Merlea Macro Matters – August 2020


Some early releases for July, notably services PMIs, have raised hopes of a V-shape recovery. But the outlook remains unsteady, as illustrated by diverging financial markets. The recovery remains patchy across sectors and economies with several factors threatening to restrain it over the next year or so.

The services sector is the weak point of the recovery, so the strong PMI readings for July in several European countries look like good news. However, we would caution that buoyant-looking PMIs can still be consistent with actual output levels below those seen before the coronavirus crisis.

Recovery remains skewed towards goods sectors, with services lagging and this pattern could persist for some time, dragging on GDP. Sweden’s experience illustrates the problem, with Q2 GDP falling 8% even though it eschewed the strict lockdowns seen elsewhere in Europe. Another risk is that even as output rises, firms may be slow to increase employment, holding back the recovery. Tightening bank credit standards are another danger, with the latest US data very concerning.

Finally, the trajectory of the virus remains a danger – in recent weeks we have seen a modest rise in cases in Europe and growth in some emerging markets remains rapid. However, the biggest news on the COVID-19 front came from Russia when President Vladimir Putin announced that his country had become the first one to approve a COVID-19 vaccine after testing it on humans for less than two months. Named ‘Sputnik V’ after the world’s first satellite, the vaccine is expected to enter mass production by year-end. But experts the world over have raised an alarm over Russia’s claims on the vaccine, saying in the absence of proper data and large-scale trials the vaccine’s efficacy cannot be trusted.

Meanwhile, Senate leader Mitch McConnell and the Trump administration want to spend more, while a significant number of Republican members of the Senate are wary of any more spending for fear of driving up debt to an unsustainable level. Treasury Secretary Mnuchin said, “There is obviously a need to support workers and support the economy. On the other hand, we have to be careful about not piling on enormous amount of debts for future generations.” Kashkari has countered, saying that “if we got the economy growing, we would be able to pay off the debt.” In any event, negotiations between the White House and Congressional Democratic leaders continue, but as of to date that the two sides remain apart, boding poorly for passing a new stimulus bill in the near term. The US and China are due to resume trade talks in the coming days that last took place in January before tensions escalated.

TikTok was the second most downloaded app in 2019

BANNED TIK TOK APP COUNTRIES LIST – India, Bangladesh, Indonesia, Hong Kong, Malesia. Now the US, UK, and Australia are also looking to ban the app.


The US President Donald Trump has clashed with China recently over two Chinese apps, TikTok and WeChat, which could be banned in the US over national security concerns. Just the latest impasse between Washington and Beijing; adding to China’s new national security law for Hong Kong, communications firm Huawei and the origin of the coronavirus.  China and the U.S. have been engaged in a trade war since last year. The ongoing Trade War is redrawing global supply chains, claiming casualties in the process. As persistent headwinds intersect with traditional seasonal softness, recent volatility can be expected to continue in the near term as markets await policy developments.



With government bond yields fast approaching zero, vanishing yield cushions have left conventional bond investments with a forward-looking risk vs return profile that is unfavourably asymmetric.


As bond yields represent the compensation that investors receive for bearing interest rate duration risk, we can look to the duration vs. yield trade-off as a good indicator of how attractive (or not) the risk vs. return proposition is.  For example, the charts below show the duration vs. yield trade-off for global and Australian government bond indices that are referenced by conventional duration based fixed income funds. In both cases yields have collapsed to near zero, meaning very low expected returns going forward. While at the same time, duration risk has increased, meaning greater risk of capital losses if yields were to rise. Therefore, investors are left facing more interest rate risk for less return.



The reality is that bond prices cannot keep going higher unless yields keep going lower, which is why, unlike with equities, the upside potential in bonds is inherently capped.  Even if stocks are expensive, there is no real limit to how high they can go. Bond prices on the other hand are bounded by the fact that hold-to-maturity returns are limited to interest payments received over the life of the bond. Any additional capital gains before then are limited by how low yields can go.

This negative asymmetry of risk vs return is unavoidable as bond yields keep going lower because when the starting point of yields is already extremely low to begin with, there is naturally less room for them to drop further. This is what makes chasing bonds at record low yields (i.e. record high prices) very different to chasing stocks at high valuations. Stocks can keep going up indefinitely, bonds cannot.  The vanishing yield cushion fundamentally changes the risk vs. reward proposition of bonds and challenges conventional assumptions about the diversification value of including conventional duration-based bond investments in multi-asset portfolios.

We have now experienced two large equity drawdown episodes (Q4 2018 and Q1 2020) where conventional duration exposure failed to reliably protect multi-asset portfolios. These are not temporary blips; they are a paradigm shift driven by vanishing yield cushions and the increasingly unfavourable asymmetry of duration risk. They should be heeded as warning signs that conventional assumptions about portfolio construction and risk diversification may no longer be reliable and that it is a bad idea to simply assume that bonds will continue behaving as they have in the past.



Listed Property

Real estate investment trusts (REITs) have had a tough year in 2020 so far. Formerly favoured for their income potential, REITs were among the hardest hit sector in the coronavirus-induced market crash in March.  While the outlook varies according to property type, many REIT sectors look poised to experience pressure on vacancy rates, property prices, and rent growth in the months ahead.

The prudent steps REITs have taken since the global financial crisis to shore up balance sheets and fortify portfolios are expected to help them withstand the longer-term challenges resulting from the pandemic. REITs in a post-COVID world, in our view, can be separated into three categories:

  1. property sectors with continued tailwinds, e.g. infrastructure, data centres, industrials
  2. sectors with short-term coronavirus impacts but strong recovery potential, e.g. residential, healthcare, hotels and resorts
  3. and sectors with longer-term uncertainties, e.g. retail (excluding essential services), office.

However, some of this uncertainty is likely discounted into stock prices.

The change over time of the spread between the earnings yield of AREITs and the 10-year government bond yield is shown in above chart


The top down considerations for the sector are positive with the DPS (dividends per share) yield spread to 10-year bonds at an all time high of 420 basis points compared to a historical spread of 210 basis points. This is driven by both a moderation in bond yields and increase in the DPS yield as the sector has been sold off. As bond rates are expected to remain lower for longer at less than 1.5% until at least 2022, we see valuation upside particularly for REITs that have sustainable income with high free cash-flow, good quality assets and a strong balance sheet.

Looking forward investors won’t be able to rely on passive investing. Active managers with the ability to balance exposure between structural growth and attractive value while avoiding the trouble spots will be well positioned to navigate the new market environment.  Looking beyond the current turmoil to a period when the capital markets have stabilised, investors can likely expect structurally lower interest rates and slower economic growth. A low rate and slow growth environment have historically been favourable for commercial real estate and may prove to be so again. Market commentators have speculated about the longer-term impact of COVID-19 on commercial real estate. Their outlooks are often guarded and frequently paint all property types with the same broad brush. Not surprisingly, some investors have become more cautious on the asset class.

It is certainly true that the historic collapse in the economy and resulting spike in unemployment have been headwinds for real estate – just as they have been for most industries. In our view, however, this broad-brush approach to real estate is misplaced. We believe there are opportunities for potentially attractive returns combined with solid risk-adjusted returns in both Australia and global real estate today; just as there were in the wake of the global financial crisis, the dot-com bust and the GFC.


Australian Equities

Looking at the share market’s performance over the last few months, some would be tempted to assume that the worst of the economic damage inflicted by the COVID-19 virus is well behind us. Economically sensitive sectors like Banks and Resources have led the rally, while many of the strongest-performing stocks have also been some of the most speculative, such as those in the buy now pay later sector. Company earnings and share prices both locally and globally have been – and are still being – driven by an extraordinary combination of factors. Some sectors, such as many retailers like JB Hi-Fi and Bunnings, have benefitted greatly from the huge short-term sugar hit of COVID-19 income support plus super withdrawals, while other sectors – such as travel, tourism, tertiary education and hotel accommodation – have seen their activity down anywhere between 50 and 95%. These factors have in combination played a big role in helping the Australian share market recover to the 6,000 level, well above the 4,500 level in March. The question then is: have Governments and relevant authorities done enough shield the economy from the worst of the recession so the economy can get to the ‘other side’ of the pandemic smoothly as things return to ‘normal’? Is the share market rally justifiable and sustainable? These are almost impossible questions to answer given the range of factors at play, At Merlea we remain cautious about the outlook, and highlight the reasons why we continue to skew our portfolios defensively.

The ASX 200 dropped 36.5% (from peak to trough) this year. Now it’s trading about 15% below its rolling 12-month high – Morgan Stanley.


It is difficult to understand what ‘normal’ is going to look like for many sectors as we head towards 2021. While the Jobkeeper and Jobseeker income supports have been extended until March, which will help reduce pain for many individuals and businesses and provide further near-term support for some share market sectors, it’s difficult to see how this can be sustained indefinitely. There is a real prospect of a ‘fiscal cliff’ in coming quarters.

The other major issue is the higher level of unemployment in the year ahead. On top of the current official 7.4% unemployment rate, Macquarie Bank estimates around 3.5 million of Australia’s 14 million-person workforce – the equivalent of 25% of Australia’s registered workforce – are currently on Jobkeeper. How many of these ‘stood down’ workers will have a job to return to remains uncertain, as many sectors are unlikely to recover quickly. Given this, the number of unemployed could rise rapidly to over 10% as we head towards 2021, which will be a major headwind for the economy. Diminished household spending power, record household debt, and higher unemployment are therefore likely to weigh increasingly on economic activity and on many Australian companies’ earnings in FY 2021 and potentially into FY 2022. Many companies are actively looking to reduce their labour forces and defer or cut capital expenditure because of the uncertain outlook in 2021. We believe that the recovery phase for the Australian economy will be prolonged, rather than V-shaped. Investors faced with the prospect of persistently low interest rates will continue to seek higher yields from the share market. In an environment where an increasing number of companies are likely to be reporting lower earnings and dividends, investors will increasingly gravitate towards those with defensive characteristics such as proven sustainable earnings and dividend yields.


Global markets

As the world emerges from lockdown, the full extent of the damage done to economic output and company balance sheets is yet to be fully understood. How, and when, economic growth can recover will be of extreme importance to investors. But for now, they are trusting that governments will continue to do “whatever it takes” to keep companies afloat. The financial assistance from governments has led to equity market resilience, despite the global economy facing one of the worst recessions it has ever experienced. As investors struggle to find returns from less risky assets, such as bonds, they feel compelled to take more risk, which has resulted in equities recovering to pre-Covid levels, as the chart below shows.


Despite this optimism, the reality is that we can expect to see slower economic growth, higher unemployment, and lower profits for some time to come. Ultimately, company earnings drive returns and finding companies with a good growth outlook will become harder, which makes careful stock picking so important. Today’s high valuations rely on businesses generating good results, which makes the rise to such confident levels somewhat surprising.

Historically August has had muted performance… given the fluid coronavirus situation, the uncertainty regarding the timing of fiscal stimulus and signs of economic data stalling out, August could be more turbulent than it has in the past. There is arguably more uncertainty about the future of the economy and markets swirling around than answers. And for many a fresh round of fiscal stimulus for Americans stricken by the COVID-19 pandemic ranks top among the list of concerns. I feel in terms of market outlook wall street is focused on two things:

  1. the outcome of Fiscal Stimulus / extended [unemployment] benefits and
  2. the path of the virus.


Looking near-term, markets are vulnerable to negative news after a 40% rebound and with sentiment on the verge of triggering our overbought signal. Over the medium-term, the supportive cycle outlook should allow equities to outperform bonds.

Different regions of the world are recovering from the COVID-19 pandemic at different paces. Many Asian countries have had experience dealing with past epidemics, including SARS, and they have thus tended to recover more quickly than the rest of the world. And at this point, Europe looks to be recovering faster than many parts of the United States.  The extent that Asia and Europe recover more quickly than the United States may shift the focus away from companies with a strong presence in the United States to those with businesses in regions that are recovering more rapidly. We would expect companies focused on these regions to generate more revenue than those whose markets are constrained by lockdowns.

Globalisation was already in reverse before COVID-19. The 2008 financial crisis undermined the trust of western voters in the free market capitalist model. The backlash continued with Brexit, the rise of Trump and the US/China trade war. The virus is only accelerating the anti-globalisation trend. Global supply chains are being unwound and the pandemic has created fears about food security and pressure for domestic production of medical supplies. Developed markets should benefit relative to emerging markets as there will be less technology transfer and less export-led growth. The unwinding of globalisation is a headwind for emerging markets.

Ongoing low interest rates favour higher yielding assets such as stocks, property and infrastructure over government bonds and cash. We are recommending investors diversify portfolios using gold, absolute-return strategies (such as hedge funds) and real assets (such as roads, energy, and infrastructure). While we must accept that taking some risk is necessary, these strategies hedge against falling equity markets and can provide longer-term inflation-proof returns.



There is a disconnect between the stock markets and Main Street. Stock prices remain elevated despite economic data indicating deep economic harm. The fiscal, monetary, and political responses to the COVID-19 crisis globally have led to a world awash with liquidity and short-term fiscal stimulation. Much of that liquidity has gone into the stock markets, explaining a great deal of the markets’ ascent in the second quarter.  The FAAANM stocks (Facebook, Apple, Alphabet, Amazon, Netflix, and Microsoft) appreciated 263.82% since 2015, about one-third of the S&P 500 Index’s return. The rest of the US equity market (S&P 500 Index without the FAAANMs) appreciated 35.68%. However, if you exclude the FAAANM stocks from US indexes, the US equity markets have performed about in line with overseas’ markets, and any difference is from currency moves.  There are 4 reasons to be cautious:

  1. Hidden vulnerabilities e.g. the lockdown-driven decline in economic activity and spike in unemployment has left the U.S. economy more exposed to risks
  2. Risk of second wave of infection, COVID-19 is a novel virus, meaning it has no exact precedent. A new round of infection is possible and its burden on the health care system and potential for renewed closures is unknown.
  3. Heightened geopolitical tensions, The US/China relationship is further strained since the COVID crisis, defined by greater competition and less cooperation.
  4. Absolute valuations are not cheap, stock prices are attractive relative to bonds, but by the most common measure of valuation, P/E ratio, they are not cheap. Stock prices relative to 12-month forward earnings per share stood at 21x at the end of May.


The key question looking ahead is whether markets will continue to climb based on monetary and fiscal responses or whether something could make equity markets unwind. I continue to believe that stock market and economic fundamentals will not remain disconnected forever. I think companies that will do well over time will have: clear business strategies, economic moats, workforce diversity, attention to Environmental, Social and Governance (ESG) factors, returns above the cost of capital, strong balance sheets and positive cash flow.



European assets have staged a comeback. The Euro rose to its highest level in more than two years against the U.S. dollar, and the region’s benchmark index, the Stoxx 600, is set for a second straight month of gains greater than those of the S&P 500 index, in dollar terms, according to data from FactSet. The most important reason for this upswing, is that Europe is recording far fewer new cases of coronavirus. The second reason is politics. When European leaders reached an agreement on a 750 billion euro ($888 billion) recovery fund, it wasn’t the size of the deal that impressed investors, but the fact to raise money collectively and give grants to the countries hit hardest by the pandemic was a message that there is some political will to further the project that created the euro two decades ago. European unity could still be found in an emergency, despite fraying on the edges caused by the exit of Britain from the European Union. Money from overseas is flowing into exchange-traded funds that buy European stocks, and there are signs that European investors are returning to their home markets and selling dollar-denominated assets, which is strengthening the Euro. Since late May Europe’s stock market has recorded stronger gains than the S&P 500 index, after taking the strength of the Euro into account. While investors should start to take advantage of the relative cheapness of European equities, a sustained recovery in the stock market will depend on consumer and business confidence returning, which would in turn stir economic activity.



After the nationwide state of emergency was lifted on 25th May, economic activities are coming back led by service sectors, which were hit hard by the COVID-19 pandemic. Manufacturing side is forecast to start recovering soon and to lead the economic recovery in FY2021. On the positive side, Japan’s biggest export market is China, which is easily the strongest-performing large economy in the world right now. Also, well over half of Japan’s goods exports are destined for Asia, which is generally outperforming the rest of the world amid the pandemic. Unfortunately, Japan’s second-largest export market is the United States, which is grappling with a rising wave of COVID-19 infections and is potentially headed toward a double-dip recession. In addition, many of Japan’s exports to Asia are reexported elsewhere, which diminishes some of the benefits of exporting to markets that are further along in their re-normalisation process. Japanese exports are also looking less competitive due to the strong value of the Yen.

Conflict between Japan and China over disputed islands in the East China Sea is also flaring up again. Previous conflict over the islands resulted in anti-Japanese protests and boycotts.

Japan’s policymakers have provided ample fiscal and monetary stimulus to cushion the fall in demand amid the worst times of the pandemic and to support growth as the country attempts to renormalise. However, consumers remain cautious as health risks linger and uncertainty over the future clouds the outlook. Manufacturers are expected to continue to struggle with weak global demand, a strong currency, and geopolitical risks. Japan’s economy should improve from here, but growth will likely remain subdued.



China’s economy returned to growth in the second quarter after a deep contraction at the start of the year, but unexpected weakness in domestic consumption underscored the need for more policy support to bolster the recovery after the shock of the coronavirus crisis.

Asian share markets and the Chinese Yuan fell, partly reflecting the broad challenges facing the Chinese economy as it grapples with the double-whammy of the pandemic and heightened tensions with the United States over trade, technology, and geopolitics. Those risks were partly reflected in separate retail data that showed Chinese consumers kept their wallets tightly shut, pointing to a bumpy outlook. This is very much a story of government stimulus-led recovery, which is very much focused on the industrial side. Retail sales were down 1.8% on-year in June – the fifth straight month of decline and much worse than a predicted 0.3% growth, after a 2.8% drop in May.

Domestic job losses have been one of the worries for consumers, as many businesses struggled to stay in the black. The rising tensions with the United States and the pandemic have added to structural issues that China has been facing for years, including demographic changes, over-investment, low industrial productivity, and high debt levels. The industrial economy offered some hope for the Chinese economy as it begins to regain its footing, with output in the vast sector rising 4.8% in June from a year earlier, the third straight month of growth, the data showed, quickening from a 4.4% rise in May. Domestic demand will drive China’s recovery ahead, but external demand could be a risk to the growth outlook given the possibility of large second round of coronavirus infections overseas .The outlook remains  positive in sectors that benefit from increased service consumption in China, including e-commerce, online life services, education, healthcare, and logistics. China’s broad adoption of online payments, fast delivery systems, and reliable telecommunication infrastructure provided companies with a foundation as they move their business online.





With the US Federal cutting interest rates to zero, there has been less incentive to hold dollars.  Cutting interest rates meant the already low returns that investors received from investing in debt, or bonds, were nudged even lower.

Gold has since therefore regained its popularity, with the price climbing back up to its highest point in nearly seven years. A shorter supply of the precious metal has also bolstered its price, as the virus has forced mines to close.  Central banks have been net buyers of gold over the past 10 years. Gold plays an important part in central banks’ reserves management, and they are significant holders of gold. According to the World Gold Council: “Today, central banks own almost 34,000 tonnes (t) of gold, making it the third-largest reserve asset in the world. The increase in central bank demand for gold reflects current geopolitical, political, and economic conditions, as well as structural changes in the global economy. Gold is both a liquid, counter-cyclical asset, and a long-term store of value. As such, it can help central banks meet their core objectives of safety, liquidity and return.”

Gold is also considered a good hedge against the risk of inflation because the rising cost of goods and services tends to erode the value of the dollar. And as central banks print more money as part of attempts to stimulate economies, and some may fear this could result in inflation. If this were the case this could impact the value of other assets. Meanwhile, “gold over a long period of time tends to hold its value in real terms” so can be considered as a “refuge” against this risk.


GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (October 2008 to June 2020)

Gold prices have a relationship with volatility unlike other asset classes.


Even if gold prices have hit a near-term point of exhaustion, the longer-term prospect for gold prices (and precious metals generally speaking) continues to hold. Like during The Great Recession, the Federal Reserve has responded with expansionary monetary policy. Unlike during the Great Recession, the federal government’s fiscal policy response has proven extremely robust. Rising federal deficits typically fuel inflation expectations as well as higher interest rates; but with the Federal Reserve keeping its main rate tethered near zero through 2022, we may very well be stuck with a net-result of the enhanced fiscal stimulus being higher inflation, but not higher interest rates.



Crude oil hit a post-pandemic high this week, rising to nearly $43 a barrel on Wednesday as domestic crude supply fell for a third straight week. Consumption has also improved in China, where manufacturing activity continues to expand following countrywide lockdowns. China’s oil demand has recovered to more than 90% of the levels seen before the coronavirus pandemic struck early this year, a surprisingly robust rebound that could be mirrored elsewhere in the third quarter as more countries emerge from lockdowns. Countries such South Korea, Australia and Vietnam where virus cases are broadly under check will see an improvement in petroleum demand. The official China manufacturing purchasing manager’s index (PMI) ticked up to 51.1 in July, representing the fifth straight month the gauge has been above the 50.0-line separating expansion from contraction. The private Caixin/Markit PMI, meanwhile, came in even higher at 52.8.

PMI is a forward-looking indicator that can help investors get a sense of where commodity prices might be headed one to six months down the road. That is because one of the things PMI looks at is new orders. If factories are receiving a wave of new orders for, say, automobiles, you can reasonably expect that they will need to consume more energy to run their operations, not to mention use more metals and other raw materials. All this activity is supportive of commodity prices—oil’s especially, based on China’s PMI data above.

Sector 12 Month Forecast Economic and political predictions 2020



Upside 74c

Downside 67c


The US dollar is near milestone lows, after a triple blow of retreating yields, soft U.S. economic data and a dip in safe-haven demand exerted broad selling pressure.

The RBA minutes will be the key for the AUD/USD traders as the Aussie central bank’s latest dovish tone needs justification. The RBA kept its benchmark unchanged while adding to Quantitative Easing (QE) in its latest meeting.





Gold to stay in holding pattern, could retrace to $1,750 an ounce in the short term


Gold prices saw their largest single day drop last week, but a technical correction is to be expected in this bullish environment. U.S. dollar and lower interest rates as the two driving forces behind the gold price rally.


“Despite the steepest sell-off since April 2013, the longer-term outlook remains constructive for gold





I remain bullish on nickel for three reasons:

1. the market is underestimating a medium-term (1-3 years) recovery in base-metal prices.

2. Second-generation lithium-ion batteries use nickel manganese and cobalt, creating higher energy densities and thus a longer driving range.

3. “Smart money”.  BHP Group makes a big play on nickel In June, BHP’s acquisition of Norilsk’s Honeymoon Well Project.




We expect iron ore prices to ease from current spot levels, with metallurgical coal still having to navigate a difficult period as major importing regions manage their re–openings in the first half of financial year 2021. COVID–19 permitting, sustained improvement is possible in the second half of the financial year.


Oil and copper prices are both highly susceptible to swings in global policy and economic uncertainty.


Oil has suffered through demand collapse, with the crash in pricing that this created only forestalled by a combination of very large withdrawals of supply and the partial normalisation of terrestrial mobility conditions.


Copper demand has been much more resilient, reflecting the nature of its end–uses and its greater exposure to China’s recovery. Coupled with profound COVID–19 related difficulties on the supply side of the industry, this has enabled copper prices to recover quickly from the trough they initially fell into amidst the financial panic of March.





Infrastructure, data centres, industrials preferred


Valuations have gotten more reasonable and the long-term prospects of many REITs still look promising. After all, real estate is not as correlated to other asset classes.



Australian Equities




In the short term, we maintain a cautious outlook for Australian equities with P/E ratios of stocks across various industries trading significantly higher than their historical averages. We predict the market will finish the calendar year flat.







Long dated bonds, 5-year duration


Inflation linked bonds



The RBA is targeting a risk-free interest rate further out along the yield curve. On 19 March 2020, the Board announced a target for the yield on 3-year Australian Government bonds of around 0.25 per cent, to help lower funding costs across the economy. The Bank is purchasing Australian Government bonds across the yield curve to help achieve this target.


The Bank expects to maintain the target for three-year yields until progress is being made towards the Bank’s goals of full employment and the inflation target.



Cash Rates


Hold 0.25 %



Governor Lowe has emphasised that the economic recovery depends on health outcomes and how quickly confidence is restored, where the recent COVID-19 outbreaks in Victoria have presented an additional downside risk.  Unwilling to consider negative interest rates, the RBA is essentially all out of tools to manipulate monetary policy and is now looking to the Government to provide support to the economy through fiscal measures.


Global Markets




Risk to US stocks include concerns about the pandemic,

fading fiscal stimulus, volatility around the election and worsening relations with China


Despite COVID-19 headwinds, trend US growth remains stronger than in other developed markets, and technology exposure sustains the market opportunity. The market’s attention will likely focus on valuations, the 2020 presidential election cycle and whether Fed policy programs are effective in stimulating demand.






Europe’s exposure to financials and cyclically sensitive sectors-such as industrials, materials and energy-gives it the potential to outperform in the second phase of the recovery, when economic activity picks up and yield curves steepen.


European policymakers are showing greater unity, but weak manufacturing sentiment persists. The ECB has made efforts to offset the effect of lower rates, but we see banks remaining a drag. We maintain a more cautious view, which reflects a lower outlook for earnings, and valuations that are no better than

neutral relative to history.

UK – Domestic political tensions have eased, but uncertainties over Brexit and UK economic prospects remain. This defensive market appears historically cheap, so long as corporate profits are not too severely impacted.






Although a recovery is expected, it is expected to take at least two years to return to pre-infection profit levels.


Equity valuations, particularly on a price-to-book-value basis, have been attractive relative to other markets, in our view. However, weaker economic activity following a consumption tax rise and global trade concerns are unfavourable for the Japanese market. Earnings per share and return on equity are weakening relative to peers. However, we have tempered our caution about this cyclical market.





Emerging markets


China remains ahead in terms of the extent of its recovery, which, along with a weaker dollar, should be supportive for emerging markets and for the materials sector.



Risks to global growth highlight emerging markets’ idiosyncratic risks and underlying cyclicality. However, valuations remain attractive to us relative to developed market peers and return on equity is improving.





Chinese stocks have rallied to a five-year high after a survey suggested the nation was recovering from the economic blow of coronavirus.


Rising tension between Beijing and Washington remained a source of concern for investors.


China’s economy faces a persistent impact from COVID-19, weak global demand and heightened geopolitical tensions. Further support from fiscal or monetary measures may be required. Trade disputes remain unresolved in the longer term and are a symptom of broader tensions. Valuations have become elevated, and we maintain a neutral view of this market.


Consumer-oriented services such as advertising, healthcare, or insurance have room to grow and are now more accessible to foreign investors.




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