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US Equities New Record High Overrides Fears of Rising Inflation

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The U.S. equity market set a record high during the last week of July with the benchmark S&P 500 index closing higher for the sixth consecutive month, overriding fears of rising inflation and a potential slowdown in economic growth. On July 19, the U.S. Business Cycle Dating Committee announced that the COVID-19 induced two month U.S. recession from March to April of 2020 was the shortest on record, putting the 1980 February to July recession in second place.

Upcoming key events include Fed Chairman Powell’s keynote speech at the Jackson Hole Economic Symposium on this year’s theme “Macroeconomic Policy in an Uneven Economy,” on Aug. 26, which follows the July jobs report that came out on August 6^th. Goldman Sachs economists “expect the Fed will first hint that it intends to decrease the size of its $120 billion monthly asset purchases at its September meeting, formally announce tapering in December, and begin tapering in early 2022.” Chairman Bernanke’s 2013 ‘taper tantrum’ statement that the Fed “could in the next few meetings take a step down in its pace of purchases” started a five-day, 40 basis point rise in the 10-year UST yield to 2.6% and 5% drop in stocks.

GAMCO’s Private Market Value (PMV) with a Catalyst™ stock research ideas highlighted as ‘stock picks’ during BARRON’S 2021 Midyear Roundtable, published in the July 19, issue, were: CNH Industrial (CNHI) that recently purchased Raven Industries (RAVN), a leader in precision-agriculture technology, Mexico’s TV network Grupo Televisa (TV) popular with the Spanish-speaking population, Deutsche Telekom (DTE) with a valuable stake in T-Mobile US (TMUS), Vivendi (VIV) a play on music streaming, ViacomCBS (VIACA) a restructuring play, Liberty Braves Group (BATRA) with John Malone at bat, Madison Square Garden Sports (MSGS) with James Dolan up, and Traton (8TRA) a truck maker spun out of Volkswagen with 25% of the Class 8 truck market in Europe, and now in the U.S. via its purchase of Lisle, Illinois based Navistar Inc.

Looking to M&A, Willis Towers Watson (WLTW) and Aon (AON) mutually agreed to walk away from their all-stock, $30 billion merger. Willis Towers Watson agreed to be acquired by Aon in March 2020 and terms of the deal called for Willis Towers shareholders to receive 1.08 shares of Aon for each share. In June, the U.S. DOJ filed suit to block the deal even though the European Commission had already granted conditional regulatory approval after the parties had agreed to sell overlapping business units that generated billions of dollars in revenue. Following efforts to negotiate additional divestitures to mollify the DOJ, an impasse was reached with the regulator and the parties opted to continue as separate companies. Willis Towers Watson received a $1 billion termination fee from Aon as a result, and will use the funds to buy back $1 billion of its stock. The unexpected move resulted in spreads widening on other mergers in sympathy.

Although this was a shock to the M&A market, we believe conditions are strong for continued strength building off of the record $2.8 billion from the first half of the year. Favourable dynamics remain in place, including historically low interest rates, accommodating debt markets, substantial dry powder held by private equity firms and management teams looking to better compete in an overall evolving global marketplace. While more deals do not necessarily translate to outsized returns, it, coupled with these various drivers, certainly provides for an encouraging landscaping and backdrop for investment opportunities within a portfolio like ours.

Rounding out our outlook with the convertibles space, the global convertible market saw some weakness in July, weighed down by a few large Chinese issuers. While some of these issues are now more attractively priced, we continue to view them cautiously. July was also the worst month for new issuance globally in nearly two years with only $3.4 billion of convertibles pricing. We are confident that issuance will pick back up as companies exit quiet periods around earnings and we approach typically busier fall months. The fundamental reasons for increased convertible issuance are still quite intact with low interest rates, increasing equity prices, and favourable tax environments available to most potential issuers.

To summarize, GAMCO continues to expect more deals — mergers, spinoffs, and other forms of financial engineering. Stocks should continue to do well with politicians spending to ensure a good economy for the midterms, and convertibles are an appealing way to stay invested in equities with the benefit of asymmetric risk exposure.

___________________________________________

To access our proprietary value investment methodology, and dedicated merger arbitrage portfolio we offer the following UCITS Funds in each discipline:

GAMCO MERGER ARBITRAGE

GAMCO Merger Arbitrage UCITS Fund, launched in October 2011, is an open-end fund incorporated in Luxembourg and compliant with UCITS regulation. The team, dedicated strategy, and record dates back to 1985. The objective of the GAMCO Merger Arbitrage Fund is to achieve long-term capital growth by investing primarily in announced equity merger and acquisition transactions while maintaining a diversified portfolio. The Fund utilizes a highly specialized investment approach designed principally to profit from the successful completion of proposed mergers, takeovers, tender offers, leveraged buyouts and other types of corporate reorganizations. Analyzes and continuously monitors each pending transaction for potential risk, including: regulatory, terms, financing, and shareholder approval.

Merger investments are a highly liquid, non-market correlated, proven and consistent alternative to traditional fixed income and equity securities. Merger returns are dependent on deal spreads. Deal spreads are a function of time, deal risk premium, and interest rates. Returns are thus correlated to interest rate changes over the medium term and not the broader equity market. The prospect of rising rates would imply higher returns on mergers as spreads widen to compensate arbitrageurs. As bond markets decline (interest rates rise), merger returns should improve as capital allocation decisions adjust to the changes in the costs of capital.

Broad Market volatility can lead to widening of spreads in merger positions, coupled with our well-researched merger portfolios, offer the potential for enhanced IRRs through dynamic position sizing. Daily price volatility fluctuations coupled with less proprietary capital (the Volcker rule) in the U.S. have contributed to improving merger spreads and thus, overall returns. Thus our fund is well positioned as a cash substitute or fixed income alternative.

Our objectives are to compound and preserve wealth over time, while remaining non-correlated to the broad global markets. We created our first dedicated merger fund 32 years ago. Since then, our merger performance has grown client assets at an annualized rate of approximately 10.7% gross and 7.6% net since 1985. Today, we manage assets on behalf of institutional and high net worth clients globally in a variety of fund structures and mandates.

Class I USD – LU0687944552
Class I EUR – LU0687944396
Class A USD – LU0687943745
Class A EUR – LU0687943661
Class R USD – LU1453360825
Class R EUR – LU1453361476

GAMCO ALL CAP VALUE

The GAMCO All Cap Value UCITS Fund launched in May, 2015 utilizes Gabelli’s its proprietary PMV with a Catalyst™ investment methodology, which has been in place since 1977. The Fund seeks absolute returns through event driven value investing. Our methodology centers around fundamental, research-driven, value based investing with a focus on asset values, cash flows and identifiable catalysts to maximize returns independent of market direction. The fund draws on the experience of its global portfolio team and 35+ value research analysts.

GAMCO is an active, bottom-up, value investor, and seeks to achieve real capital appreciation (relative to inflation) over the long term regardless of market cycles. Our value-oriented stock selection process is based on the fundamental investment principles first articulated in 1934 by Graham and Dodd, the founders of modern security analysis, and further augmented by Mario Gabelli in 1977 with his introduction of the concepts of Private Market Value (PMV) with a Catalyst™ into equity analysis. PMV with a Catalyst™ is our unique research methodology that focuses on individual stock selection by identifying firms selling below intrinsic value with a reasonable probability of realizing their PMV’s which we define as the price a strategic or financial acquirer would be willing to pay for the entire enterprise. The fundamental valuation factors utilized to evaluate securities prior to inclusion/exclusion into the portfolio, our research driven approach views fundamental analysis as a three pronged approach: free cash flow (earnings before, interest, taxes, depreciation and amortization, or EBITDA, minus the capital expenditures necessary to grow/maintain the business); earnings per share trends; and private market value (PMV), which encompasses on and off balance sheet assets and liabilities. Our team arrives at a PMV valuation by a rigorous assessment of fundamentals from publicly available information and judgement gained from meeting management, covering all size companies globally and our comprehensive, accumulated knowledge of a variety of sectors. We then identify businesses for the portfolio possessing the proper margin of safety and research variables from our deep research universe.

Class I USD – LU1216601648
Class I EUR – LU1216601564
Class A USD – LU1216600913
Class A EUR – LU1216600673
Class R USD – LU1453359900
Class R EUR – LU1453360155

GAMCO CONVERTIBLE SECURITIES

GAMCO Convertible Securities’ objective is to seek to provide current income as well as long term capital appreciation through a total return strategy by investing in a diversified portfolio of global convertible securities.

The Fund leverages the firm’s history of investing in dedicated convertible security portfolios since 1979.

The fund invests in convertible securities, as well as other instruments that have economic characteristics similar to such securities, across global markets (but the fund will not invest in contingent convertible notes). The fund may invest in securities of any market capitalization or credit quality, including up to 100% in below investment grade or unrated securities, and may from time to time invest a significant amount of its assets in securities of smaller companies. Convertible securities may include any suitable convertible instruments such as convertible bonds, convertible notes or convertible preference shares.

By actively managing the fund and investing in convertible securities, the investment manager seeks the opportunity to participate in the capital appreciation of underlying stocks, while at the same time relying on the fixed income aspect of the convertible securities to provide current income and reduced price volatility, which can limit the risk of loss in a down equity market.

Class I USD LU2264533006

Class I EUR LU2264532966

Class A USD LU2264532701

Class A EUR LU2264532610

Class R USD LU2264533345

Class R EUR LU2264533261

Class F USD LU2264533691

Class F EUR LU2264533428

Disclaimer:
The information and any opinions have been obtained from or are based on sources believed to be reliable but accuracy cannot be guaranteed. No responsibility can be accepted for any consequential loss arising from the use of this information. The information is expressed at its date and is issued only to and directed only at those individuals who are permitted to receive such information in accordance with the applicable statutes. In some countries the distribution of this publication may be restricted. It is your responsibility to ﬁnd out what those restrictions are and observe them.

Some of the statements in this presentation may contain or be based on forward looking statements, forecasts, estimates, projections, targets, or prognosis (“forward looking statements”), which reﬂect the manager’s current view of future events, economic developments and ﬁnancial performance. Such forward looking statements are typically indicated by the use of words which express an estimate, expectation, belief, target or forecast. Such forward looking statements are based on an assessment of historical economic data, on the experience and current plans of the investment manager and/or certain advisors of the manager, and on the indicated sources. These forward looking statements contain no representation or warranty of whatever kind that such future events will occur or that they will occur as described herein, or that such results will be achieved by the fund or the investments of the fund, as the occurrence of these events and the results of the fund are subject to various risks and uncertainties. The actual portfolio, and thus results, of the fund may differ substantially from those assumed in the forward looking statements. The manager and its affiliates will not undertake to update or review the forward looking statements contained in this presentation, whether as result of new information or any future event or otherwise.

Multi Asset Credit and Absolute Return Fixed Income: Better Together?

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At a time when interest rates are either ultra-low or even negative, positive inflation-adjusted returns are in short supply. To achieve them, bond investors have turned to strategies that have the flexibility to invest in different types of fixed income, the most popular of which are multi asset credit (MAC) and absolute return fixed income (ARFI).

Both have plenty to commend them. But they should not necessarily compete for investors’ capital.

We would argue that it doesn’t have to be a case of one or the other. In fact, combining the two can improve a bond portfolio’s diversification and increase its overall risk-adjusted returns over the long run. That’s because MAC strategies tend to do particularly well when interest rates and bond spreads are stable, while ARFI portfolios outperform during periods of credit stress or when interest rates are volatile.

Universe and diversification

For a start, MAC strategies tend to have a tilt towards high yield rather than investment grade bonds. This helps them perform especially well when market volatility is low and yield spreads between corporate and government bonds are narrowing. Their overall credit investment remit, however, can be very broad; some portfolios include investments in private debt and loans. This means MAC strategies traditionally offer greater diversification than a direct allocation to high yield credit. It is the freedom to allocate capital across credit sectors that gives portfolio managers the opportunity to secure excess returns. Not only can they shift between investment grade and high yield, but also within those broad sectors into loans, subordinated bank debt and more.

By comparison, the ARFI universe tends to be, by design, much broader, embracing the full fixed income toolkit; the investment styles and the sources of excess return or ‘alpha’ are more diverse than for MAC strategies. In many cases such portfolios also invest in credit, but often do so alongside currencies, interest rate products and derivatives. Probably the most common feature of ARFI strategies is the incorporation of capital protection/risk mitigation trades. The aim here is to improve risk-adjusted returns, but it also means that absolute return strategies tend to lag during bull markets in credit spreads.

ARFI strategies also use all the investment tools available, including derivatives, to manage risk – keeping the desired exposure while hedging out unwanted risk – across the full spectrum of fixed income sectors. This makes ARFI strategies less sensitive than MAC strategies to the overall direction of the credit market. For example, an ARFI strategy can protect against the risk of inflation and rising rates by taking a negative duration position.

As ARFI strategies usually have a lower allocation to high yield debt than MAC portfolios, they tend to have lower solvency capital requirements (SCR), making them more attractive as investments among insurance companies that are subject to Solvency II regulations.

The differences between the two strategies mean that correlation of the returns generated by ARFI and MAC strategies tends to be relatively low, and certainly much lower than between the returns of the different funds within the MAC universe (see Fig. 1). Combining the two strategies could thus offer diversification benefits compared to investing in just one.

Liquidity versus returns

As a rule of thumb, credit investments and emerging market bonds tend to be less liquid than developed market sovereign debt and currencies. Thus, MAC strategies – which invest heavily in such assets – are usually less liquid than their ARFI counterparts, particularly if they have allocations to loans or private debt. This makes the risk of a sharp drawdown – or a sizeable peak to trough capital loss – more significant for the MAC strategies. This is particularly challenging during periods when market liquidity evaporates, as was the case in March 2020 and December 2018 (see Fig. 2). This is also the case even when comparing the top quartile MAC strategies with Pictet’s Absolute Return Fixed Income strategy.

On the flip side, by capturing this liquidity premia, MAC strategies tend to deliver higher returns, on average, than their ARFI peers over the course of a market cycle.
For a typical MAC strategy, up to 80 per cent of performance would be attributed to movements in yield spreads. By comparison, Pictet’s Absolute Return Fixed Income strategy aims to diversify the sources of return evenly between spreads, rates and currencies. By doing so, Pictet targets a liquid portfolio at all times.

The source of return also tends to be different, with MAC taking a more bottom-up approach and ARFI tending to place more emphasis on top-down, macroeconomic factors in portfolio construction. In our ARFI strategy, for example, only about 10 per cent of overall performance comes from security selection.

Manager diversification matters

One downside of the ARFI approach is the fact that the strategies are not homogenous, and success is highly dependent on manager skill. Due diligence is thus paramount. The same can also be said of MAC, where return dispersion within the universe is similarly high.

Both are dependent on portfolio managers’ timing when rotating between different investments. In fact, this is arguably more important for MAC strategies given that such portfolios concentrate investments in a narrower range of sectors and are less liquid.

Best of both worlds?

Despite their differences, MAC and ARFI vie for the same type of investor – one who is looking for a flexible approach that generates returns even in the current climate of low yields and low credit spreads. Yet, there are enough differences for the two types of strategies to be complementary. MAC can offer access to more exotic and less liquid securities that offer the prospect of higher yield. A well-balanced ARFI strategy, meanwhile, can harness strong macroeconomic trends while reducing risk and yet still delivering positive real returns.

By combining the two and selecting the managers that play to each strategy’s strengths, investors can thus achieve better risk adjusted returns than by focusing on either one in isolation (see Fig. 3).

Written by Andrés Sánchez Balcázar, Head of Global Bonds team at Pictet Asset Management.

Discover more about Pictet Asset Management’s wide range of fixed income strategies.

Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.

Important notes

This material is for distribution to professional investors only. However it is not intended for distribution to any person or entity who is a citizen or resident of any locality, state, country or other jurisdiction where such distribution, publication, or use would be contrary to law or regulation. Information used in the preparation of this document is based upon sources believed to be reliable, but no representation or warranty is given as to the accuracy or completeness of those sources. Any opinion, estimate or forecast may be changed at any time without prior warning. Investors should read the prospectus or offering memorandum before investing in any Pictet managed funds. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

This document has been issued in Switzerland by Pictet Asset Management SA and in the rest of the world by Pictet Asset Management Limited, which is authorised and regulated by the Financial Conduct Authority, and may not be reproduced or distributed, either in part or in full, without their prior authorisation.

For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.

Pictet Asset Management Inc. (Pictet AM Inc) is responsible for effecting solicitation in North America to promote the portfolio management services of Pictet Asset Management Limited (Pictet AM Ltd) and Pictet Asset Management SA (Pictet AM SA).

In Canada Pictet AM Inc is registered as Portfolio Managerr authorized to conduct marketing activities on behalf of Pictet AM Ltd and Pictet AM SA. In the USA, Pictet AM Inc. is registered as an SEC Investment Adviser and its activities are conducted in full compliance with the SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref. 17CFR275.206(4)-3.

Pictet Asset Management: No Need for Evasive Action

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There is no summer lull for investors this year. The global economy is powering ahead despite the resurgence of COVID-19 infections while inflationary pressures continue to build, particularly in the US. Then there’s renewed upheaval in China.

The Chinese government’s surprise ban on for-profit after-school tutoring, essentially shutting down the circa USD100 billion edu-tech sector, has raised concerns about an intensification of Beijing’s regulatory crackdowns. The latest intervention comes on the heels of cybersecurity investigations of the ride hailing app DiDi and other e-commerce companies, increased scrutiny of overseas IPOs and the imposition of fines and restrictions on some of China’s largest e-commerce firms.

Authorities have also moved to restrict the use of the variable interest entities (VIE) structure – holding companies based in tax haven jurisdictions and designed to allow foreign investors to invest in key sectors such as tech without giving them any operational control.

A positive reading of such developments is that they are a belated response to innovation and the breakneck growth of industries that flourished in the absence of a regulatory framework. Even though such moves would in effect add a permanent ‘risk premium’ to Chinese stocks and bonds, the should not fundamentally change China’s growth model or the broader investment case for the country’s financial assets.

Nonetheless, a greater degree of caution seems sensible and we feel justified in taking profits in Chinese bonds, which have performed strongly year-to-date.

More broadly, we retain a neutral allocation across equities, bonds and cash; still, we continue to favour assets that benefit from stronger economic potential, such as European stocks.

Our business cycle analysis shows that economic activity is picking up strongly across the euro zone, following a sharp deceleration over the last two quarters. Purchasing manager indices remain buoyant, especially in the service sector. Retail sales have meanwhile recovered above the pre-pandemic trend. Bank lending conditions are also easing, which augurs well for future credit growth. Overall, it would seem that European economic growth is more likely to to surpass consensus forecasts than the US, where we are starting to see some signs that its expansion is moderating. Worryingly, second quarter GDP growth came in at just 6.5 per cent on an annualised basis – some 2 percentage points below the consensus forecast.

China’s growth has clearly peaked with industrial production, retail sales and construction all coming in below their three-year average. Even so, we still expect a very respectable 10 per cent expansion in GDP for the year – some distance above the 8.5 per cent consensus forecast.

Should Beijing’s regulatory crackdowns threaten growth, however, there is some comfort to be taken from our liquidity indicators, which show that China has plenty of monetary fire power. Indeed, we already saw authorities take action in July, when the People’s Bank of China (PBOC) announced a 50 basis point cut in the reserve requirement ratio (RRR); we expect to see more action in coming months.

The US is moving in the opposite direction, with the US Federal Reserve edging into the first stages of a tightening cycle. Notably, at its latest meeting, the US central bank highlighted the improvement in economic conditions and “progress” in the labour market. However, we expect the tightening journey to be a relatively slow one, and for now US monetary policy remains the loosest of all the world’s major economies, according to our models.

One of the clearest signals from our valuation models is that US Treasures now look expensive, particularly when compared to levels implied by the cyclical trends we monitor.

The same applies to US equities. US stocks’ price-to-earnings ratio of 21.5 times based on 12 month forward earnings can only be sustained if trend growth is unchanged, profit margins are stable at high levels and bond yields stay low. So far, the recovery in US earnings has been in line with GDP (see Fig. 2), and we think further upside to this year’s corporate profit growth is unlikely in the absence of an upward revision to US GDP growth forecasts.

Technical indicators suggest the correlation in the returns of equities and bonds has turned negative again, improving the diversification appeal of fixed income.

Another conclusion to draw from our technical gauges is that investors appear more cautious. This is arguably reflected in the strong inflows into government bonds seen in recent weeks, as well as into equity funds that invest in quality stocks. Some USD6.7 billion flowed into tech, healthcare and consumer goods stocks in the first three weeks of July at expense of cyclical sectors, according to EPFR data. Approximately USD3.1 billion was withdrawn from financials, materials and energy stocks in the same period.

Opinion written by Luca Paolini, Pictet Asset Management’s Chief Strategist.

Discover Pictet Asset Management’s macro and asset allocation views.

Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.

Important notes

This material is for distribution to professional investors only. However it is not intended for distribution to any person or entity who is a citizen or resident of any locality, state, country or other jurisdiction where such distribution, publication, or use would be contrary to law or regulation. Information used in the preparation of this document is based upon sources believed to be reliable, but no representation or warranty is given as to the accuracy or completeness of those sources. Any opinion, estimate or forecast may be changed at any time without prior warning. Investors should read the prospectus or offering memorandum before investing in any Pictet managed funds. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

This document has been issued in Switzerland by Pictet Asset Management SA and in the rest of the world by Pictet Asset Management Limited, which is authorised and regulated by the Financial Conduct Authority, and may not be reproduced or distributed, either in part or in full, without their prior authorisation.

For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.

Pictet Asset Management Inc. (Pictet AM Inc) is responsible for effecting solicitation in North America to promote the portfolio management services of Pictet Asset Management Limited (Pictet AM Ltd) and Pictet Asset Management SA (Pictet AM SA).

In Canada Pictet AM Inc is registered as Portfolio Managerr authorized to conduct marketing activities on behalf of Pictet AM Ltd and Pictet AM SA. In the USA, Pictet AM Inc. is registered as an SEC Investment Adviser and its activities are conducted in full compliance with the SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref. 17CFR275.206(4)-3.

As Markets Edge Back Toward Normal, Fed Optionality Could Be Key

| For Beatriz Zúñiga | 0 Comentarios

26021684772_7c7d87530e_c (1) — Foto cedida. A medida que los mercados vuelven a la normalidad, las opciones de la Fed podrían ser claves

As investors search for clues about when and how the US Federal Reserve will normalize monetary policy, Fed Chairman Jerome Powell deserves a place in the “central bank Hall of Fame” for developing a management and communication style that has provided the central bank with plenty of options to normalize policy depending on how growth and inflation evolve.

Powell has connected with markets very differently than his predecessors, showing a willingness to be behind the curve as he uses policy to curb inequality and unemployment, but ready to raise rates or cut quantitative easing if things don’t turn out as planned.

That covenant with markets distinguishes him from previous Fed chairs: Alan Greenspan spoke opaque “Fedspeak” but revealed little, Ben Bernanke spoke plainly but vacillated and Janet Yellen, shadowed by the “taper tantrum” from the year before her tenure, was hesitant to normalize rates despite ideal conditions for such action. Four years of clearly communicating policy and being flexible when needed has convinced markets that Powell’s Fed needs policy optionality. With 10-year US Treasuries yielding about 1.4% despite consumer prices increasing 5.4% in June, markets are signaling that, based on his record, Powell is a safe pair of hands.

Powell earned this reputation quickly. He became Fed chair in early 2018 amid a 10-day, nearly 10% S&P 500 drawdown and immediately showed his fortitude. Despite market jitters, he pressed ahead with the Fed’s planned policy tightening, hiking rates four times in 2018. And, unbowed by the memory of the “taper tantrum,” pre-pandemic he had set a plan to reduce the Fed’s $4.5 trillion balance sheet over four years via $50 billion of monthly sales.

More recently, Powell’s bold actions to thwart pandemic disruption through unprecedented policy support and innovative liquidity programs were undertaken with assuredness. He also changed course when needed, as when he allowed Fed purchases of high-yield securities, and he found broad bipartisan support for his policies during a time when US politics have been divided and acrimonious.

Now, with stocks markets buoyant, the US economy enjoying its most rapid expansion since 1984 and prices spiking in certain sectors, Powell is nearing the end of his first term, which expires in February. With an announcement on his potential renomination expected by October or November, in my view, Powell deserves a second term to manage the transition back to normalized monetary policy.

Policymakers question Fed role in housing market

Powell’s Fed faces unique challenges to keep the US economy from overheating as it emerges from its pandemic-induced hibernation: Interest rates remain near zero and the Fed’s balance sheet continues expanding by $120 billion monthly. Policymakers are questioning whether these accommodations are still needed, particularly the Fed’s support for a housing market in which prices are already at record highs and forecast to continue rising. While the Fed should soon announce its tapering plans, policymakers are keenly aware of having missed inflation targets for the past decade and the fact that labor supply could jump as emergency jobless benefits expire and schools reopen.

As Fed watchers debate whether the Fed is ahead of or behind the curve, the reality is Powell’s policy of allowing inflation to run above its 2% target to compensate from a decade of insipid price gains. Fed strategy is to always be slightly behind the curve, thereby affording optionality.

Powell’s Fed has been clearly signaling it is keeping all options open. St. Louis Fed President James Bullard has openly questioned whether the Fed should buy mortgages, Dallas Fed President Robert Kaplan has said he supports tapering sooner rather than later, and Fed Governor Christopher Waller has said the Fed should taper this year to allow for the option of raising rates in late 2022, if needed.

Investors can expect even more clarity on upcoming Fed policy actions, both on tapering and the timing and pace of potential rate increases, at the Fed’s annual Jackson Hole retreat in August and then in the following weeks as Fed officials reinforce any evolution of policy via their public appearances.

Implications for investors

For fixed-income investors, conditions suggest there is little credit or liquidity risk, with interest rate risk now front and center. Low levels of credit risk can be attributed to the improvement in US corporate balance sheets during the pandemic, a rapidly strengthening US economy, and a consumer sector remarkably flush with cash to spend. Liquidity risk, too, should remain subdued thanks to the Fed’s deft handling both of policy and communication, as evidenced by the sanguine market reaction to the Fed’s announcement in June that it plans to unwind its corporate bond purchasing program (the Fed’s Secondary Market Corporate Credit Facility.) On the other hand, interest rate risk could carry significant volatility in either direction over the coming quarters.

Given the Fed’s desire for policy optionality to fight unwanted inflation and the fact that many large US public pension plans are close to being fully funded, we could see increased demand for very long-duration debt, possibly resulting in a bear flattening of the US Treasury yield curve.

In such a scenario, all yields would rise but the front and intermediate portions of the yield curve would rise a little faster than the long end. This suggests that investors should have some credit spread so their fixed-income portfolios can still generate income. And in the current price environment, investors should also beware paying premiums for securities, which can introduce mark-to-market downside volatility should there be a sharp increase in interest rates or asset class outflows.

With so many unknowns, empowering the crisis-proven Powell to continue leading the Fed would assuage investor concerns and, if markets are to be believed, is probably the best option.

A column by James Dudnick, Portfolio Manager and Director at Allianz Global Investors.

Wage Inflation, Excessive Issuance and Dearth of Liquidity Should Caution Bond Investors

| For Cecilia Prieto | 0 Comentarios

lifesaver-933560_640 — Pixabay CC0 Public DomainSalvavidas. Seguridad

Recently, the Fed spoke about how the U.S. economy was developing better than they had expected. They saw both growth and inflation as higher than they previously forecasted. This prompted the board of governors to move their timing of hikes forward by a few months, although still a couple of years from now. This was a punch in the market’s gut.

The timing estimate alteration was more due to positioning differences, really than a huge change in communication from the Fed. I would say that the Fed unanimously adopted a new inflation targeting framework last year, and part of that inflation targeting framework was that they would wait much longer to act than they had previously. It would be very unusual if the Fed were to change that framework again so quickly, and more likely the statement was simply the acknowledgement of the fact that growth and inflation were maybe notably higher, but still not likely to change their trajectory much.

However, inflation expectations are picking up. There are a lot of questions around the effects of inflation, both in the United States and globally. Although it’s difficult to figure out how temporary supply/demand balances might pass through to long-term price pressures, what investors really need to be looking at are the changes to levels of global wages. Wages are much stickier than goods prices. Lumber costs can go up and down, and commodity costs generally can go up and down, but once you get an increase, it’s hard to unring that bell. As somebody once said to me, “A raise is a raise for about three months, then it’s just your salary.” It almost never goes the other way. We’re seeing some wage pressures and some elements of a labor shortage, definitely in the U.S. and potentially globally. Keep an eye out.

Real Yields are Negative, but Consumer Balance Sheets are Strong

Real yields across the world in developed markets are essentially negative. This is an unprecedented condition and something which is extremely stimulative to the global economy, but the removal of that stimulus and the removal of that combination are challenging as we have seen recently. The market’s reaction to Fed remarks may be exaggerated, but negative real yields continue to be a dominant force. One of the reasons why Bond Connect is so interesting and so important is that China represents a vast market with positive real yields—hard to find elsewhere.

Global households in many places around the world are in much better shape than governments or companies. The consumer balance sheet, in aggregate, is strong relative to both historical metrics as well as versus the health of corporate and government balance sheets. The ability for consumers to service and pay down debt provides a strong fundamental tailwind for securitized bonds, particularly consumer-backed ABS and residential mortgage securities. Securitized bond investing allows investors to access sectors and securities with different risk/reward characteristics, underlying loan diversification, and loss protection features.

Increased Market Size Does Not Equal Greater Liquidity

I would caution investors who believe that lots of supply and larger market size equals good liquidity. Unrestrained issuance doesn’t necessarily lead to better investment opportunities.

In fact, liquidity tends to increase in good times, and evaporate in very bad times, and this exacerbates the market cycles that we’re seeing. When markets have a thirst for liquidity, it’s nowhere to be found, and that’s the environment we’re in, and a direct result of how markets have evolved due to regulation and to investor preference.

Liquidity is particularly important, given flows can be dramatic. One of the reasons why we saw the fastest downturn in credit markets in history in March 2020, was that flows in the worst week were 18 times worse in 2020 than the worst week in 2008. So, more money into markets, more money in and out of markets means that liquidity management is more and more important. That provides an opportunity. If you have got cash when other people don’t, you get some great prices, and ultimately that’s how we’re structured to manage and that’s what we executed in 2020.

Summary: Risk Up, Reward Potential Down

Generally, however, the compensation for taking on risks of over and above high-quality fixed income is pretty low. Heavy issuance by both corporates and the government at low rates has created a lot of unattractive paper. Therefore, we’re risk adverse, but the risk we are taking is more in global consumer balance sheets versus corporate or Treasury balance sheets.

And lastly, across the world you’ve seen a significant increase in duration and interest rate risk with a significant decrease in yield: The global aggregate index is at a duration of 7.4 years and a yield of 1.1. In 2010, the global aggregate had a duration of 5 years, so less interest rate risk, and a yield of 3.1, so almost three times as much yield. In 2000, back when everybody was buying internet stocks, just like they are today, the global aggregate had a duration of 5, so the same as 2010, but its yield was 5.8, which was a significant real yield, significant over and above inflation.

All this is to say risks are relatively high in fixed income and rewards are relatively low. Fixed income is really being used as a policy tool globally, and that’s just something that we as investors both in global fixed income and in global equities are required to navigate, and it’s producing some very unusual markets.

Jason Brady, CFA, is President and CEO at Thornburg Investment Management.

Important Information

The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This information should not be relied upon as a recommendation or investment advice and is not intended to predict the performance of any investment or market.

This is not a solicitation or offer for any product or service. Nor is it a complete analysis of every material fact concerning any market, industry, or investment. Data has been obtained from sources considered reliable, but Thornburg makes no representations as to the completeness or accuracy of such information and has no obligation to provide updates or changes. Thornburg does not accept any responsibility and cannot be held liable for any person’s use of or reliance on the information and opinions contained herein.

Investments carry risks, including possible loss of principal.

Outside the United States

This is directed to INVESTMENT PROFESSIONALS AND INSTITUTIONAL INVESTORS ONLY and is not intended for use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to the laws or regulations applicable to their place of citizenship, domicile or residence.

Thornburg is regulated by the U.S. Securities and Exchange Commission under U.S. laws which may differ materially from laws in other jurisdictions. Any entity or person forwarding this to other parties takes full responsibility for ensuring compliance with applicable securities laws in connection with its distribution.

Please see our glossary for a definition of terms.

Founded in 1982, Thornburg Investment Management is a privately-owned global investment firm that offers a range of multi-strategy solutions for institutions and financial advisors around the world. A recognized leader in fixed income, equity, and alternatives investing, the firm oversees US$45 billion ($43.3 billion in assets under management and $1.8 billion in assets under advisement) as of 31 December 2020 across mutual funds, institutional accounts, separate accounts for high-net-worth investors, and UCITS funds for non-U.S. investors. Thornburg is headquartered in Santa Fe, New Mexico, USA, with additional offices in London, Hong Kong and Shanghai.

For more information, please visit www.thornburg.com

In Private Equity, the AFOREs Will Continue to Diversify Between Local and Global Sectors

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Screenshot 2021-07-06 110628 — Photo: Rulo Luna CC. Foto:

The supply of private equity funds listed on the Mexican stock exchanges (BMV and BIVA), as well as AFOREs’ investments in them, have almost doubled in just over three years. Between December 2017 and March 2021, the number of vehicles increased from 88 to 172 vehicles (+ 95%) while the investments of the AFOREs rose from 7.797 million dollars to 15.365 million dollars (+ 97%).

Mexico is perhaps the only country that has private equity funds registered in its stock exchanges, however, this occurred since the institutional investor can only acquire securities that are the subject of public offering, so making it public was the solution found to give institutional investors access to this asset class in 2009.

In December 2017, investments in private equity were basically local, the real estate sector (30% of the capital called) led the list; followed by infrastructure (21%); private debt (17%); private equity (14%) and energy (11%) to name the most relevant.

By allowing global investment as of January 2018, what has been observed is a recomposition that has allowed the AFOREs to diversify both by sectors and globally.

In December 2017, 93% of the resources were concentrated in 5 local sectors, while by March 2021, 91% were concentrated in 6 sectors where 5 are local and one global. In another 5 additional sectors there are the remaining 7%.

In 2017, investments in CKDs and CERPIs accounted for 4.9% of assets under management and by May 2021 they reached 6.2%, however, it must be taken into account that in the period the assets under management of the AFOREs increased 55% from 160.251 million dollars in December 2017 to 247.825 million dollars as of May 2021.

If you break down 6.2% of the private equity investments held by the AFORE, it means that in just over three years 5.2% are local investments (from 4.9 to 5.2%) and 1% are global investments.

The incorporation of global investments in private equity is not only causing sector diversification, but also a rebalancing between local and global investments. We already observed this recomposition when the AFOREs were allowed to invest in equities (2005), where in the first instance they were allowed local investments and later global investments through a variety of vehicles such as ETFs, mandates and in recent years mutual funds. Currently 14.1% of the assets under management of the AFOREs are in international equities and 5.8% in national equities, which means that 71% of equities are international and 29% local.

Today the AFOREs’ investments in private equity, 80% are in local investments and 20% are global, so as assets continue to grow, the composition of local and global investments will continue to seek sectoral and global diversification.

Column by Arturo Hanono

It’s Always the Right Time for Emerging Markets

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city-1209105_640 — Pixabay CC0 Public DomainEmergentes . Asia emergente

Two questions about investing in emerging markets (EM) are increasingly common: Does it make sense to time allocations to emerging market equities? And given the MSCI’s EM Index’s historic, near-doubling from its March 2020 low, is it time to get out?

Trying to time shifts is difficult in any market, but even more so in emerging markets. Market timing questions aside, there are several compelling reasons to maintain a consistent and material allocation to emerging market stocks, if not increase it.

Why Emerging Markets Should Comprise a Consistent Allocation Within a Portfolio

Developing economies represent about 85% of the global population and generate nearly half of global gross domestic product (GDP), thanks in large part to a rapidly expanding middle class. Not only are these economies contributing a significant portion of the world’s economic output, but their collective GDP has also proven more resilient through the pandemic and is expected to rebound more this year and next. According to the International Monetary Fund’s World Economic Outlook from January, advanced economies are estimated to have declined 4.9% in 2020 and are forecast to expand 4.3% this year and 3.1% in 2022. By contrast, emerging and developing economies collectively declined just 2.4% in 2020 and are seen growing 6.3% in 2021 and 5% next year.

The faster economic growth should be supportive for emerging market earnings, if past experience is any guide. Despite the rapidly increasing importance of emerging markets in a global context, the companies in emerging markets represent less than one quarter of global stock market capitalization. This will very likely grow over time.

While the long-term investment opportunity in EM is compelling, there are portfolio benefits as well. Since its inception in 1988 through December 31, 2020, the MSCI EM Index has delivered a 10.2% annualized total return, which is similar to the S&P 500 Index’s 11% annualized gain and considerably more attractive than the MSCI EAFE Index’s 5.4% rise. Importantly, emerging markets tend to behave differently than their developed-market counterparts as they both under- and outperform each other at different points in time, providing meaningful asset diversification over market cycles.

Indeed, because EM economies and capital markets are less mature, emerging markets still experience pronounced business cycles. This attribute alone could provide a material performance advantage over time, particularly for portfolios that are actively balanced across the growth/value spectrum throughout the cycle. This balance can enhance diversification while positioning the portfolio to take advantage of sector and style rotations.

Although the S&P 500 Index extended its outperformance in the latter half of the last decade, the MSCI EM Index’s 18.7% return in 2020 slightly beat the S&P 500 Index’s 18.4% gain. And over the first two months of 2021, the developing country benchmark more than doubled the return of the S&P 500, perhaps signaling a turn in the cycle. If so, that would reinforce the long-term performance of emerging market equities as well as the portfolio diversification benefit of consistent exposure to emerging markets.

Putting the Last Few Years into Context

Emerging market equities frequently oscillate between strongly positive and sharply negative performance. Putting the moves of the last several years into context illustrates this dynamic nature of EM investing and supports our view that it’s always the right time to be invested in EM.

Following the 2008 Global Financial Crisis, emerging markets rebounded sharply on the back of strong domestic consumption trends and bold stimulus programs, particularly in China. Expectations and valuations grew quickly, but were subsequently disappointed as the debt-fueled stimulus programs began to wear off. Most emerging markets were left with a debt overhang. By 2015, the U.S. Federal Reserve had tapered its asset purchases and then steadily lifted its key rate from late 2016 through mid-2019, spurring a strengthening U.S. dollar. The dollar headwind was too much for most emerging market earnings translated into greenbacks, despite consistent underlying EM growth trends. And while relative valuations favored developing country stocks in recent years, the U.S.–China trade dispute and questions about the future growth rate of China also weighed on broader developing country equities.

Entering 2020, economic conditions looked strong for many emerging markets but the spread of COVID-19 and to a lesser extent an oil price war between Russia and Saudi Arabia ultimately resulted in the first quarter being the worst quarter for global equities since the Great Financial Crisis. A flight to safety ensued as a general sense of fear overcame the markets, resulting in elevated capital flows out of EM and into the perceived safety of the U.S. dollar. The impact was especially painful for EM economies with elevated macro sensitivity to oil as well as those seen as too dependent on foreign investment.

Ultimately, though, with vaccine developments stoking the reopen trade and the U.S. election easing geopolitical tensions, emerging market equities finished an unprecedented 2020 on a high note. The MSCI EM Index returned just under 20% during the fourth quarter, its highest quarterly return in more than a decade.

The years following the Great Financial Crisis have shown once again that emerging markets are volatile. However, investors who maintained consistent exposure to EM during this period would have realized an attractive return on their EM allocation, with annualized performance of 10% for the MSCI EM Index from December 31, 2008, through December 31, 2020. Note that during this period the MSCI EM Index outperformed the S&P 500 50% of the time on a quarter-by-quarter basis, illustrating again that EM markets behave differently than their developed-country counterparts and reinforcing the argument that maintaining a consistent allocation to EM can enhance asset allocation diversification.

What Lies Ahead?

Many of the structural drivers that were beginning to emerge prior to COVID will come back into focus, helping to position emerging markets to potentially outperform in 2021. Among them, capital markets that continue to broaden and deepen, improving consumption trends fueled by rising incomes and an expanding middle class and new types of products and services that are continuing to penetrate many EM economies. Combined with massive global liquidity injections, highly accommodative interest rates, a weakening U.S. dollar, accelerating global growth and the deployment of COVID vaccines, emerging market stocks should have the wind at their back in 2021. Indeed, a recent global fund managers’ survey from Merrill Lynch showed that a record 62% of global money managers were overweight EM and two-thirds predicted that EM will be the top-performing asset this year. Yes, emerging markets are volatile. But it’s our strong view that because of the compelling long-term returns and portfolio diversification benefits, emerging market equities should remain a consistent and material portfolio allocation.

Charles Wilson, PhD is a portfolio manager at Thornburg Investment Management.

Founded in 1982, Thornburg Investment Management is a privately-owned global investment firm that offers a range of multi-strategy solutions for institutions and financial advisors around the world. A recognized leader in fixed income, equity, and alternatives investing, the firm oversees US$45 billion ($43.3 billion in assets under management and $1.8 billion in assets under advisement) as of 31 December 2020 across mutual funds, institutional accounts, separate accounts for high-net-worth investors, and UCITS funds for non-U.S. investors. Thornburg is headquartered in Santa Fe, New Mexico, USA, with additional offices in London, Hong Kong and Shanghai.

For more information, please visit www.thornburg.com

Important Information

The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This information should not be relied upon as a recommendation or investment advice and is not intended to predict the performance of any investment or market.

This is not a solicitation or offer for any product or service. Nor is it a complete analysis of every material fact concerning any market, industry, or investment. Data has been obtained from sources considered reliable, but Thornburg makes no representations as to the completeness or accuracy of such information and has no obligation to provide updates or changes. Thornburg does not accept any responsibility and cannot be held liable for any person’s use of or reliance on the information and opinions contained herein.

Investments carry risks, including possible loss of principal.

Outside the United States

This is directed to INVESTMENT PROFESSIONALS AND INSTITUTIONAL INVESTORS ONLY and is not intended for use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to the laws or regulations applicable to their place of citizenship, domicile or residence.

Thornburg is regulated by the U.S. Securities and Exchange Commission under U.S. laws which may differ materially from laws in other jurisdictions. Any entity or person forwarding this to other parties takes full responsibility for ensuring compliance with applicable securities laws in connection with its distribution.

Please see our glossary for a definition of terms.

Pictet Asset Management: An Unfavourable Mix of Slower Growth and Rising Inflation

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The global economy is expanding at a solid pace. Developed countries are responsible for much of that growth thanks to the rapid vaccine rollout and the lifting of lockdown measures.

But economic momentum is beginning to ease as central banks prepare themselves to scale back monetary stimulus in response to rising price pressures.

A less favourable mix of growth and inflation, tighter liquidity conditions and high valuations for riskier asset classes lead us to maintain our neutral stance on equities.

Within equities, we are underweight economically-sensitive sectors – including consumer discretionary stocks – while in fixed income we are underweight riskier bonds such as US high yield debt.

At the same time, we continue to hold overweight positions in defensive assets such as US Treasuries and Chinese local currency bonds.

Our business cycle analysis shows price pressures are becoming more visible in the US.

The country’s consumer price index excluding food and energy is increasing at a 3-month annualised pace of 8.2 per cent, the highest since 1982.

Core PCE, the US Federal Reserve’s preferred measure of inflation, also rose 3.4 per cent to hit its highest level in nearly 30 years.

However, we believe the bout of inflationary pressure is transitory, owing to supply distortions and a surge in demand for items that were most affected by the pandemic, such as used cars.

Stripping out the impact from these Covid-sensitive items and the base effect, our analysis shows inflation is still stable at around 1.6 per cent (1).

The Fed now appears set to hike interest rates as early as end-2022 after it unexpectedly upgraded this year’s growth and inflation projections in June.

Higher interest rates could come even sooner if wage inflation picks up from the current 3 per cent year-on-year pace – which will in turn pressure corporate profit margins.

In Europe, economic conditions are improving rapidly as the bloc’s vaccination programme and business re-openings gather pace.

Further improving the region’s prospects, euro zone countries will soon begin receiving funds from the EUR750 billion recovery fund, which is expected to boost growth by at least 0.2 percentage points both this year and next.

Economic momentum in emerging countries is levelling off as Chinese growth cools after a strong rebound. We think domestic demand will replace exports as the main contributor to economic growth, which will in turn boost retail sales and fixed asset investments.

Our liquidity indicators support our neutral stance on risky asset classes.

Liquidity conditions in the US and euro zone are the loosest in the world, thanks to continued monetary stimulus from central banks.

In contrast, China’s liquidity conditions are now tighter than before the pandemic as Beijing resumes its crack down on debt after a 2020 boom in lending among small and medium enterprises.

However, a further slowdown in the world’s second largest economy may prompt the People’s Bank of China to switch to easier monetary policy later this year. This will see the central bank intervene in the foreign exchange market to weaken the renminbi currency.

Our valuation models suggest equity valuations are at their most expensive levels since 2008. Tighter liquidity conditions and a further increase in real yields are likely to pressure global price-earnings multiples, which we expect to decline by up to 20 per cent in the next 12 months.

Our model suggests that corporate profits should grow globally around 35 per cent year-on-year this year. We think consensus earnings growth forecasts for the next two years — at around 10 per cent — are too optimistic as that would take EPS clearly above the pre-Covid trend, which is unlikely given that profit margins are already stretched.

Our technical indicators remain moderately positive for equities. Within fixed income, Chinese government debt – in which we are overweight – is the only asset class for which technical signals are positive.

Opinion written by Luca Paolini, Pictet Asset Management’s Chief Strategist.

Discover Pictet Asset Management’s macro and asset allocation views.

Notes:

(1) Covid-sensitive items: lodging away from home, used cars, car rentals, airline fare, televisions, toys, personal computers.

Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.

Important notes

This material is for distribution to professional investors only. However it is not intended for distribution to any person or entity who is a citizen or resident of any locality, state, country or other jurisdiction where such distribution, publication, or use would be contrary to law or regulation. Information used in the preparation of this document is based upon sources believed to be reliable, but no representation or warranty is given as to the accuracy or completeness of those sources. Any opinion, estimate or forecast may be changed at any time without prior warning. Investors should read the prospectus or offering memorandum before investing in any Pictet managed funds. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

This document has been issued in Switzerland by Pictet Asset Management SA and in the rest of the world by Pictet Asset Management Limited, which is authorised and regulated by the Financial Conduct Authority, and may not be reproduced or distributed, either in part or in full, without their prior authorisation.

For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.

Pictet Asset Management Inc. (Pictet AM Inc) is responsible for effecting solicitation in North America to promote the portfolio management services of Pictet Asset Management Limited (Pictet AM Ltd) and Pictet Asset Management SA (Pictet AM SA).

In Canada Pictet AM Inc is registered as Portfolio Managerr authorized to conduct marketing activities on behalf of Pictet AM Ltd and Pictet AM SA. In the USA, Pictet AM Inc. is registered as an SEC Investment Adviser and its activities are conducted in full compliance with the SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref. 17CFR275.206(4)-3.

Mind Tricks

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Jay Powell’s press conferences leave the listener wondering whether one is being the victim of a sort of mind trick, or listening to a tongue twister. From “we are not even talking about talking about” (referring to tapering asset purchases), to labeling the latest FOMC as the “talking about talking about” meeting.

The Fed has a long tradition of resorting to obtuse language, dating back to its Jedi Grandmaster, Chairman Greenspan; who left a legacy of phrase-riddles to remember, such as: “I know you think you understand what you thought I said but I’m not sure you realize that what you heard is not what I meant”.

The new Fed chair, by contrast, has radically changed tactics; he speaks with crystal clarity, but elevating the discussion to the meta-meta level; a kind of quantum monetary world where, like Schrödinger’s cat, one thing and the opposite can happen at the same time; or happen not to happen; in Powell’s parlance.

This game of smoke and mirrors is for the sole purpose of keeping all options open. In the old days, when monetary policy enjoyed great room for maneuver, this calculated ambiguity allowed the Fed to surprise the market. But today, with interest rates at zero, the goal is to try not to unnecessarily unsettle financial markets.

In the past, the market was wary of the Fed, who was seen as the responsible adult in charge of “taking away the punch bowl”; ending the party before the economy could overheat. Nowadays, instead, the Fed is like a father trying to find ways not to upset a spoiled child, who always asks for more jelly beans and is notoriously famous for throwing tantrums.

In this respect, the recent policy shift does not represent a great change; something like threatening to take the goodies away if the school grades in a few years are not good enough. Bearing in mind that the average business cycle lasts less than 5 years, the kid has reacted with a “we’ll see” attitude.

However, the true recipient of the message has not been the market. The Fed also plays cat and mouse with other actors who influence (and are influenced by) its monetary policy: commercial banks transmitting it, other central banks whose decisions affect the dollar, and finally, the federal government, which sets the fiscal policy.

The relationship between the Fed Chairman and the US President is often a tug of war. In a recession, monetary and fiscal policy must work in tandem, but when the recovery begins, the central bank often becomes a constraint on the government. For example, Trump’s pro-cyclical fiscal stimulus provided the excuse for Janet Yellen to begin normalizing interest rates; while Robert Rubin and Alan Greenspan struck a bargain whereby the Fed maintained an accommodative policy, in exchange for the US Treasury reducing the fiscal deficit. This contributed to lengthening the economic cycle, and to run a fiscal surplus for the first (and last) time since 1969.

Exiting a crisis is tricky, and requires some coordination. After the financial crisis, for example, central banks had to continue to do all the heavy lifting, while governments retreated into austerity. That is why when the pandemic broke out, governments were urged to act with courage this time.

Initially, the Fed encouraged the government to do too much rather than too little. But as the saying goes, “be careful what you wish for”. The latest stimulus package passed by President Biden exceeded all expectations and, along with a more rapid reopening thanks to the success of the vaccination program, provided a major boost to the economy, stoking inflationary fears.

Fed members are, after all, human beings, with careers and reputations to protect; and continuing to deny the possibility of considering a policy normalization in these circumstances, was beginning to make them seem disconnected from reality, or worse still, accomplices of the government. Furthermore, if fiscal policy is finally taking the baton, it makes sense for monetary policy to start decoupling, in order to be ready to intervene when the next crisis hits.

The change in the “Fed dots” is a first step in that direction, although more symbolic than anything else. Fed members know how difficult it was to begin to normalize monetary policy after the financial crisis; and the gap that separates its long-term projections (or, rather, “aspirations”) from current interest rates, seems impossible to bridge.

The Fed would welcome slightly higher inflation, if it were accompanied by robust economic growth. However, it needs to calibrate carefully in order not to risk its independence. The biggest threat is that the precedent set by the pandemic will tempt politicians to use the fiscal bazooka when faced with a “normal” recession. After all, the old adage “never waste a good crisis” has taken on a different meaning, with the government giving away money almost indiscriminately to citizens and businesses.

In short, Jay Powell has managed to pivot from a corner, thereby initiating the process of disconnecting monetary policy from fiscal policy. And by stating that he will not let inflation get out of control, he has also brought long-term interest rates down (once the market deciphered the message). Not bad for a Jedi apprentice!

An article by Fernando de Frutos, Chief Investment Officer at Boreal Capital Management

Aiming for Zero: Europe Raises its Clean Energy Game

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Shifting into a higher gear. This is precisely what the European Union has just done as it steers towards a more sustainable economy. Its new climate blueprint – which EU lawmakers and national governments have agreed in principle to make legally binding – proposes cutting greenhouse gas emissions by 55 per cent compared with 1990 levels by the end of the decade.

That is significantly more ambitious than the EU’s previous target of 40 per cent, and means the region could become climate neutral by 2050.

It’s not difficult to see why the EU should want to pursue a green recovery with such determination.

Executed well, the plan, to be adopted in May 2021 and apply from 2022, offers the tantalising prospect of restoring both the environment and the economy back to full health.

The funds being set aside certainly point in that direction. The package will translate into approximately EUR7 trillion of new green investments by 2050. Crucial for the region’s economic prospects, a large proportion of that money will be channelled to the environmental industry (see Fig. 1) – a fast-growing sector that is making an ever larger contribution to GDP.

The industry’s gross value add (GVA) – a measure of its contribution to national output – rose to EUR286 billion in 2015, up 63 per cent from 2003. Within the sector are some especially vibrant industries such as resource management, which includes renewable energy and energy efficiency and has grown 150 per cent over that time (1).

More broadly, Europe’s environmental goods and services industry can now claim to rival that of the US.

It already employs 4 million full-time equivalent workers, up 38 per cent from 2003, and has contributed more than 2 per cent to the region’s GDP in 2015 (1).

EVs: the green light

Under the European Commission’s new set of criteria for green investments, producers of rechargeable batteries, energy efficiency equipment, non-polluting cars, wind and solar power plants will be able to win a formal green label. That could prove transformative for Europe’s transport, energy and real estate sectors.

Take autos, if European governments are to achieve their growth and pollution targets, electric vehicles (EV) will have to evolve into a strategic industry.

Here, the approach is one of carrot and stick.

France has a EUR8 billion programme to boost its EV industry with a goal of producing more than 1 million electric and hybrid cars every year over the next five years. The plan also includes a financial incentive that would reduce the cost of buying an EV by up to 40 per cent.

Germany also stepped up its support for zero-emission transport, doubling subsidies to as high as EUR9 billion, following a prior increase in November 2019 (2).

These incentives have already had a clear impact on EV take-up. German EV sales, for example, rose to account for 13 per cent of total car sales in August 2020, compared with just 2.5 per cent in the same month in 2019.

Regulators are also playing their part. Europe, the second biggest EV market after China, now has tough new emissions standards. Every car manufacturer must cap emissions for its entire fleet to 95g of CO2/km on average by end-2020 – some 20 per cent below the average emission level in 2018. This cap will drop to 81g by 2025 and to 59g by 2030.

Those who fail to meet the standards will pay a heavy price: the fine is EUR95 for every g/km of excess emissions per vehicle. Car manufacturers that fail to improve their CO2 emissions compared with 2019 levels face possible fines of several billions of euros every year.

All of this will help further boost e-mobility’s growth (see Fig. 2).

Pictet AM

Build back better

Construction will also be at heart of the European recovery plan – not least because 70 per cent of all buildings in the region are over 20 years old.

The European Green Deal reserves some EUR370 billion – or EUR53 billion a year – for renovation to boost energy efficiency and decarbonise existing buildings. That would represent a big boost to the European renovation industry, which was worth EUR819 billion in 2019 (3).

Europe is also proposing to commit EUR100 billion in research and development (R&D) spending in digital and environmental sectors. The seven-year programme, launching in 2021, aims to boost productivity and growth and maintain competitiveness in sectors consistent with the Green Deal’s objectives. The Commission estimates each euro invested in R&D would have a leverage effect of EUR11.

When it comes to sustainability, Europe has just raised the bar. Its ambitious green spending commitments and stricter regulations not only give an environmental template for other countries to follow, they also offer the prospect of stronger economic growth and open up new investment opportunities.

Pictet AM’s Clean Energy strategy: investing in the energy transition

Europe’s 2050 climate target is set to disrupt and transform a number of industries, each representing rich and diverse investment opportunities which are underappreciated by the wider market.

E-mobility: Some 80 per cent of today’s transport energy needs to be converted to electricity to meet the emissions target. BNEF expects 57 per cent of all passenger vehicle sales will be electric globally by 2040, compared with only 3 per cent in 2019. This will likely boost investments into not only EV manufacturers but, more significantly, supporting technologies such as batteries and power semiconductors, as well as smarter grid networks and charging infrastructure.
Renewables: Under the European plan, the share of renewables in power generation must rise to 85 per cent by 2050 from today’s 20 per cent, with the bulk of that covered by wind and solar. The way we generate power is transforming as an increasing number of European power utilities ramp up their production of renewable energy with aggressive expansion plans. Underlining this trend, while total EU energy generation declined almost 10 per cent in July from the year before, renewable energy generation rose over 8 per cent.
Green buildings: All new European buildings must be “nearly net zero energy” starting 2021. We also expect a significant increase in demand for “retrofitting” existing buildings. This should support companies producing high-performance building materials and insulation, heat pumps and LED lighting as well as smart Heating, Ventilation and Air Conditioning (HVAC) and building energy management systems and other energy efficiency technologies and equipment.

Written by Steve Freedman, Sustainability and Research Manager in the Thematic Equities team at Pictet Asset Management.

Discover more about Pictet Asset Management’s long expertise in thematic investing.

Notes:

(1) Based on 2010 prices. Source: European Environment Agency (EEA)
(2) https://insideevs.com/news/443518/germany-plugin-car-sales-august-2020/ and https://cleantechnica.com/2020/09/04/germany-in-august-electric-vehicles-crushing-it-at-record-13-2-market-share
(3) Euroconstruct

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