Coffee Break 26.08.2019

LAST WEEK IN A NUTSHELL

  • The Eurozone flash PMI unexpectedly rose to 51.8 in August (vs a consensus of 51.2) thanks to solid growth in services and a tentative stabilisation in the manufacturing contraction.
  • Facing the current economic downturn and the prospect of more central bank accommodation, the German 10y Bund yield traded below - 0.70 %, and for the first time the German 30-year bond was offering negative yields.
  • The G7 summit and the Jackson Hole Fed symposium confirmed that more fiscal and monetary stimulus are likely in an effort to counter the economic slowdown and uncertainty triggered by a deteriorating trade and currency war context.
  • European politics featured the resignation of Italian PM Conte and Brexit talks of British PM Johnson in Berlin and Paris.

 

WHAT’S NEXT?

  • In the Eurozone, the German IFO Business Climate survey will give us an insight of the economic trend perception.
  • In the US, the second estimate of Q2 GDP and the Conference Board’s consumer confidence indicator will be published.
  • President Trump might respond to retaliatory tariff news from China. It appears to be a tough time for trade with global production data still weak.

INVESTMENT CONVICTIONS

  • Core scenario
    • We have a moderately constructive long-term view and have tactically added some equity exposure after the steep decline following the trade war escalation.
    • As the business cycle is hit by prolonged uncertainties on trade, central banks have become the first line of defence. The ECBsignaled a readiness to resume economic stimulus by September. The Fed has announced a rate cut by 25bps at the last FOMC but there is likely more to come.
    • In Emerging economies, Chinese authorities are mitigating the impact of the trade war and slowing global growth by using currency, monetary and fiscal tools. 
    • Fiscal stimulus in Europe (Germany, Italy) and the US starts to be discussed, but implementation may take time.
  • Market views
    • The confidence in the recovery is jeopardised by aggressive trade war rhetoric and a delayed stabilisation in global macro data. Economic surprises remain persistently negative.
    • Central bank sare acting as rates have been lowered in Emerging markets and in the US.
    • Equities continue to register strong outflows while bonds benefit from inflows. Credit markets remain resilient.
  • Risks
    • The US-China trade conflict. In the absence of a deal, US President Trump has announced an additional tranche of tariff increases and China announced retaliation measures. In addition, China has let its currency slide.
    • Geopolitical issues (e.g. Iran, Kashmir, Hong Kong) 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 (e.g. UK, Italy). Boris Johnson’s readiness to leave the EU even without a deal is scaring business owners and has weakened the GPB. 

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We stay tactically overall slightly overweight equities and are ready to add further equity exposure in order to benefit from a better risk/reward. We keep a tactical regional bias via a growing overweight US equities vs an underweight Europe ex-EMU equities. We are neutral everywhere else. In the bond part, we are underweight duration and we continue to diversify out of low-yielding government bonds via exposures to credit, preferably by European issuers and Emerging markets debt in hard currency. In terms of currency, we keep a long JPY and an even shorter GBP. We also have an exposure to gold, which we recently added to, in order to increase the portfolio hedging as it is unprecedented in the post-WWII era that the two biggest economies are in a trade (and wider) fight.

 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are slightly overweight 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 relatively safer choice. The labour market and consumption are strong while inflation is in check.
    • We are neutral Emerging markets equities. The US Fed’s dovish stance is a tailwind for the region but the trade war is a major hurdle. Financial markets remain relatively resilient, but the hard data has room for improvement.
    • We are neutral euro zone equities. We are aware of the restraining factors such as the vulnerability of global trade. As a result, Germany is experiencing a manufacturing recession. But the European Central Bank is ready to act in September. The labour market and consumption are still supportive.
    • We stay underweight Europe ex-EMU equities. The region has a lower expected earnings growth rate 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. It has to be seen if the government sticks to its plan increasing the consumption tax from 8 to 10% in October.
  • We are underweight bonds, keep a short duration and diversify.
    • We expect rates and bond yields, especially German 10Y yields, to stay low - or negative.
    • The ECB will have a new president on November 1st. The nomination of Christine Lagarde is good news for those expecting the dovishness to last beyond the 8-year presidency of Mario Draghi.
    • Emerging market debt has an attractive carry and the dovish stance of the 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 Emerging debt in hard currency and EUR-issued corporate bonds.
    • We also have an exposure to gold in order to increase the portfolio hedging.