Market overview

Lyxor Cross Asset Research Q2 2020 : This Time is Different

Macro & Market Views

As DM countries enter glaciation to contain the pandemic, the toll on their economies will be described with superlatives. Exit strategies will need careful balancing between two evils: risking an outbreak relapse or jamming the economic recovery. Our base case is a recession with the bulk of the hit in Q2. We see a U-shaped recovery unfolding in Q3 and Q4 supported by stimulus but constrained by restrictions remaining in place. Companies may also seek to unload their ballooning debt, constraining employment, and capex. In our view, the liquidity crisis is unlikely to morph into a solvency crisis, unless the pandemic were to last much longer than expected.

 


Longer term, this crisis could leave scars, including an accelerating deglobalization. Political and geopolitical shifts are also possible when the time for a crisis-management assessment comes. The crisis could alter U.S. elections prospects while EU integration could be under pressure from its current lack of economic coordination and renewed border checks within the Schengen area.


A majority of tactical indicators seem consistent with a market trough. Yet, until we know more about the time to return to ‘normal’, the true economic impact of shutdowns and the degree of stimulus’ pass-through to the real economy, a decisive risk reweighting looks premature to us.

 


Credit markets went through extreme dislocations, paving the way for juicy opportunities. We are Neutral on U.S. High-yield and O/W on EU and UK High-grade, amid central bank asset purchases. The U.S. Treasury yield curve bear-steepening highlights policy support but also doubts about the recovery. We see U.S. 10Y Treasury yields rebounding towards 1.5% within a year, consistent with a U-shaped normalization scenario. We expect a bear-steepening in Bunds despite ECB’s purchases. We are Neutral on U.S. equities amid fair valuation. We favor Quality and remain O/W Staples vs. Discretionary. Attractively valued Financials should benefit from a steeper yield curve. In Europe, we favor cheaper and more defensive UK to EMU equities. EU Consumer Discretionary stocks exposed to China look attractive. We are also O/W Financials.
EM economies remain behind the virus curve and are facing multiple pressures, prompting us to U/W EM equities and debt. The OPEC+ alliance tumbled and while a coordinated cut appears speculative, the world output is set to decrease as the pandemic crushes global demand. We see Brent prices recovering towards $35/b by the end of Q2, supported by lower global output and a U-shaped recovery. Gold’s technicals look stretched but global tail-risks, deflation fears, massive monetary, and fiscal stimulus are powerful fundamental drivers. We are O/W on gold for hedging purposes.

 

Alternative Strategies

Alternative strategies were initially resilient during the turmoil, but cracks appeared mid-March as most strategies, except CTAs, experienced losses. Our views were defensive: O/W Event-Driven and Relative Value, N CTAs & Global Macro, U/W L/S Equity.


Going forward, we reduce credit risks while looking for opportunities in selected areas. Overall, we maintain a preference for Event-Driven vs. L/S Equity. We cut exposure to Global Macro in EM and L/S Credit to N. Both are vulnerable to the global economic contraction and to capital outflows. Low beta strategies might still be able to perform however. We upgrade Fixed Income Arbitrage to O/W. The strategy is less sensitive to economic downturns than L/S Credit and might benefit from opportunities in fixed income.


We maintain the O/W stance on Merger Arbitrage. Wide deal spreads are an opportunity for discretionary strategies, which can shorten portfolio duration and take advantage of price dislocations on safe deals. Our stance also remains unchanged on L/S Equity (U/W), Global Macro (N) and CTA (N). CTAs have met expectations with regards to their risk mitigation features while Market Neutral L/S faced difficulties. Finally, our stance on L/S Equity (U/W), Global Macro (N) and CTA (N) remains unchanged. It is important to note that CTAs have met expectations with regards to their risk mitigation features while Market Neutral L/S faced more difficulties.