Reopening to a new world - Investment Outlook Third Quarter 2020 - HSBC Private Banking
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Reopening to a new world Investment Outlook Third Quarter 2020
Global Chief Market Strategist
Contributors Willem Sels
willem.sels@hsbcpb.com
+44 (0)207 860 5258
Global Investment Strategist, Managing Editor Head of Asset Allocation
Neha Sahni Stanko Milojevic
neha.sahni@hsbcpb.com stanko.milojevic@hsbcpb.com
+44 (0)20 7024 1341 +44 (0)20 7024 6577
Regional Chief Market Strategists
Belal Mohammed Khan Cheuk Wan Fan
belal.mohammed.khan@hsbcpb.com Cheuk.wan.fan@hsbcpb.com
+41 (0)58 705 5273 +852 2899 8648
Jose Rasco Jonathan Sparks
jose.a.rasco@us.hsbc.com jonathan.sparks@hsbcpb.com
+1 (1)212 525 3264 +44 (0)20 7860 3248
Patrick Ho James Cheo
patrick.w.w.ho@hsbcpb.com james.cheo@hsbcpb.com
+852 8525 8691 +65 6658 3885
Global Head of Fixed Income Global Head of Equities
Laurent Lacroix Kevin Lyne Smith
laurent.lacroix@hsbcpb.com kevin.lyne-smith@hsbc.com
+44 (0)207 024 0613 +44 (0)207 860 6597
Global FX Coordinator Senior Fixed Income Credit Specialist
Nicoletta Trovisi Elena Kolchina
nicolettatrovisi@hsbc.com elena.kolchina@hsbcpb.com
+44 207 005 8569 +44 0207 860 3058
Head of Sustainable Product Offering
Sophie Haas
sophie.l.haas@hsbcpb.com
+44 (0) 207 024 0283
Global Market Analyst, Real Estate Investment Head of Alternative Investment Funds
Guy Sheppard William Benjamin
guy.r.sheppard@hsbc.com william.a.benjamin@hsbc.com
+44 (0)207 024 0522 +44 (0)207 024 1546
2
Contents
Letter to clients 05
Portfolio Strategy 06
Embracing the uncertainty –
a long term perspective 10
High debt levels and the path forward 14
Equities16
Fixed Income 18
Currencies and commodities 20
Themes22
» Re-emerging Asia 22
» Fourth industrial revolution 16
» Investing in a low yield world 25
» A sustainable world 26
Hedge Funds 28
Private Markets 30
Real Estate 31
Disclaimers32
Investment Outlook Third Quarter 2020 3
Investment Outlook Q3 2020 Investment Outlook Q3 2020
Reopening to a new world Asian investment themes
4
Welcome
Message from our Global Chief Market Strategist
Dear client,
The economic crisis we are facing cases, has been too sharp. From here, Finding the companies and areas that
is unprecedented because it is so we think equity markets will enter into a can outperform the general economy is
very sudden, sharp and widespread. volatile consolidation phase. important, because economic growth may
Unemployment has shot up at record now be structurally lower than before,
speed, and many businesses are Another difference with Main Street is that due to high debt loads. Contrary to some
struggling to survive, which will pose the firms represented in the major stock investors, however, we do not think that
challenges to the expected rebound in market indices are typically larger, and these debt piles will create inflation. In fact,
demand. Although the US and some have better access to a variety of funding we think inflation will remain low, allowing
European economies are gradually options than the rest of the economy. In interest rates to stay low as well. And
reopening, it will take a long time for GDP, the uneven recovery that we are likely of course, this should be good for high
consumer and business confidence to get to see, we believe that it is critical for quality investment grade debt.
back to last year’s levels. investors to differentiate between firms,
as better positioned companies may Reopening the economy to the new world
There is no rule book for investors in this have lost some of their competitors, have will not be easy. For investors, it will be
unprecedented situation. As they struggle more options to invest and adapt to the important to build resilient portfolios
to forecast the short-term and long-term changes in the world, and have the ability to weather the short term volatility we
impact of COVID-19 on earnings and to continue to pay dividends. We thus like are likely to see as we go through the
interest rates, it is understandable that companies with resilient earnings and reopening and recovery process, and
markets have been extremely volatile. The strong balance sheets (quality and low the US elections. Sticking to quality
political implications are uncertain too, leverage). This differentiated approach assets, a defensive sector positioning
with the trend towards de-globalisation applies as well to our EM country picks and diversifying with gold and alternative
creating additional challenges. Amid all of within stock and bond markets, and assets are three useful strategies. It is
the uncertainty, we thus continue to take we continue to favour China over EM equally important to position for the
a prudent approach and are focused on countries with less financial flexibility. longer term, in quality growth stocks
building resilient portfolios. In fixed income, we continue to prefer and companies or themes that are well
the higher quality balance sheets in positioned for the changes stemming from
To many investors, the serious challenges investment grade over those of high COVID-19. As market timing is particularly
on Main Street do not seem to be yield companies. difficult, it is by staying invested in quality
reflected on Wall Street, where stocks assets in these areas, that we believe
have bounced sharply from their March Technology is one of the main engines we can weather both the short term
low. This is in part because unprecedented of the stock market recovery, and this uncertainty and participate in the eventual
economic pain has also triggered should remain the case. Areas such as upside we foresee.
unprecedented policy action, which has online consumption and automation are
seriously reduced the tail risk of a credit two of the themes which we believe are
crisis, and allowed capital markets to well placed in the post-COVID world.
continue to function. Massive global Healthcare should also be another
liquidity injections are also creating structural growth area in the otherwise
expectations of asset price inflation, as we uneven recovery, as households and
saw after the Global Financial Crisis (GFC). governments are likely to prioritise health
And of course, equity markets tend to look in their spending. We also believe that the Willem Sels,
forward, and economies will eventually crisis has highlighted many environmental, Global Chief Market Strategist
recover. Still, these arguments provide only social and governance issues, and
partial comfort amid all the uncertainty, therefore think that sustainable investing, 14th May 2020
and we believe that the bounce in price and themes such as the electric revolution
/ earnings ratios, to new highs in some should see growing interest.
Investment Outlook Third Quarter 2020 5
Portfolio Strategy
» For the next 3-6 months, we The interconnectedness of the global and is part of a broader trend towards
position for a U-shaped recovery economy matters as well. As China de-globalisation. We believe that in many
by building resilient portfolios. reopens, its bounce is held back by very countries, governments and companies
The complex process of reopening weak European and US demand. And in are looking at re-onshoring production and
economies, the US elections, US- some other emerging markets, infection jobs, to secure the supply chain and create
China relationship and uncertain rates are still rising. They typically do national champions in strategic industries.
oil price outlook are all likely to not have the deep pockets of Western
contribute to market volatility. governments and central banks to So amid all this uncertainty and scope
support their economy, and many do not for volatility, why have equity markets
» For the longer term, we consider
have the similarly strong broadband and bounced from their mid-March lows? As
how COVID-19 will change the
telecom infrastructure that the developed usual, equity markets have not waited for
world, and expect low growth,
markets have, to shift the economy online. economic data to turn positive, and have
low inflation, and strong structural
Weakness in EM could keep the global taken the flattening of COVID-19 infection
demand for healthcare, automation
economy weaker for longer. curves as a leading indicator of future
and digital services.
improvement. In the 12 months after the
As economies try to reopen, the scope for Gulf War related correction, the S&P 500
The short term: positioning positive as well as negative headlines is rebounded by 29%; following the Tech
for a U-shaped recovery elevated, and hence we believe volatility Bubble correction, it rebounded by 33%;
will remain higher than usual. How and after the Global Financial Crisis, the
A V-shaped recovery scenario assumes
politicians handle the reopening – or are market rallied by 68% in just 12 months.
that after a sharp, short fall in Q2, the
perceived to be doing – will be important Markets also hope that central bank action
global economy is gradually reopened
in elections. The US-China relationship creates asset price inflation, and policy
from May, without too many hiccups,
is becoming a big political topic again, measures have significantly reduced the
leading to a quick rebound in Q3. At the
other extreme is the L-shaped scenario,
where the economy has difficulty to Traffic volumes are picking up slowly, suggesting the economy has already
recover at all, because of a succession of troughed
new virus strains, and the gradual decline
Portfolio strategy 1
in policy makers’ ability to continue to
support the economy. 140
Car traffic volumes, rebased at 100 in January
Brazil Germany Italy UK US
We believe that the truth probably lies 120
in the middle, and we position for a
U-shaped recovery. The US and European 100
economies are gradually reopening, but
it may not be straightforward. Although 80
some households will want to spend a lot
60
when coming out of confinement, others
will have lost some of their income or their
40
jobs during the crisis and will need to save.
Some will also be much more hesitant
20
than before – maybe for quite a while
- to travel or have social contact. And
0
companies which have seen their cash 13-Jan 27-Jan 10-Feb 24-Feb 9-Mar 23-Mar 6-Apr 20-Apr 4-May
flow and profits plummet may be slow
to rehire or invest, as they try to gradually
Source: Apple, HSBC Private Banking as at 13th of May 2020.
rebuild their cash positions and capital.
6
Portfolio
… but GDP may remain below strategy
the 2019 2 quite some time
level for
DM real GDP level
114
EM real GDP level
112
110
108
106
indexed at 100 in 2019
104
102
100
98
96
94
92
90
88
2019: 2019: 2020: 2020: 2021: 2021:
Q1 Q3 Q1 Q3 Q1 Q3
Source: IMF, HSBC Private Banking as at 13th of May 2020. Forecasts are subject to change.
Dashed lines show the GDP trend before COVID-19 distorted its long term path.
risk of a credit crisis and restored some costs to adapt production and distribution risk of substantial re-widening of credit
order in the money markets, which were to make it safer for employees and spreads. Still, while we hold overweight
two major concerns in mid-March. customers, which could lower margins. positions in global and US investment
grade bonds, we maintain a small
But the bounce, to new P/E valuation Therefore, we would not be chasing underweight in Global and European high
highs, seems a bit sharp. Equity markets the recent sharp equity market rally. As yield bonds as default rates are likely to
usually only rise sustainably after uncertainty remains high, we believe it spike further in the short term. Across
earnings assumptions have become very is prudent to focus on building resilient the bond market, we remain selective, as
conservative. In a U-shaped scenario, portfolios. This includes multi-asset rating downgrades have accelerated.
we believe US EPS could fall as much as diversification and a focus on quality
30% in 2020, while the analyst consensus stocks with sustainable earnings and By remaining invested in quality assets,
still only incorporates a 20% drop (in manageable leverage. As for EM bonds and long term themes that have been
part because they expect a V-shaped and stocks, we remain very selective, and reinforced by COVID-19 (see next page),
rebound in earnings in Q3 and Q4). This believe local currency bond performance we believe we can weather the volatility
hypothesis was challenged during the will be hit by EM FX weakness against we expect to see as we transition the
US earnings season, where CEOs gave USD. We continue to favour China and U-shaped recovery, while remaining
a lot of guidance which, in our view, Asia over Latin America or EM Europe. positioned to participate in the eventual
points to a slower pickup in Q3 due to By comparison, we think that developed market upside.
significant medium-term challenges. Many market credit is well supported by central
companies are also pointing to significant banks’ action, which should help limit the
Investment Outlook Third Quarter 2020 7
The longer term: China being one of the more resilient and AI-based medical diagnosis and
countries, while South Africa and Turkey virus containment solutions, as is
How COVID-19 may are more vulnerable. already happening in Asia. Clearly, many
change the world companies in the sector will benefit
We don’t share some investors’ fears (see our investment thematics section).
While short term market direction that higher debt will boost inflation in the Governments may also want some of the
may principally focus on the current developed world, as weak demand should most critical equipment and supplies to be
issues, we think it is important as well keep inflation muted. As we saw after the produced at home, and healthcare is one
to start to position for the world after GFC, central bank liquidity should create of the sectors where we may see a wish
COVID-19. So what are the challenges asset price inflation, but consumer price to build national champions.
and the opportunities? inflation (CPI) should remain low, allowing
policy rates to stay low for many years. For households too, healthcare will
The challenge: a long path to balance take up a higher share of discretionary
sheet improvement Companies’ and households’ balance spending. Healthy food producers, meat
sheets, debt loads and earnings will also substitutes, sports and health insurance
Government support measures have been have deteriorated during the crisis. We are likely to see more demand. Finally,
absolutely essential to help households think companies and many households as people are worried about picking up
and companies bridge the crisis months, will try to cut discretionary spending for infections, automation and no-touch
but they will leave us with significantly quite some time after the virus has been technology should see rising demand.
more government debt. The Global beaten, weighing on cyclical industries. This includes contactless payments,
Financial Crisis (GFC) has shown that Companies may also reduce share autonomous transportation and should
higher debt loads will probably lead to buybacks and dividends, which could be benefit investments in 5G.
lower trend growth. This is because a negative for equity market performance.
governments will need to be more
selective in their discretionary spending, Online access: the new utility
prioritising healthcare, and they may raise Our health: the number one priority The shock of confinement has led to a
taxes once businesses and households Western governments were less prepared leap in the share of online businesses
are strong enough. for the COVID-19 pandemic than some in the global economy. Online access is
Asian nations, which had gone through forced upon all of us, across age groups,
In developed markets, we may see SARS. They are now quickly raising geographies and activities. Across the
some more rating downgrades, but healthcare spending, and will continue world, there is likely to be significant
markets should not seriously question the to build hospitals, buy equipment and investment in capacity and bandwidth,
sustainability of government debt. This hire staff in preparation for any future benefiting equipment providers, while
is different in emerging markets, where pandemic. The COVID-19 experience telecom companies benefit from the
we expect increasing differentiation, with may also speed up the use of big data pickup in volumes.
Three Reopening A new world
Challenges U-shaped recovery: Focus on resilience Positioning for the long term
1. Low growth Defensive sector positioning Automation
Quality stocks Digital consumer
New Asian consumer
Healthcare
Private equity
2. Low income Cash management solutions Carry opportunities in EM and DM
A focus on IG and EM HC Private credit
Resilient dividends Select real Estate
3. Uncertainty Differentiation & a selective approach Diversification
Gold as a hedge Hedge funds
Differentiation
Sustainability
8
Consumers who have newly discovered We think, though, that the shock of grade and are selective in our dividend
the ease of internet shopping and COVID is leading some investors and strategies in the short term, but see
entertainment will probably stick to the companies to reassess their role in opportunities in private credit and real
habit, supporting our ‘Digital Consumer’ society, and this could lead to more estate in the longer term. Uncertainty
theme. As we spend a much larger part of attention to ESG criteria, and sustainability requires selectivity, picking companies
our lives online, the offering is broadening in general. While the drastic reduction with manageable leverage and EM
quickly, beyond entertainment and in pollution levels due to slowdown in countries with solid fundamentals. And of
shopping already: education, religious economic activity may only be temporary, course, diversification remains paramount
services and sports classes (not just we think the current crisis has raised the and our principal long term strategy to
e-sports) are shifting online, for example. importance of biodiversity preservation, manage portfolio volatility.
as we observe a growing trend of new
Working habits have changed, too. Many viruses originating from animal species, It is important, however, to keep in
bosses have discovered that people just like COVID-19. mind that the ample global liquidity can
can be very productive at home (even create a strong tailwind for markets, as
when wearing athleisure outfits), and The young may continue to lead the drive it is bound to create some asset price
many workers may like to work from towards sustainable living, public health inflation. We need to balance this against
home more regularly. Demand for new and environmental protection, but the size the uncertainties and slow structural
technologies of virtual offices and smart of the COVID-19 shock may create more growth, and thus believe it is right to
home systems should thus increase. interest in sustainable investing across remain invested while managing the risks.
age groups. Timing the bounce is near impossible,
Real estate has been adapting to the but this strategy allows us to benefit from
changes in retail and flexible working for
some time, but COVID-19 is accelerating
Our strategy the eventual market upside. Indeed, we
have made a number of changes in recent
the trend. To attract employees to come Our strategy is designed to navigate months (downgrade of cyclical sectors,
into the office and retain quality staff, the short term headwinds by building Latin American stocks and EM local
firms adapt their corporate real estate. resilient portfolios, as we go through currency bonds, but upgrade of Chinese
This may mean that, gradually, secondary a U-shaped recovery, while also and South Korean stocks and global
office space has a fall in demand whilst looking into the opportunities and the investment grade) but have remained
Grade A space benefits. correct positioning for the longer term, invested. This balanced strategy also
including differentiation and attention to allowed us not to panic sell in mid-March,
sustainability. We also continue to address or chase the rally in late April.
ESG and sustainability the three challenges we formulated at the
One of the biggest providers of ETFs start of the year, namely low growth, low When markets move dramatically,
has pointed out that during the recent yield and elevated uncertainty, as these however, the long term return outlook
correction, ESG-based ETF flows have challenges remain very relevant. The changes, and hence, it is important to
been much more resilient than those table on the left summarises adapt the long-term Strategic Asset
of traditional ETFs. And our Global how investors can balance all of Allocation (SAA), as we did in April.
Research colleagues have calculated that those objectives through a mix of Following credit spread widening, and
companies with high ESG scores and complementary positioning strategies. given the central banks’ support and
climate tilts outperformed their market structurally low bond yields, we have
benchmarks. To some extent, the two To address the low growth challenge, we increased the allocation to developed
may be linked, as fewer outflows should maintain a defensive sector positioning market credit and reduced our allocation
support the price. In addition, indices with and a focus on resilient earnings (quality to safe haven government bonds. When
a climate tilt typically include fewer oil & stocks) in the short term, while looking portfolios are anchored around a strategic
gas companies or airlines, which have at opportunities for superior structural asset allocation, consistent rebalancing
been performing particularly poorly. And growth in technology, healthcare, means that investors buy assets that
lastly, ESG screening often uses criteria Asian consumption and private market have fallen and become cheaper (and
that you also use when you opportunities. In spite of low income, we sell assets that have rallied sharply). In
look for ‘quality’ companies, and the limit the amount of risk we are willing to the long run, this results, on average, in
‘quality’ factor has outperformed broad take when looking for additional yield. We buying low and selling high.
indices recently. currently maintain a focus on investment
Investment Outlook Third Quarter 2020 9
Embracing the uncertainty –
a long term perspective Long term replacement charts
To date, 2020 has shaped up to be a An unprecedented shock to US employment
strikingly unique year, marked by a US non - farm payrolls, monthly change
number of unprecedented disturbances 5
to our society, our communities,
and our very lives. These events will
0
inevitably hold a special section in
history books in the decades to
-5
come. But how did the global markets
Millions of people
deal with other unforeseen events in
the past? -10
Familiar charts and figures that investors
-15
had routinely used to gauge and assess
the investment environment simply got
-20
broken. Three specific examples are
particularly astonishing. First, the weekly
count of new applicants for jobless -25
benefits in the US jumped from 282 1940 1950 1960 1970 1980 1990 2000 2010 2020
thousand to 6.87 million in only two weeks Source: Bureau of Labor Statistics, HSBC Private Banking as at 13th of May 2020.
at the end of March, after being confined
to a range between 162 and 695 thousand While these specific shocks have just market analysts in the past. This exercise
during its entire 53-year history. Second, happened for the first time ever, it is can help us reassess the ongoing market
20.5 million non-agricultural jobs were lost crucial to recognise that is not the first environment more objectively, with
in the month of April alone - a reading that time that something new has happened reference to how markets have historically
dwarfs the previous worst-ever print of for the first time ever. Let us revisit some responded to other shocking, previously
-1.9m seen in September 1945. Third, unheard-of
of the historical events that shockedLong term charts calamities.
the crude oil price in the US, as proxied
by the front month WTI futures contract,
Who would have expected that US oil prices would turn negative?
turned negative for the first time ever in
April and reached the level of -$38 per WTI Crude Oil
barrel at its nadir. 80
How should investors interpret these
60
baffling figures? Nobody has a playbook
for 20.5m monthly job losses, for negative
oil prices, or for the $2trn stimulus 40
package deployed in response to the
sudden recession. Any qualitative or
USD/bbl
20
quantitative models fitted to historical
levels of these indicators are now entirely
unfit for purpose. These figures are not 0
only unprecedented, they were, to most
observers, unthinkable, or at least not
worth spending the time to think about -20
until they actually popped up on their
screens. Importantly, our view remains -40
that the most important mantra for
investors is to be and to remain invested, Dec 2018 Mar 2019 Jun 2019 Sep 2019 Dec 2019 Mar 2020 Jun 2020
even in face of these unprecedented Source: New York Mercantile Exchange, Bloomberg, HSBC Private Banking as at 13th of May 2020. Past
economic and market events. performance is not a reliable indicator of future performance.
101) A
ll money becomes 10.25% to 20% in March 1980, when entered negative territory for the first time
the economy was still coming out of a in history was rather scary. The DAX index
paper in the 1970s. recession. Such an extreme and rapid rate opened 9.94% lower, with contagion also
For most of human history, money was hike had never before been associated spreading across the globe on that day.
tangible. Coins were minted out of precious with a key global currency, in the entire Investors were baffled. How could bond
metals, and banknotes represented industrial history. The global economy yields be negative? What was this going to
claims on bullion, redeemable on request. dipped back into a recession shortly mean for the economy? Was growth going
Breaking the link with gold, either by thereafter, but the Fed stuck to its script to be negative, too? Were we
replacing gold with cheaper metal coins, and kept its policy rate above 20% until about to enter a deflationary spiral? As with
or by refusing exchange of banknotes to inflation was definitively brought back the other events detailed above, it was not
bullion, would normally trigger confidence under control. This came at a cost of possible to make historical comparisons or
issues – leading to currency depreciation, surging unemployment and a string of look for historical patterns, as 10-year bond
and in severe cases, hyperinflation (such bankruptcies and bank failures, raising yields of a developed economy of this size
as in the Weimar Republic in the 1920s). existential questions over the long term had never visited these levels before.
While most European currencies broke impact of then-novel and radical monetary
their link to gold around the second world policy measures.
war, they remained pegged to the US
Dollar which continued to be backed by 3) Bond yields turn negative
gold. However, the US gold reserves began
to get depleted as uncertainties began to
in the 2010s.
grow around expensive wars abroad and Negative interest rates were, until very
unimpressive growth domestically. After an recently, thought to be inconceivable. To
emergency closure of the “gold window” be paid to borrow from someone, or to
and a series of devaluations, by the US have to pay someone to borrow from you,
government, it became clear in the early once seemed laughable. But this became
1970s that gold was no longer money and reality a few decades after interest rates
all money was paper. The brave new world reached their all-time highs in the 1980s.
of free-floating fiat currencies without a Currently, the German government can
hard anchor was truly earth-shattering, and borrow at -0.55% annual interest over a
completely unthinkable to many until that 10-year period. This means that investors
very moment. Panic ensued, and the value are lending 105 euros in order to receive
of USD collapsed relative to gold. The price 100 euros back in 10 years’ time. While we
of gold in USD terms soared by more than are (almost) used to this concept today,
300% between 1971 and 1974. the day when 10-year Bund yields first
2) Interest rates jump to Long
Interest rates jumped in the termbut
1980s, replacement
are now at acharts
long-term historical low
20% in the 1980s. Cash rate history
The 1970s will always be remembered as 25
the decade of stagflation – poor economic Short-term interest rate
growth mixed with uncontrollable inflation
levels. Inflation was for the most part 20
driven by the exogenous geopolitical
shocks that sent oil prices soaring, but
was also exacerbated by ineffective 15
economic policies that sought to counter
this effect, such as price controls. For
most of the history until the late 1970s,
10
interest rates on hard currencies had
been confined comfortably below the
10% handle. However, the self-reinforcing
5
inflationary momentum of the 1970s
seemed unstoppable, driven by a perfect
storm of both exogenous and endogenous
0
factors. Paul Volcker, the Federal Reserve
1920 1930 1940 1950 1960 1970 1980
chairman at that time, decided to take
Source: University of Lausanne, Refinitiv Datastream, 1920-1954: 3-month T-bill rate; 1954-2020: effective
a radical step in fighting inflation, and Fed funds rate, HSBC Private Banking as at 13th of May. Past performance is not an indicator of future
practically doubled the policy rate from performance.
Investment Outlook Third Quarter 2020 11In spite of their severity, uniqueness, Long recovered,
Balanced portfolios have historically term charts
and we believe this will again be
and shock-value, a casual look at market the case
performance reveals that neither of these Balanced Portfolio
events would have caused permanent
damage to disciplined investors. Of 1920s 1930s 1940s 1950s 1960s
course, this is only a small selection of 1970s 1980s 1990s 2000s 2010s
widely unanticipated, never-before-seen
market shocks in modern history. Other 400%
notable and unprecedented events
include the 20% drop of S&P 500 index
300%
in one day in 1987, the dot-com bubble
of the late 1990s, the 9/11 attacks, and
the collapse of house prices in 2007. We
200%
know that each of these events caused
considerable amounts of uncertainty and
were associated with substantial sell-offs 100%
at each of these points. However, we
also know that global markets eventually
recovered to reach new all-time highs in 0%
the aftermath of each of these events.
Major macroeconomic accidents such as -100%
yr: 1 2 3 4 5 6 7 8 9 10
the ones that are unfolding at the moment,
inevitably raise questions about what the Source: Bloomberg, Refinitiv, HSBC Private Bank calculations as at 13th of May 2020. Past performance is
not a reliable indicator of future performance.
future brings. They raise questions about
the sustainability of the prevailing social disorientation and confusion, fear may exact reason why disciplined investors
and economic order. And in the context compel investors to sell right at the bottom earn attractive returns over the long term.
of personal wealth and investing, they and only re-enter after the previous peak In a hypothetical world where the risk of
raise existential questions about financial has been long surpassed, this time in fear interim losses and drawdowns could be
markets and future market returns. For of missing out. eliminated by means of market timing,
this very reason, such circumstances there would be little or no reward in
typically trigger sharp market sell-offs. To state that the odds are stacked against investing, and all investable assets would
These are dangerous times, as they can investors in the game of market timing be earning the same rate of return equal
lure investors to act on impulse, or entice would be superfluous. But it is very to the cash rate. In our world, however,
them to switch from being long-term important to highlight that the ability to embracing market volatility by being
investors to trying their hand at short-term endure market volatility in difficult times invested and remaining invested is key
speculation, attempting to capitalise by is the most important skill in investing. to success, even as the global economy
getting out of the markets on time with Sticking to the script when, fearful, and global markets continue to deliver
an intention of re-entering at a more short-term focused, or overleveraged unexpected, unprecedented, and even
favourable moment. In severe cases of market participants are capitulating is the unthinkable events and figures.
12Investment Outlook Third Quarter 2020 13
High debt levels and the
path forward
The increased borrowing in response to For much of the post-war period, wanting to lend, and households and
COVID-19 has led to renewed concerns productivity growth boosted GDP, but low companies wanting to borrow. Moreover,
that governments will be saddled with investment spending has kept productivity central banks treasure their independence
too much debt. But how much debt is weak since the global financial crisis. We and have an inflation targeting mandate,
‘too much’ and ‘will it create inflation’? often get asked whether, in the absence and a sustained spike in inflation is
of stronger growth, debt will effectively thus unlikely, unless their mandate is
Following the financial crisis, professors be monetised by Quantitative Easing, or changed. Finally, there are persistent
Rogoff and Reinhart stated that growth even ‘helicopter money’. As any profits the inflation headwinds such as declines of
typically begins to suffer when debt central bank makes on bond investments workers unions’ power, and technology
reaches 90% of GDP. But how the debt from interest rate payments are typically displacing jobs, with any productivity
is structured, in what currency, and the paid back to the government, it greatly gains feeding through to lower prices or
nature of the creditor are all key factors, raises the level at which debt becomes higher profits, rather than higher wages.
meaning that sustainability can vary unsustainable. After a recession, there is usually a period
greatly from country to country. of lower inflation due to overcapacity, and
Japan is a case in point, where markets thus expect inflation to remain
Borrowing for productive investment, government debt has been sustainable below 2%, even five years from now.
particularly in starved areas such as even though it stands at an enormous
infrastructure investment in the US or 240% of GDP. This is because 43% of For most developed economies that
Europe, is likely to have a net positive this debt is owned by the Bank of Japan, borrow in their own currency defaulting
impact. The related transfer of wealth with the bulk of the remainder owned is a choice rather than a necessity,
from future taxpayer to the present is domestically within the private sector. The because the central bank can always step
worthwhile if it generates enough growth large intervention of the BoJ, along with a in, making a default very unlikely. But in
to cover the cost of debt. Following the willing private sector to hold debt, means the Emerging Markets, where much of
same logic, the borrowing in reaction that they have successfully been able to the borrowing is in USD, defaulting can
to COVID-19 tries to reduce the hit on keep the 10-year government bond yield eventually be the only option when a rising
economic growth, by avoiding mass in a very low range of 0-20bps. We believe dollar makes debt levels unsustainable. In
bankruptcies and permanent scarring many developed markets will follow this this case, EM countries have often chosen
to the economy. While this makes framework of financial repression, keeping to default on their local debt rather than
economic sense, debt is likely to jump by their government’s borrowing costs low, their USD debt because they are reluctant
a very significant 20% of GDP for many and helping to gradually reduce the debt to lose access to USD funding.
developed markets struck by COVID-19, pile as long as nominal growth is positive.
even under optimistic growth scenarios. In the US, we believe the Fed will play its In conclusion higher debt levels in the
part in controlling the yield curve, keeping developed world are likely to persist for
Like any debt, the ability to repay is its policy rate close to zero for several some time and may linger, as in the case
dependent on income, or in this example, years, while 10-year yields should trade of Japan. This may provide a headwind
GDP growth and the rate of taxation. around 0.5% by the end of 2020 and 1.0% to growth but is unlikely to lead to a debt
Governments have income in perpetuity, by end of 2021. sustainability crisis while rates are near
and we expect rising taxes on higher zero. We think central banks will assist in
earners and corporates. Taxation alone is But will balance sheet expansion fuel keeping yields at low levels, which should
unlikely to solve the problem of mounting inflation? If so, it could theoretically not be too difficult given the weak
debt, however. Previous episodes of high help governments erode the debt as a inflation outlook.
developed market debt have been eroded percentage of nominal GDP. In recent
through a combination of inflation, growth years, the problem has been that the
and financial repression. transition of central bank liquidity into
the broad economy depends on banks
14Investment Outlook Third Quarter 2020 15
Equities
Equities naturally look forward to the historically low in most major countries and earnings estimates, creating market
recovery, but the sharp bounce in as are market rates. Therefore the cost of volatility. Overall, we foresee some further
valuations seems exaggerated, and capital should be quite attractive for better downgrades by analysts in the coming
earnings may see further downgrades. rated companies as we begin to climb weeks, to reflect the current pessimistic
We thus expect volatile range trading out of this deep recession. Fiscal policy view from corporate America. We
in the short term and focus on quality has been quite expansive in numerous therefore think that a defensive sector
stocks and defensive sectors. We countries as national governments have allocation is appropriate, with a focus on
see opportunities in technology and recognized the importance of keeping quality companies, which maintain
healthcare, as COVID-19 is accelerating the health crisis from becoming a full strong balance sheets and positive net
some existing long term trends. blown financial crisis. Inflation remains cash positions.
muted and while we may see some
Equity markets have been quite volatile so issues with demand push inflation in The US remains one of our principal
far this year as the corona virus turned into the recovery, they should be isolated overweight markets though, and one of
a global pandemic. The policies of social and temporary shocks. Technology the reasons is the leading role of the US
distancing and economic shutdown in remains one of the major drivers of Federal Reserve, providing the liquidity
many countries have led us into a deep - growth and equity market momentum, needed to support financial markets and
but hopefully relatively short - recession. as emerging technologies like 5G, big return them to some sense of normalcy
While investors adjusted positions, data, robotics and artificial intelligence in the not-too-distant future. In short, the
analysts have had to adjust their earnings converge and diffuse throughout the Powell Put persists to some extent. In a
forecasts. This not only needs to take into global economy. This should improve large country like the US, businesses can
account the short-term, but also include a productivity and innovation in the most begin to reopen state by state, and many
more realistic reassessment of corporate competitive companies driving equity workers will return to their jobs. Demand,
earnings for the next twelve months. market index averages, while smaller, in both the household and business
Indeed, we do not believe that the global less technologically advanced or less well sectors, should begin to improve and
economy will turn on a dime and make up capitalized companies may lag behind. normalize. There should be significant
for all the lost opportunities of the first half pent-up demand from some households
of the year for quite some time. Clearly, in and companies, especially in interest-rate
any forecast of the global economy and Powell and Profits sensitive sectors, but on the other hand,
equity markets certain assumptions on the US equities may remain volatile as high unemployment may depress demand
spread of the virus and ensuing economic investors struggle with the differing from other households. It is at this point,
aftershocks must be made, and it would outlooks between the short and as the economy truly begins its expansion,
be natural for analysts and investors to err long-term. In the short-term, the fits that earnings downgrades should stabilize,
on the side of caution. and starts during the recovery should or even rebound.
lead to ups and downs in valuations Equities
But as we begin to emerge from the
economic downturn, markets naturally The US has led the rebound, EM performance has been mixed, and Europe
begin to look towards improving economic has lagged.
fundamentals, although it is important to US Europe ex-UK UK Emerging markets
find the right balance here. Markets tend
to bounce quite sharply when a bottom in 180
activity is found, and they have taken the
160
rebased at 100 five years ago
flattening of COVID-19 curves as a leading
indicator for such improvement. But the
140
bounce to new price / earnings highs
seems exaggerated, and we also fear that
120
consensus earnings expectations may
be downgraded somewhat further.
100
As a result, we think we will move into a
volatile consolidation phase before we
80
rally further.
60
Major policy support has reduced the tail
May-15 May-16 May-17 May-18 May-19
risks and should help support a gradual,
Source: Bloomberg, HSBC Private Banking as at 13th of May 2020. Past performance is not a reliable
though uneven, recovery. Policy rates are indicator of future performance.
16Equities
Although valuations are supported by policy action, the jump to new highs is preserve cash. As with other regions, the
exaggerated, in our view. outlook for fiscal stimulus should be a key
driver of growth and profits and whether
S&P Stoxx 600 European equities can post solid returns
24
in the future. Increased spending at the
22 Eurozone or EU level is possible, but so far,
it has not impressed markets.
Price/Earnings ratios
20
18
The UK’s high dividends provide an
16 attraction, and we believe there is long
14 term value in some of the larger, global
companies. But until there is further
12
clarity on the specifics of how Brexit will
10 work, and with tight negotiation
8 deadlines, volatility and headline risk
Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 may remain high.
Source: Refinitiv, HSBC Private Banking as at 13th of May 2020. Past performance is not a reliable indicator of Investment Summary
future performance.
The outbreak of the coronavirus has taken
equity market volatility to unexpected
In the medium term, the flexibility of We therefore remain focused on our
levels. Until we get better clarity on how
the US economy, and its high weight strategic themes of the global power of the
the virus can be contained, and how
of technology in the index provide a domestic Asian consumer, e-commerce
quickly the global economy can begin
competitive advantage. We continue to and 5G. With the rollout of 5G networks
to expand again, uncertainty should
invest in many of our strategic themes and services we will see the continuation
prevail. But the monetary and fiscal policy
such as consumerism, technology with a of the development of new technologies in
stimulus provided should continue to
focus on 5G, robotics and automation, and new sectors and a convergence that will
provide the liquidity and the backstop
many aspects of healthcare. 2020 is also a create the jobs, wealth and profits of the
needed by the financial markets to avoid
Presidential election year, and historically future. Asia, especially China and India, are
a full-blown crisis. As the global economy,
the economy and the stock market have expected to create wealth at much faster
and eventually the outlook for corporate
produced solid returns in those years. This rates than any region of the world in the
profits, begin to improve we may become
is especially true when an incumbent in next decade. It is that wealth creation
more constructive on equities overall, with
the White House is seeking re-election. that should help build a middle class
a focus on markets in the US, the UK, and
that could provide stable growth for the
China. At that point, we could focus on
Chinese economy.
Asia & China out first more growth-oriented sectors like interest
Given a swift policy response, several rate-sensitive companies.
countries in Asia, especially China, Europe
However, until we see signs of a sustained
were among the first few countries to Several European countries struggled
rebound in global economic growth,
emerge from the coronavirus. Continued heavily with the corona virus and the
we maintain a slightly defensive sector
monetary and fiscal policy support, ECB stepped up to prevent further
positioning and selective approach. A
combined with ongoing reforms, will financial deterioration. A pickup in
focus on quality companies with strong
be helpful ingredients in the ongoing global growth should be a positive for
balance sheets and positive net cash
expansion. Infrastructure spending, Europe, as it is heavily exposed to global
seems prudent. Moreover, we focus
especially in the new digital technologies trade and EM demand, but the trend
on several key strategic themes like
should see major investment flows. China towards de-globalisation is a challenge.
technology globally (5G, robotics, &
remains in the midst of a massive shift Relative valuations remain attractive but
emerging healthcare) and improving
to a digital- and technologically-driven investors are currently more likely to look
consumerism in the emerging markets
society with a stable consumer base. And for sustainable growth than focus on
(especially Asia & China) which should be
it is becoming less dependent on low-end valuations. Income investors continue to
big drivers of equity market momentum.
manufacturing exports to the world, which look at European equities which often pay
have been fragile during the US-China compelling dividends, but some dividends
trade tensions and the COVID-19 crisis. have been cut as companies try to
Investment Outlook Third Quarter 2020 17Fixed income
The structurally low rates outlook and lowered our 10-year gilt forecast from China, where an acceleration in monetary
very accommodative policies should 0.4% to 0.2% for the end of 2020. In the easing is evident and direct effects of the
support the search for yield. But we Eurozone and other DM sovereigns, bond lockdown have faded (see more below).
focus on investment grade and are yield targets remain unchanged, as their
selective when picking our companies current levels have already been hovering When looking at the broader bond market,
and EM country exposure, because around all-time lows for some time. performance has retraced a large part
of low growth, rising defaults and low of the sell-off, and we believe we have
oil prices. Aggressive stimulus by the Federal entered a consolidation phase. This
Reserve has reduced the tail risk of a consolidation comes despite ongoing
The fast-spreading pandemic hit our systemic credit crisis in our opinion. Taking uncertainties around the full effect of the
highly-integrated global economy in an into account the improved risk-reward COVID-19 pandemic on global growth,
unprecedented way, and despite current trade-off in DM credit markets and the unemployment, trade, corporate earnings
steps towards ending the lockdown dovish Fed guidance, we upgraded our and individuals. These challenges are
measures, we are expecting a record views on Global and US Investment compensated by unprecedented global
drop in global output. Global real GDP Grade credit to a small overweight after response and support from governments
is expected to fall by 4.8% in 2020, with having downgraded it at the start of the and central banks, which provide some
the US, Japan and the Eurozone poised COVID-19 crisis. We believe this sub-asset comfort. Nevertheless, we refrain from
to decline by 7.0%, 4.1% and 8.1% class of the bond market offers attractive upgrading our views on Global High Yield
respectively. Mainland China, the world’s carry opportunities when compared to (HY) and we continue to have a mild
second largest economy is still expected cash positions or DM government bonds. underweight due to deteriorating credit
to expand, but only modestly at +1.7%, In order to weather any potential credit metrics. Additionally, we expect default
the slowest pace on record. Global GDP spread volatility in the short-run, we focus rates to climb at a rapid pace in Europe
should remain below the 2019 level for on the shorter-part of the yield curve (i.e. but even faster in the US, partly due to the
some years and our central scenario is for 3- to 5-year maturities). outsized exposure to the Energy sector.
a U-shaped economic recovery.
Most of the fiscal response so far has The DM IG credit market has also
Central banks and governments have been come from major DM economies, while recovered from its lows and appears less
forced to commit trillions of dollars to keep Emerging Market (EM) economies have dislocated than in March as IG spread
households and companies afloat and been more cautious. This partly reflects curves are back to being positively sloped
prevent financial markets from collapsing concerns about their ability to drive (i.e. wider spreads for longer maturities).
and liquidity from drying up. One of fiscal expansion without endangering Several central bank programmes
the by-products from the co-ordinated debt sustainability and access to market including the Fed’s new Primary Market
actions is a surge in budget deficits and funding. We have recently factored in Corporate Credit Facility (PMCCF) as
an increase in government debt. The these risks and therefore remain very well as the Secondary Market Corporate
upcoming surge in sovereign bond supply, selective in our EM bond allocation.Fixed
We income
Credit Facility (SMCCF) and the ECB’s
mostly in the form of short-dated bills, avoid commodity net exporters and favour €750bn Pandemic Emergency Purchase
could have an impact on yield curves
and the risk premia of global sovereigns. The size of the policy stimulus is unprecedented, as shown in the expansion of
Fortunately for bond markets, central central banks’ balance sheets
banks may come up with yet more
7000 Fed ECB
unconventional measures, such as yield
curve control, which has been the case in 6000
Billion, local currency
Japan for several years and has just been
initiated in Australia. These new measures 5000
could avoid a repricing of government
4000
default risk and anchor sovereign yields
at very low levels, mostly in Developed 3000
Markets (DM). Considering that interest
rates are set to remain close to zero for 2000
years and the debt overhang might weigh 1000
on future growth, we lowered our 10-year
US Treasury yield forecasts to 0.5% from 0
1.5% and to 1% from 1.5%, for the end Mar-05 Mar-08 Mar-11 Mar-14 Mar-17 Mar-20
of 2020 and 2021 respectively, and also Source: Federal Reserve, European Central Bank, HSBC Private Banking as at 13th of May 2020.
18Fixed income
EM hard currency bond spreads are still wide, offering an attractive risk/return From the top down perspective, EM
trade-off economies have also strengthened
EM Latam EM EMEA US HY compared to GFC of 2008-2009, with
1400 EM ASIA Comp EM ASIA HY reduced external imbalances, high FX
reserves and stronger fiscal balances.
1200 This is especially true about China, which
1000 has significant internal resources to prop
up the economy. While it is still difficult
Basis points
800
to assess the precise ultimate impact of
600 Coronavirus on the Chinese economy,
400 we remain constructive on Chinese
credits, but with a focus on quality names
200 with low leverage and strong ability to
0 attract capital. We like Chinese Property
Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Developers in hard currency (HC),
due to their domestically oriented
Source: Bloomberg, HSBC Private Banking as at 13th of May 2020. Past performance is not a reliable operations and improving credit profiles.
indicator of future performance. Additionally, property transactions are
Programme (PEPP) provide support for grade BBB- and the EM default rate is starting to pick up again following the
the Global IG corporate bond market. We expected to increase only marginally this period of containment (albeit not back to
view such facilities as an important circuit year, from 1.0% to 1.3% (and from 2.0% normal levels).
breaker, which should anchor corporate to 4.8% for HY-rated bonds in EM). EM
credit spreads and prevent a spill-over companies are now much more resilient As for Local Currency (LC) debt, our
beyond sectors directly affected by the when compared to US HY, where the top conviction is still on mainland
COVID-19 pandemic. The programmes average rating is B+ and the default rate is China bonds. A clear acceleration in
also highlight central banks’ commitment expected to rise from 2.9% to as high as monetary easing is evident and provides
to their respective credit markets. 8.0% by year end. a supportive backdrop to local rates.
JP Morgan’s inclusion of China in their
Beyond global investment grade bonds, Given the global nature of the current EM indices should also be supportive to
we continue to have an overweight on EM crisis, we do not have strong regional capital flows towards the domestic bond
corporate bonds in Hard Currency (HC), preferences outside of China at the market over the coming months.
but take a selective approach, favouring moment and rely on a bottom up
companies with low leverage, positive investment approach, looking for As for our global sector preferences we
cash flows and ability to raise capital. companies with stronger fundamentals favour non-Cyclicals, Healthcare, TMT
across regions. In contrast to DM, many and Financial companies, with a focus
Overall, we believe that EM corporate EM companies have been focusing on on quality names with low leverage and
bonds in HC continue to offer a good risk/ de-leveraging in recent years, in order strong ability to raise capital. On the
return trade-off, having started with strong to reduce their vulnerability to external other side of the spectrum, we remain
credit fundamentals before the pandemic, factors. As a result, it is possible to find underweight DM sovereign bonds and
and offering a substantial yield pickup defensive names even among commodity global HY corporate credit, mostly due
over DM bonds. The average rating Fixed
of EMincome
producers, including Energy and Metals to tight valuations for the former and
corporate bonds remains an investment and Mining. deteriorating credit metrics for the latter.
EM defaults are likely to be much lower than for US high yield, in spite of
wider spreads.
18% US HY EM HY
16%
14%
12%
default rate
10%
8%
6%
4%
2%
0%
2000
2004
2006
2005
2008
2009
2020F
2003
2002
2007
2001
2018
2010
2016
2019
2015
2013
2014
2012
2017
2011
Source: JPM CEMBI Index, ICE BofAML Index, Bloomberg, HSBC Private Banking as at 13th of May 2020.
Investment Outlook Third Quarter 2020 19Currencies and Commodities
We expect currency markets to be Currencies
The uncertain environment is creating and supporting
volatility, commodities
gold and keeping
volatile, with a Risk on / Risk off tone, USD at elevated levels.
but continued mild upside for USD.
We are selective in emerging markets 1800
Gold USD index (RHS)
106
currencies and continue to like gold as 1700
a tail risk hedge in portfolios. Oil prices
1600 101
should remain low as the supply glut is
unlikely to disappear any time soon. 1500
USD/oz
1400 96
The Risk on – Risk off (RORO) 1300
phenomenon has been the main driver
1200 91
of FX movements since the start of the
year. The COVID-19 pandemic created 1100
a significant disruption in the global 1000 86
economy, pushing investors towards Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20
safe-havens. However, in currency and
Source: Bloomberg, HSBC Private Banking as at 13th of May 2020.
other markets, the flattening of infection Past performance is not a reliable indicator of future performance.
curves was taken as a leading indicator,
leading to an improvement in risk appetite by low growth, low commodity prices rally further. CHF has some of the same
from late March, and causing some and low inflation. Later on, we believe qualities and should also be supported
investors to go for risk assets. Investors’ the FX market would refocus on a in this scenario. Gold should be another
optimism has been tempered, however, country’s external balances, its structural winner in such a scenario, supported
as they increasingly acknowledge that a vulnerabilities, the level of foreign by its negative correlation to risk assets.
recovery might take a while, and could ownership of its equity and bond markets, On the other side, we believe AUD and
be shallow. In the year to date, the best and political factors. We believe the winner NZD would struggle due to their risk-on
performing currencies thus are still the among G-10 in such an “L-scenario” would character, and we believe GBP would
safe-havens such as USD, JPY and be JPY, as it could benefit from both be down too, though slightly less. In the
CHF, while currencies positively phases. The “risk-off” behaviour would Emerging Markets (EM), we could see
correlated to risk appetite recorded losses logically bring inflows into the currency, RMB and RUB being relatively resilient
so far in 2020. and its enviable international investment versus other EM currencies. RMB may
position should also help the currency to benefit because China’s growth depends a
While we believe the FX market will
remain sensitive to the RORO, we need Currencies
EM currency performance has been andwe
mixed, and commodities
believe CNY will remain
to have a wider view of what could come more resilient than many others.
next and how we could look at the FX
market in a post-pandemic environment. China Brazil Mexico Russia
To do so, we adopt a scenario analysis that 120 Turkey India Indonesia
sets out our range of possible outcomes,
and the implication of each of them on the 110
FX and commodity markets. We believe
indexed at 100 in January 2015
100
that scenario analysis is the best solution
90
in such a blurry environment. We discuss
the market consequences of 3 possible 80
recovery scenarios for the coming months,
70
namely the “L-shaped”, the “V-shaped”,
and the “U-shaped” recoveries. 60
50
An “L-shape” is a scenario in which
the global economy fails to rebound 40
significantly even after the easing of 30
COVID-19 containment measures. We
Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20
could witness two phases in this scenario.
This first one would see dominance of Source: Bloomberg, HSBC Private Banking as at 13th of May 2020.
a “risk-off” tone that would be initiated Past performance is not a reliable indicator of future performance.
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