Coffee Break 11.06.2019

LAST WEEK IN A NUTSHELL

  • The Federal Reserve and the European Central Bank signalled their readiness to act in case of adverse contingencies. The prolonged uncertainty on US trade policy (new tariffs against China and Mexico, negotiations with Japan and the EU) means that downside risks have increased.
  • The US added of 75K non-farm payrolls, undershooting expectations, but strengthening the case for the Fed to cut its funds rate. Bond yields fell and equity values recovered strongly.
  • US President Trump toured Europe and met leaders from the Western Alliance. In parallel, Russian President Putin and Chinese President Xi and his accompanying delegation of 1,000 people held a summit.
  • Euro zone data showed that the economic activity expanded at a modest pace in May: the service sector improved while the manufacturing sector weakened further.

 

WHAT’S NEXT?

  • 10 Conservative MPs are vying to replace UK PM Theresa May. A series of secret ballots will be held on 13, 18, 19 and 20 June.
  • The preparation of the end-of-month G20 summit in Osaka has started with meetings of finance ministers and central bankers.
  • The publication of inflation data in the US, China, Germany and France will be of note.
  • Other data highlights include China trade, credit, and activity indicators.

INVESTMENT CONVICTIONS

  • Core scenario
    • We have a moderately constructive long-term view but are aware of political pitfalls, in particular the re-ignited trade and technology tussle, which may last longer than initially thought.
    • The political risk premium has increased again but the global economy is growing and seems to have hit its trough last winter.
    • Central banks have become more dovish, contributing - along with the recent increasing demand for safe soveriegn bonds - to a fall in bond yields. 
    • In Emerging economies, the measures taken by Chinese authorities to support the economy will slowly show their impact.
    • In the euro zone, the economic cycle remains less dynamic: on average over 2019, GDP growth is expected to be at 1.3%.
  • Market views
    • Stabilizing or improving macro data would likely lift global bond yields whereas chilling business activity and the escalating trade conflict will jeopardize confidence in the recovery.
    • The readiness to act of the Fed and the ECB put a floor to the recent decline in equity values.
    • Equity fund flows remain negative in recent weeks: investors are staying cautious in the light of recent trade tensions.
    • European and Japanese equity valuations are below their historical average, whereas US and Emerging markets are close to long-term averages.
  • Risks
    • The US – China trade conflict is at the top of the list. It could further weigh on output growth and trigger further spikes in volatility. We expect this to be a lasting issue, beyond trade.
    • Geopolitical issues (e.g. Iran) are still part of unresolved current affairs. Their outcome could still tip the scales from an expected soft landing towards a hard landing.
    • Political uncertainty in Europe (European institutions, Italian public finances, “Brexit”, limited margin of maneuvre).

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We stay overall neutral equities with a regional tactical bias: overweight US equities vs underweight UK. We are neutral everywhere else. In the bond part, we have decided to lower the duration by 0.25 year and we continue to diversify out of low-yielding government bonds via exposures to credit and Emerging markets debt in hard currency.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are neutral equities
    • We are overweight US equities. We think there is still a Trump put in addition to a Fed put, which makes the region a safer choice.
    • We are neutral Emerging markets equities. The US Fed’s willing ness to cut rates is a tailwind for the region but the trade war is a major hurdle. We still have a growth expectation above 6% for China this year.
    • We are neutral euro zone equities. We expect a rise in the equity market but are aware of the restraining factors such as the vulnerability of global trade. The labour market and domestic demand remain decent. Most foreign investors have left the region, leading to a consensus underweight in spite of cheap valuation.
    • We are underweight Europe ex-EMU equities. The region has a lower expected earnings growth and thus lower expected returns than the continent, justifying our negative stance.
    • We stay neutral Japanese equities. Absence of conviction, as there is no catalyst. The region could catch up if the news flow around international relations improves and global growth renews with more traction.
  • We are underweight bonds and keep a short duration
    • We expect rates and bond yields, especially German 10Y yields, to rise gradually from depressed levels.
    • A slower but still expanding European economy could lead EMU yields higher over the medium term. There is an unfavourable carry on core and peripheral European bonds. The ECB is accommodative and will add a new TLTRO.
    • Emerging market debt has an attractive carry and the dovish stance of the US Fed represents a tailwind. Trade uncertainty and idiosyncratic risks in Turkey and Argentina are headwinds.
    • We diversify out of low-yielding government bonds, and our preference goes to US High yield, as a dovish Fed, low inflation and receding recession fears point towards the carry trade.