportune time, as the global economy is digesting the first wave of the Covid-19 crisis and a second wave seems to be on its way.
• The US presidential election represents another risk factor. Uncertainty is likely to increase in September and October, not only because Trump is known for his polarization, but also because the US fiscal package currently under construction could become a pawn in the election campaign.

Equity risk premium remains attractive

The equity risk premium of the S&P 500 has remained relatively stable between 350 and 400 basis points in recent months (graph 3). Compared with previous years, the values are above the historical average – a similar picture can be seen on other global equity markets. Moreover, the risk premium in the US is more than 500 basis points higher than at the turn of the millennium, when investors even accepted a negative premium. Of course, interest rates were much higher back then, but the capital market today indicates that, in the medium to long term, investors are compensated for the risks they take on equities.

Headwinds will cause volatility, while selection remains key

Our investment strategy continues to have a constructive basic tenor, although the headwinds are likely to cause volatility. At investment strategy level, we prefer equity risks to bond risks, since the investor in the former category is better compensated for the risks taken. Within equities, the focus is less on regions than on industries or individual stocks, i.e. selection is most important. We continue to favor pharmaceutical companies that continue to show an attractive risk/return ratio in historical comparison. In the fixed income universe, corporate bonds still offer a positive return, but here too selection is key. In emerging market bonds, we would stay on the sidelines for the moment. Despite the enormous price advances in gold, this asset class remains attractive to us in the medium to long term. However, since trees do not grow into the sky, we would not chase the rally, at least not in the short-term.

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Imprint
Publisher: LGT Bank (Switzerland) Ltd., Glärnischstrasse 36, CH-8027 Zurich
Author: Thomas Wille, Head Research & Strategy, Email: thomas.wille@lgt.com
Editor: Alessandro Fezzi, E-Mail: alessandro.fezzi@lgt.com
Source: LGT Bank (Switzerland) Ltd.

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