Coffee Break 20.05.2019

LAST WEEK IN A NUTSHELL

  • The US-China trade negotiations remained the main market driver over the week, as China’s State Council announced retaliatory tariffs on about $60 billion of US imports, with the tariff rates to be raised from the current 5%-10% range to 5%-25%, effective June 1st.  
  • In the UK, “Brexit” talks between Prime Minister Therea May and the Labour have broken down, as both sides were unable to bridge the important policy gaps. May’s fourth attempt to put her Withdrawal Agreement to lawmakers in early June now looks as slim as ever.
  • Economic figures confirmed that the euro zone’s economy is bottoming out with the Q1 GDP up by 1.2% YoY, thanks to a rebound in Germany and the end of the technical recession in Italy.
  • Chinese data on retail sales, industrial production and investment disappointed for the month of April while regional US manufacturing data and housing permits surprised on the upside.

 

WHAT’S NEXT?

  • 512 million Europeans from 28 (!) member states will go to the polls electing the European Parliament from May 23rd to May 26th. Investors will closely watch the results given the rise of populist and national forces.
  • The Federal Reserve will publish the minutes of its last Federal Open Market Committee. Investors will be looking at hints of a possible rate cut to boost inflation. 
  • From a macro-economic perspective, investors will look to the evolution of Germany’s business confidence (Ifo) and the Flash PMI of May for the euro zone.

INVESTMENT CONVICTIONS

  • Core scenario
    • We have a moderately constructive long-term view but are aware of political pitfalls. The Global economy is growing and seems to have hit its trough last winter. 
    • The political risk premium has decreased and central banks have become more dovish, stalling the normalisation of their monetary policy.
    • We take some comfort in the improving macro data in China, bottoming out in Europe and stabilising in the US.
    • In Emerging economies, the measures taken by the Chinese authorities to support the economy are helping and the GDP data just surprised on the upside.
    • In Europe, the latest economic indicators surprised on the upside. On average over 2019, GDP growth is expected to be at 1.3%.
  • Market views
    • Equity fund flows remain negative in recent weeks despite positive performance of markets: investors are staying cautious in the light of recent trade tensions.
    • The corporate sector remains a large buying source via buybacks.
    • European and Japanese equity valuations are below their historical average, whereas US and Emerging markets are back to long-term averages.
    • Improving macro data in China and Europe would likely alleviate upward pressure on the USD, downward pressure on inflation expectations and lift global bond yields.
  • Risks
    • Geopolitical issues are still part of unresolved current affairs. Their outcome could still tip the scales from an expected soft landing towards a hard landing.
    • 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.
    • Persisting slowdown in Europe and Emerging markets in spite of easing measures.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We stay neutral equities as a whole. We have tactical tilts on regions though as we see more potential for a catch up in specific regions’ macroeconomic data and equity valuation. In our selection, we take into account the re-ignited trade tensions, dovish central banks, low rates and low inflation but acknowledge the rally in risky assets since the start of the year. We favour Emerging markets equities over US equities and we favour euro zone equities over Europe ex-EMU. We stay neutral Japanese equities. In the bond part, we keep a short duration and diversify out of low-yielding government bonds.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are neutral equities
    • We are underweight US equities. We expect slower, but positive, earnings growth in 2019. Equity valuations have recovered and are now at fair value as stock prices rose and earnings expectations were revised downwards.
    • We are overweight Emerging markets equities. Chinese growth is the key driver: monetary support and fiscal easing should ensure a growth target above 6%. Trade conflict is clearly not resolved yet. The Fed’s pause is a tailwind for the region.
    • We are overweight euro zone equities. Macroeconomic figures are bottoming out and domestic demand remains decent. Most foreign investors have left the region, leading to a consensus underweight. Valuation remains cheap and below historical average despite the recent rebound.
    • 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 are 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 pause in the Fed tightening represent a tailwind. Trade uncertainty and idiosyncratic risks in Turkey and Argentina represent 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.