Coffee Break 16.09.2019

LAST WEEK IN A NUTSHELL

  • The ECB validated the risk-on environment by announcing new quantitative easing measures “for as long as necessary” and cut its bank deposit rate in order to support the dwindling euro zone economy.
  • China and the US showed goodwill gestures in their trade negotiations as China renewed purchases of agricultural goods and the US delayed, by two weeks, the next increase in tariffs.
  • 2020 US election candidates Sanders, Biden and Warren were on stage during the third Democratic primary debate. Of note, none of the candidates appeared opposed to the tariff policy of the current administration.
  • The US Consumer Price Index increased by 1.7% YoY while core-CPI rose by 2.4%. Also, US retail sales rose by 0.4% in August beating expectations of 0.2% increase.

 

WHAT’S NEXT?

  • The main event of this week is the US FOMC followed by Jerome Powell’s press conference. Markets expect another 25bp rate cut, following last July’s 25bp cut, which was the first rate cut since 2008.
  • The Bank of Japan, Bank of England and the Swiss National Bank will also publish monetary policy decisions.
  • In terms of data, we expect the Eurozone consumer confidence indicator and the CPI as well as industrial production data for the US and China.
  • In the UK, the Supreme Court will be examining the prorogation of Parliament. Further, Boris Johnson will meet EC president Jean-Claude Juncker.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario is moderately constructive in the long-term. Hence, we are currently overweight equities vs bonds.
    • There is no imminent recession and recession fears in the US appear exagerated.
    • Uncertainties for financial markets remain the trade war and the slowdown in manufacturing. Economic surprises are now improving as expectations have been cut.
    • In Emerging economies, Chinese authorities are mitigating the impact of the trade war and slowing global growth by using currency, monetary and fiscal tools.
  • Market views
    • Central banksare acting, as rates have been lowered in Emerging markets and in the US. In the euro zone, the European Central Bank announced new quantitative easing measures and a cut in its bank deposit rate. Fiscal stimulus in Germany was also strongly encouraged.
    • A bottoming-out of the macro data is surfacing outside of the US. The confidence in the recovery is still jeopardised by the on-and-off trade war rhetoric.
    • Investors’ positioning on equities is light (negative flows) and the relative valuation vs. bonds remains attractive.
  • Risks
    • Some risks have receded early-September, including political uncertainties in Europe, particularly in Italy where the newly formed left-leaning coalition is more euro zone friendly.
    • The US-China trade conflict. The United States and China have agreed to resume negotiations in Washington “early October” in a first face-to-face meeting between the two sides since the trade war's escalation in recent weeks.
    • 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.
    • Brexit. Parliament has been suspended in the UK until mid-October 2019.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are overweight equities and have added to our equity exposure in order to benefit from the improving risk/reward environment. We keep a tactical regional overweight on the US and EMU vs. an underweight Europe ex-EMU equities. We are neutral on Emerging markets and Japanese equities. In the bond part, we are underweight duration and 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, a short USD and a short GBP. We also have an exposure to gold.

 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are 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. Consumption is strong, the labour market remains solid while inflation is in check.
    • We are neutral Emerging markets equities. The region has underperformed the most year-to-date and could offer some upside. A dovish US Fed is a tailwind.
    • We are overweight euro zone equities. We are aware of the restraining factors such as the vulnerability of global trade, and the manufacturing recession in Germany. Fiscal stimulus in Europe (the Netherlands, Germany, Italy) starts to be discussed, but implementation may take time. A window of opportunity just opened with political uncertainty receding somewhat.
    • 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. Brexit is a major hurdle.
    • We stay neutral Japanese equities. Absence of conviction, as there is no catalyst. It seems increasingly likely that the government will stick to its plan and increase the consumption tax from 8 to 10% in October.
  • We are underweight bonds, keeping a short duration and diversify.
    • We expect rates and bond yields, to stay low.
    • 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.
    • We diversify out of low-yielding government bonds, and our preference goes to Emerging debt in hard currency and EUR-issued corporate bonds.
    • 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 also have an exposure to gold in order to increase the portfolio hedging