Our View

Banking on the recovery

12.01.2021

Dr Felix Brill · Dr Thomas Gitzel · Bernhard Allgäuer · Harald Brandl

Reading time: 9 Min

Financial markets have started with confidence into the new year. A hard Brexit has been avoided and the signs for 2021 are in favour of a recovery despite the high Corona case numbers.

There is no sign of taking a breather or slowing down. The stock markets made further strong gains in December and the first few days of January. The defining theme is the expected economic recovery. Further impetus has been given by the fact that crucial political issues have been resolved.

Whether it was the Brexit trade agreement or the Democrats in the US winning the run-off elections for the two Senate seats in Georgia, the results were positively received by the markets. As justified as the optimism for 2021 might be, and as much as we pointed out the reasons for it in our December investment magazine Telescope entitled "The Green Recovery“, a healthy degree of caution is advisable in our view.

The Corona virus still has a firm grip on our lives and politics in the here and now. And the Capitol riot in Washington has drastically demonstrated how deeply divided American society is. The wild swings in Bitcoin's price over the past few days are also a stark reminder that financial markets are not a one-way street.

At the turn of the year, we have adjusted the strategic investment quotas in asset management and feel encouraged by the the latest developments. With a strategic increase in the equity quota, we are banking on the economic upswing in the coming years and consider alternative investments to be essential in order to be prepared for setbacks. In particular, we consider insurance-linked securities (ILS) to be a very useful part of the asset allocation in the current year.

Asset Allocation as of January 2021

Key to Asset Allocation

Our View on the Portfolio

Shorter duration to reduce interest rate risks
European equities with catch-up potential
Attractive insurance premiums for insurance-linked securities

Government bonds remain unattractive beyond the diversification effect
Tactical restraint on USD bonds

Our View on the Economy

Lean economic diet at the beginning of the year

The Covid-19 pandemic is putting a strain on economic development in the first quarter. Around the globe, new and even stricter protection measures are being taken. In many countries, particularly in Europe, gross domestic product (GDP) will therefore shrink in the first three months of the year. On the other hand, a second large relief package in the US is a positive. The government checks for private households and smaller businesses will keep the US economy afloat in the coming months. Likewise, the newly won majority of the Democrats in the US Congress promises more government stimulus this year. Finally, vaccination programmes have been set up in many countries which should allow for a gradual return to normality in the second half of the year. So 2021 promises improvements but it won’t be straightforward.

The distribution of a vaccine promises a gradual return to normality during 2021
The low interest rate environment continues to provide a tailwind for the construction industry
The public sector is ready to provide generous financial relief

Due to the particular anatomy of the Corona recession, catch-up effects will be weaker
The recovery is hampered by rising insolvency numbers
The sharp widening of budget deficits will constrain fiscal policy in the future

Our View on Monetary policy

Fed will not move for the time being

The Fed has seen no reason to change its monetary policy stance at the last meeting. Yet it stressed that it will continue the securities purchase programme until substantial progress has been made in the labour market and regarding inflation. This at least extends the time horizon of quantitative monetary policy, since there has only been talk so far of "several months." Given the European Central Bank's renewed easing, there were expectations that the Fed would step up its measures as well. With the US economy performing relatively well in the face of adverse circumstances, Fed Chairman Jerome Powell did not see the need to act. Powell insisted that Congress would adopt, as it later did, another relief package. The Fed's calculation is likely to be that no additional monetary policy stimulus is needed if financial policy is used.

The end of expansionary monetary policy has not yet been reached
Despite a recently unchanged policy, the Fed is ready to act at any time

Central banks' arsenal will be limited in the future
Increasing risk of asset bubbles

Our View on Government Bonds

Majority for Democrats lifts US yields

The Democrats' victory in the runoff for the two Senate seats in the US state of Georgia had a significant impact on the yield of 10-year Treasury bonds as yields have returned to above 1%. The market participants seem to think that the US President-elect Joe Biden will be able to set his political agenda to motion to the greatest extent possible with the congressional majority. Biden's large-scale infrastructure programme would lead to higher debt and thus a larger bond supply. However, it remains to be seen whether Biden will actually push through extra spending with a majority of just one vote in the Senate against Republican criticism. He will probably seek consensus. Nevertheless, at least part of the infrastructure programme is likely to be drawn up. We believe that the expectations of market participants are justified.

The ECB's net purchase volume covers the net debt issuance of government bonds in 2021
Euro-periphery bonds may benefit
Government bonds help to diversify a portfolio

Government bond issuance has increased massively
Rising public debt ratios are likely to worsen sovereign credit quality
Government bonds carry a high interest rate risk

Our View on Corporate bonds

Be prepared for potential downgrades

Corporate indebtedness has risen sharply since the financial crisis. Despite record-low interest rates, an increasing number of companies are unable to pay their interest from cash flow. An analysis by the Fed New York shows that Covid-19 has accelerated this process. Credit rating agencies respond with a review of the credit rating and issue outlooks which are equivalent to potential up- or downgrades. The gap between such potential downgrades and upgrades has never been so big. At present, the outlook for 1224 companies is negative (up from 600 last year) . On the other hand, the outlook is positive for only 161 (250 a year ago). We do not think that a compensation of less than 1% for investment grade bonds and 3.5% for high yield bonds is sufficient in this environment. We expect that, sooner or later, central banks will allow a controlled increase in the risk premium.

Central banks have unlimited resources to buy corporate bonds
The low interest rate environment is likely to continue for a long time
Further fiscal relief measures to support the economy will be provided if necessary

Fundamental data have deteriorated significantly as a result of the pandemic
Number of credit rating downgrades doubled in 2020 compared to the previous year
Support for central banks could be called into question if inflation risks emerge

Our View on Equities

Optimistic mood

Despite the global health crisis, investors are looking to the future. Their focus is on tangible solutions and the willingness of states to provide support to the ailing economy. Likewise, uncertainties such as those around Brexit, are diminishing, and the change of government in the US promises a return to proven diplomatic practices in international politics. The fundamental valuation have been cooled down by improved profit growth prospects, and the rapid pace of digitisation supports global profitability and optimisation of existing and the emergence of new business models. Europe and the emerging economies in Asia offer the most attractive catch-up potential, Switzerland offers high quality and stable yields.

An end to the global health crisis seems close with vaccines being administered
Fiscal policies strengthen growth momentum

The temporary euphoria in stock markets can lead to higher price fluctuations
Equities in the technology and Internet consumption segments appear overvalued

Our View on European equities

Stronger together

The pandemic appears to be bringing decision-makers in the European Union (EU) in line. If a federal debt structure was unthinkable at the beginning of last year, it will now enter into force just as much as a trillion-dollar fiscal stimulus package. It seems that Europe is moving forward after all. The stock markets in Europe are well placed, because the fundamental valuations are as low as the profit expectations of market participants. In this constellation, small progress is already sufficient to achieve great effects. Expected growth in mobility, rapid digitisation and a focus on infrastructure renewal create opportunities across the whole spectrum of the European economy. This should also be beneficial to European stock markets.

The EU reconstruction plan together with the new EU budget make more than EUR 1.8 trillion available under the fiscal financing framework for the next seven years
European equities are attractively valued

The health crisis is not yet under control
Certain tensions in international trade remain unresolved

Our View on Alternative Assets - ILS

Excellent outlook for 2021

The first forecasts for the 2021 Atlantic hurricane season have already been published. Seven hurricanes (three of them severe) and 16 designated storms are expected. This is about average comparing with the last ten years. Last year, 13 hurricanes and 30 designated storms were recorded, due to the weather phenomenon La Niña. It was only the third time that six hurricanes made landfall in the US. Fortunately, in most cases, this happened in sparsely populated areas. The damage at USD 60-65 billion was high, but fell well short of USD 278 billion in 2017. Some of these damages are not insured or covered by insurance. The remaining damage that was paid to Insurance-linked Securities (ILS) was lower than expected. Compared to 2020, insurance premiums are significantly higher today. The outlook for 2021 is therefore excellent.

Performance independent of financial markets and the economy
Higher premiums after damage in the past
Excellent diversification

Risk of major losses due to unusually severe natural disasters
Does not benefit from recovery when the corona virus is overcome
The greatest risk is a hurricane over the Florida metropolis, e.g. Miami

Our View on Currencies

Dollar weakness looks over-stretched

The USD is now in a descent that has lasted for more than eight months. There are now a whole series of indicators signalling a consolidation or even backward movement. The positioning of speculative investors on a continued weakness of the USD as a counter-indicator warrants particular caution. But the deviation from the broad dollar index to the two-year rolling median also shows that the bow may be overstretched in the short term. We are sticking to our view of a longer-term weakness in the US dollar. In the short term, however, we are expecting a consolidation which may also entail a short-term strength of the US currency.

USD: The recent sharp devaluation of the Greenback suggests a backlash
GBP: The Brexit deal opens up further appreciation potential for sterling
AUD: Benefits from China's Economy

Emerging-market currencies benefited only partially from the weakness of the US dollar due to a difficult fundamental situation
The Turkish lira remains weak
CHF: The signs are for depreciation against the euro

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Find past publications here:

Our View for 2021

Our View in November 2020

Our View in October 2020

Important legal advice

This documentation was produced by VP Bank AG (hereinafter the bank) and distributed by the companies of the VP Bank Group. This documentation does not constitute an offer or an invitation to purchase or sell financial instruments. The recommendations, estimates and statements contained therein reflect the personal views of the relevant analyst of VP Bank AG at the time of the date stated on the documentation and can be changed at any time without prior notice. The documentation is based on information that is considered reliable. This documentation and the assessments or assessments made therein are prepared with the utmost care, but their accuracy, completeness and accuracy cannot be guaranteed or guaranteed. In particular, the information contained in this documentation may not include all relevant information on the financial instruments covered or their issuers.

For more important information on the risks associated with the financial instruments in this documentation, the proprietary business of the VP Bank Group or the management of conflicts of interest in relation to these financial instruments, and for the distribution of this documentation, see www.vpbank.com/legal_notes

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