Coffee Break 8/12/2019

LAST WEEK IN A NUTSHELL

  • In the context of the re-ignited trade war, the Chinese Yuan fell for the first time since 2008; beyond 7 vs 1 USD. A weaker Yuan combined with falling producer prices for the first time since 2016 imply deflationary pressures.
  • Several central banks, among which India, Thailand and New Zealand, cut their reference rate.
  • The euro zone manufacturing remains in the doldrums, as illustrated by declines in French, Dutch and German industrial production data.
  • The UK economy shrank by 0.2% during the second quarter, displaying its worst quarter since 2012.
  • As a response to US President Trump calling for substantial Fed rate cuts, four former Fed presidents claimed that the central bank’s independence must be protected.

 

WHAT’S NEXT?

  • The US’s July CPI will be published on August 13th. It is a good way to track changes in retail prices of goods and services, and to confirm if an annual rate of 2.1% (YoY) can be reach.
  • In China, the industrial production (forecasted at 6% YoY), the fixed asset investment and the retail sales data will be publish on Wednesday. Those economic indicators data could be another proof of the region’s slowing growth.
  • There is still time to avoid tariffs going into effect on September 1st. White House appeared to be willing to delay decision on Huawei after Beijing said it would halt US agriculture purchases. Hence, looking closely at the tensions between US and China might be useful.
  • The Q2 GDP growth in Germany and the Economic Sentiment Zew survey (expected to be 200bps lower than the previous month) may confirm the country weaknesses.

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. There are preliminary signs of stabilisation.
    • Recession fears in the US are overblown but the threat of a protracted stagnation in the euro zone has increased.
  • Market views
    • The confidence in the recovery is jeopardised by the delayed stabilisation in macro data. Economic surprises remain persistently negative and show a regional convergence.
    • Central banksare acting as rates have been lowered in Emerging markets and in the US.
    • Equities registered the strongest outflows for 2019 while bonds benefit from inflows. Credit markets remain resilient.
  • Risks
    • The US – China trade conflict is at the top of the list, especially now that in the absence of a deal, Donald Trump has announced an additional increase in tariffs by 10% by September 1st. China has already responded it would not be pressured.
    • 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 remain, especially in the UK. Boris Johnson has so far given the European Commission the cold shoulder. His 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 overall neutral equities while adding some equity exposure to US and EMU in order to benefit from a better risk/reward after the sharp correction observed since end-July. 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 added to, in order to increase the portfolio hedging.

 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are neutral equities
    • We are overweight US equities. The region is the “safer” choice, relative to other regions, as the Fed has “pivoted”. 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 and keep a short duration.
    • 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.