While the pandemic has entered into the “second wave” stage across the world, beating some of the terrifying spring records, many European countries have responded with stricter measures from public gathering bans and night club closures to new curfews and lockdowns.

Meanwhile, the world is closely watching the most influential and the least predictable anticipated event of this year: the American elections. The combined gravity of these two factors is so strong that even the unexpected news from the earnings report front have had relatively little effect on the markets – be the news positive or negative. Moreover, the political turmoil in the US is expected to continue for a while even after the first week on November, since neither party is prepared to lose without a fight.

Tactical Asset Allocation

Macroeconomics

The third quarter of this unusual year revealed some optimism as many figures representing the period’s output implied positive growth at a higher than expected level. On one hand, most companies that have reported Q3 earnings, managed to beat expectations. On the other hand, economic data showed significant growth from July to September 2020.

Namely, preliminary Q3 US GDP growth was 7.4% (reported as 33.1% annualized), and Eurozone preliminary Q3 GDP growth was 12.7%. Both figures mean high paced growth above expectations. However, the output still remains below the pre-pandemic levels, and, moreover, there are signs that the recovery has stalled. In particular, the unemployment rate in the US, while having dropped from the double digits in spring to 7.9% in September, is much higher than the long-term average and the pre-pandemic level of below 4.0%. Similarly, in Eurozone, unemployment rate remained at an elevated level of 8.3% in September. All this on top of the current pandemic developments underlines the dire need for additional fiscal and monetary stimulus.

After uplifting the public’s hopes with intensified fiscal stimulus discussion, the American government failed to come up with a deal on a new package to help the economy. There is no doubt that new stimulus will arrive, but the after-election hustle might divert policy-makers’ attention for a while.

At the same time, after the October meeting, the ECB hinted that new monetary stimulus might be introduced in December, and, in the UK, another round of much needed bond purchases is expected in November. Perhaps, this will be able give markets another push in the upward direction.

Fixed Income

It looks like October was a rather quiet month for Fixed Income as major levels did not change significantly. But this is misleading. The trading range in UST 10y was 20 bps. By mid-October investors anticipated a Democratic sweep and an agreement on the stimulus package. That is why long-term US rates started to rise, and yield curves continued to steepen. But renewed Covid worries and therefore falling equity markets pushed yields lower again.

Similar behaviour we saw in credit markets. HY spreads tightened (30-40 bps) till mid-October and widened sharply (40-50 bps) again in the recent equity-selloff. The reduced risk appetite was shown in a slowdown in HY primary market activity. Fund flows into HY assets were mixed with EM getting most of the inflows. The willingness of central banks to ramp up purchases of corporate bonds prevent credit markets to react in a more severe manner. So far, we have not seen a sell-off, just slowing demand from real money accounts. Short term we expect this trend to persist as the Covid-situation does not seem to improve and the election result needs to be clear on either way.

We are still comfortable with credit and would use a market overreaction as an entry point. The hunt for yield environment will not fade away. Although short-term volatility will persist. Therefore, we stay tuned and wait for buying opportunities in solid names.

Equities

Stock markets finished October mixed. The renewed fears of lockdowns around the globe were also mirrored in stock markets. Asia held up well whereas Europe and the US suffered losses of three to five percent. Sector-wise the energy sector suffered most due to lower oil prices. Defensive sectors such as utilities were among the top performers.

Equity Indicators

Brexit comes closer and drove valuation of UK equities even lower. UK equities have never been cheaper for the last 30 years. Both Europe and UK cannot neglect their focus on the old economy such as energy and financials and are therefore challenged structurally during this crisis.

One of the most important uncertainties – the US election – will fade away this week and markets are hopefully picking up their long-term trend again. Good fundamental data in the US and Asia should support that scenario. As a victory of the democrats seems highly probable not only in the presidential election but also in both houses, stimulus for the economy could be even higher and support further the risk-on mood. We therefore keep our neutral allocation in Equity markets.

Alternatives

The EUR could weaken against other currencies as the intensified measures against COVID-19 might lead to a further expansive ECB and economic support aid from the governments. However, momentum still plays in favour of the EUR and a further potential to outpace the other regions after relaxing the measurements are keeping it in balance.

Gold has stabilised around USD 1’900. Showing a positive correlation to stock markets and other risky assets, Gold seems to have lost its safe-haven characteristics. It might continue to go with risky assets as investors liquidate assets to raise cash and meet margin calls, a dynamic that played out in the March pandemic panic. The only way to be protected during the crisis was cash and cash is not yielding anything. Long-term speaking, economic stimulus and low interest rates should be supportive.

Oil might also pick up speed as recession fears seem to early as the outbreaks and lockdowns are kept on a regional basis and should smoothen the economic activities. Although Libya starts to export oil, it is still two thirds below its level before the civil war. Future markets are in steep contango indicating further price increases.

Hedge Funds and Private Markets are still in high demand. Investors should be cautious with the CTA strategies as they disappointed within the crisis. Good long volatility strategies are the right place to be.

Note: This report is published by Clarus Capital Group AG