Market Outlook Q3 2020

Summary

• In US, growth is expected to remain subdued in Q3 given rising Covid infections.
• Inflation will pick up, our belief is that MMT will takeover.
• Stagflation is the likely outcome and the main market narrative for the next quarter.
• We like precious metals, commodities, REITs, Tech, Utilities while for fixed income, TIPS and IG Bonds are our favorite ones.

Growth is expected to remain subdued during the next three months since many companies are cutting costs and the job market will not recover as fast as many are forecasting. Our major concern is given by the weak consumers, 60-70% of western economies are based on them and the number of jobs lost is extremely high. 

Initial US jobless claims came down significantly after the spike at the end of March 2020, this led to rising optimism among investors although the continuous claims are showing a different picture. Yes, they came down but as much as one would expect. According to us, this is a sign of a still-weak economy. 

Moreover, using the ISM PMI as a leading indicator for GDP YY, it can be seen how there may be still a leg down for the GDP (likely for the next three months). 

As the last point with regards to growth, the ED3-ED12 is showing a possible recovery (we use it as leading indicator too), but currently, the spread is flat. Another warning sign. 

How such an issue may be solved?

Here it comes the Fed/Govt policy response. Today, interesting news was published. Even though it is election year, we do think that either Dems or Republicans are going to win, stimulus checks are going to be the main tool to pursue any "fiscal policy" since monetary can do very little at the moment in our opinion. With rising cash available to people and fewer services and goods produces given the slow/zero growth recovery, inflation is the most likely outcome. We are not advocating ( at least not yet ) to hyperinflation or something similar, but it is likely that is will start to pick up and reach 2% soon. 

Given this, the market is already pricing some MMT as can be seen in the following chart.

Thus, our outlook for Q3 is soft stagflation.

Our top picks for navigating the next quarter are the following:

• Equities: we like REITs both in the US and UK, along with Tech and Utilities. REITs rely on hard assets inflation-hedged, while Tech is keen to profit from any possible shut down and it has strong momentum as a sector. Lastly, Utilities have a positive expected return is a stagflation environment. On the other side, since small-caps are highly sensitive to growth and are struggling during this period we would proceed with a short, along with value and high-dividend yield. 
• Fixed Income: US TIPS and IG bonds are our top picks. 
• Commodities: precious metals would benefit enormously from the coming inflation. The Fed will try to devalue the dollar and the MMT spree will lead to it, this is a chance to load on some commodities such as oil and agri.