Lombard Odier’s Chief Investment Officer Stephane Monier provides an assessment of the key investment convictions shaping portfolios for the second half of the year
The speed of Covid-19 vaccinations has been remarkable in the western developed world. In six months, this has translated hopes for a recovery into reality. Reviving economic prospects also bring uncertainties around unwinding monetary support, economic overheating and run-away inflation.
Covid’s economic shock is stimulating a rebound in line with our expectations. Backed by monetary and fiscal support, improving growth and earnings have driven significant rallies in most equity markets. Consequently, absolute valuations are high in both stock markets and credit. We have incorporated the recovery into portfolios by preferring risk assets. These include cyclical and value equities, as well as carry strategies and alternative asset classes, including real estate and infrastructure.
The most significant risk at this stage is the pandemic’s evolution. Despite rapid vaccine rollouts in many developed economies, large parts of the emerging world have fewer and less effective vaccines. That disparity is making economic recoveries uneven and increasing the risk of further variants.
Inflation is a concern. But price spikes will remain limited to pandemic-damaged sectors, and we see no signs that inflation is doing more than normalising. Central banks in general and the Federal Reserve in particular, will apply broad policy criteria, including fuller job recoveries, before raising interest rates.
Geopolitics retain the potential to move markets. The Biden administration is engaging with the world again and we see trade tensions easing with the European Union, and the beginnings of a new dialogue with Russia. Further, a nuclear deal with Iran would pave the way for its return to international oil markets. However, US/China relations over the long run will remain highly competitive and potentially volatile.
In the short term, we focus on this balance between recovery and pandemic, inflation and policy support. These tensions will create more market volatility.
For investors looking to shield portfolio returns, we think put spread strategies on equity indices can be attractive. The VIX, a measure of equity volatility (S&P 500), is trading close to its pre-pandemic levels of around 15% as we write, offering the opportunity to buy options at an affordable level. In case of market falls, which in our view could range between 5% and 10%, put spread strategies can be very effective protection. We believe this approach is also consistent with an environment in which it makes sense to take advantage of dips to increase equity exposure.
Finally, the pandemic continues to underline social inequalities and the threats to our changing climate. Long-term, we see unprecedented opportunities for our clients to invest in the transition to a net-zero carbon economy.