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Portfolio Management Monthly Update: July 2020

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Portfolio Management Monthly Update July 2020



Consolidation in June – pause before another all-time high or start of major reversal?

- Second COVID-19 wave potentially starting in USA and FED taking a pause with creating new liquidity put a hold on the rally in financial assets that has started in late March;

- As future economic outcomes remain highly unpredictable, volatility is likely to remain high with significant upward and downward price moves to be expected in second half of 2020;

- During June sell-off we slightly increased holdings in equities and bonds at the same time rotating to defensive ideas, therefore overall riskiness of portfolios remaining broadly unchanged.

By any standards 2020 is very challenging year for making investments. Only six months have passed, but we have already seen one of the fastest and most significant market crashes in history followed by one of the most rapid recoveries in asset prices ever. Changes that usually take at least few years to realize, in 2020 happened over the course of few months. And with market environment becoming increasingly volatile, even difference of few days is capable to make what appears to be a good investment a bad one and vice versa.

What complicates things even more in 2020 is that investors have to operate somewhat in the dark. As we discussed previously, there are plenty of unknown risk factors that may play out in one or the other direction, and these factors raise many questions, which cannot be really answered right now. Nobody can tell how future situation with

coronavirus will play out around the globe and in separate countries. Will there be new lockdowns leading to even more economic destruction or the worst is really over? How soon companies will be able to fully recover from COVID-19 crisis and would bankrupted entities be replaced by new entrants? Moreover, will there be a deflation induced by oversupply and decreased aggregate demand problems, or central banks will manage to create as much liquidity as needed to actually trigger inflation around the world? This is the question of utmost importance as completely different combination of financial assets should be held depending on which scenario would play out.

Lately we see that even economists and analysts, people that are paid to make forecasts, provide estimates that miss actual numbers by a wide margin. In fact, it is hard to blame them, as



relationships that used to work under normal business conditions, in post-coronavirus world became broken and increasingly hard to model.

For now, markets, boosted by excess liquidity and massive inflow of general public that is willing to invest, provide most positive guesses as answers to all the unpleasant questions. We in its turn do not want to play a guessing game, but want to operate with facts or at least with high probabilities that certain scenarios are likely to happen. And from what we continue to observe, facts suggest that reality may turn out to be much bleaker than what markets continue to predict1.

Key point here is that the harder it becomes to predict the future, more volatile, emotional and chaotic price movements in the markets become.

Overall, since early 2018 when global economic slowdown has first started, speed and magnitude of price movements have been only increasing, while tops and bottoms are becoming more and more extreme. Such “roller coaster” makes financial system less stable and more fragile, and thus probability of even more severe moves either up or down than what was observed recently remains high in the upcoming months. In such environment waiting out for more clarity to appear may be the most optimal solution, even though in the end some opportunities may be missed and less potential profit earned. Remember, 2019 was an excellent year, with separate equity markets rising by more than 40%, and market trending higher almost every day. But then in March 2020 in about a month not only all those gains were wiped out, but losses generated as well.

Global equity index (MSCI ACWI in EUR)

Source: Bloomberg

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1.19.

01.0

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25/12/2018 - 19/02/2020: +40.6%

19/02/2020 – 23/03/2020: -33.6%

1 Please see June 2020 Overview for more detailed discussion on economic reasons for our cautious view



With that in mind, let us return to developments which happened in June. Rally that was observed in majority of financial assets since late March has slowed down in early June, with equity indexes consolidating since then in a gradual drift lower.

Two key catalysts why equity markets at least temporarily stopped their ascent are related to spike in new COVID-19 cases being registered in USA and FED making pause in creating new liquidity.

Either due to mass gatherings, not wearing masks, widespread use of air conditioning or other less known reasons, but significant acceleration in new cases was observed in large southern US states likes Texas, Florida and California, resulting in what appears to be second coronavirus wave starting in

USA. This is incredibly worrisome, especially if these states have to be put on lockdown once again.

But just as it happened in February, when many hints suggested that COVID-19 epidemic is likely to spread from China to the rest of the world, while equity markets were updating new all-time highs, similarly today, market participants for now believe that it is temporary solvable problem. Two factors which contribute to their optimism is the fact that overall trend for number of new deaths still continues trending down and that situation in New York, state with largest amount of cases during first wave, is fully under control right now.

COVID-19 trends in USA

Source: Bloomberg

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31.0

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28.0

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11.06

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01.0

7.20

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New daily cases (7-day average) New daily deaths (7-day average)

1st wave

2nd wave in new cases is starting



Additionally, with stabilization of financial system, return of investor optimism and increase in asset prices FED reduced usage of their emergency facilities and interventions in the market. Liquidity created by central banks was the main driver of

asset price increases in spring, so not surprisingly that without newly created money, demand for assets in June also was not as strong as before.

New daily cases in selected USA states (7-day average)

Source: Bloomberg

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26.0

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30.0

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Florida Texas California New York



In July we expect that volatility in the markets is likely to continue. Apart from either positive or negative COVID-19 developments, central bank stimuli and macroeconomic releases, another very important factor in July would be linked to corporate earnings. Companies will finally release

their financial results for second quarter 2020, helping to understand the exact damage made from lockdown on revenues and earnings as well as to what extent those indicators improved after the reopening. Hopefully, guidance about second half of 2020 would also be provided.

Change in FED balance sheet and S&P-500

Source: Bloomberg

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20.0

3.20

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24.0

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28.0

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09.0

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13.0

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Inde

x va

lue

billi

on U

SD

FED balance sheet S&P-500 index



S&P-500 vs profit margin

Source: Bloomberg

6,0%

8,0%

10,0%

12,0%

14,0%

16,0%

18,0%

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S&P-500 Net profit margin

Meanwhile, we used sell-off in the second part of June as an opportunity to slightly reduce cash holdings and increase positions in both equities and bonds. Such move broadly should not increase overall riskiness of the portfolios as we rotated from more cyclical state of economy dependent sectors to more defensive ideas, like healthcare sector, Switzerland, lower volatility US stocks and “Quality” equities – companies that have healthiest balance sheets in the market, and thus capable to

overcome potential financial difficulties better than the others. In bond universe we gave preference to government bonds, as this might be literally the only asset class capable to increase in price, in case of severe correction, and should still perform relatively well in bull market, supported by central bank purchases. Our actions in July would once again be data and market dependent, therefore additional purchases as well as disposals could be expected.



Market performanceJune 2020

EUR USD EUR USD

Global equities (MSCI ACWI TR Net)

1,9% 3,2% -6,4% -6,3%

North America equities (MSCI NA TR Net)

1,0% 2,3% -3,1% -3,0%

European equities (MSCI Europe TR Net)

3,1% 4,4% -12,8% -12,7%

Pacific developed markets equities (MSCI Pacific TR Net)

1,1% 2,4% -9,1% -9,0%

Global Emerging Market equities (MSCI EM TR Net)

6,0% 7,4% -9,9% -9,8%

Government bonds (Bloomberg Barclays - Euro govt TR / US treasuries TR)

1,0% 0,1% 2,0% 8,7%

Investment grade corporate bonds (Bloomberg Barclays - EUR Aggr Corp TR / US corp TR)

1,3% 2,0% -1,2% 5,0%

Global high yield bonds, hedged (Bloomberg Barclays - Global HY TR index)

2,1% 2,1% -5,3% -4,4%

Emerging Market bonds, hedged (Bloomberg Barclays - EM hard currency Aggr TR hedged)

2,3% 2,4% -1,6% -0,7%

Oil (WTI) 39,3 9,6% -32,7%

Gold 1781,0 2,9% 17,4%

EUR/USD 1,1234 EUR: 1.2% EUR: 0.2%



Positioning July 2020

Asset Allocation - N +Equities

Fixed Income

Cash

Bond Markets - N +Government

IG corporate (EUR)

IG corporate (USD)

High yield

EM debt

Equity sectors - N +IT

Financials

Cons. Discretionary

Industrials

Healthcare

Cons. Staples

Energy

Materials

Real estate

Utilities

Communication

Equity regions - N +North America

Europe

Eurozone

UK

Switzerland

Nordics

Pacific

Japan

Pacific ex. Japan

Emerging Markets

Emerging Asia

Latin America

EMEA

current allocation previous allocation

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