Coffee Break 2/18/2019

LAST WEEK IN A NUTSHELL

  • According to Chinese President Xi the trade talks in Beijing “achieved important progress”, but “much work remains” according to the White House.
  • US president Donald Trump declared a national emergency to get funding for the border wall with Mexico. A new government shutdown was avoided but frictions with Congress prevail.
  • The euro zone’s Q4 2018 GDP grew by an estimated 0.2% QoQ as the German economy stagnated but did not contract.
  • US retail sales plummeted in December, posting the steepest drop since 2009. To recall, December was the worst month since 1931 for US equities and marked by the start of the longest government shutdown in US history. In the meantime, consumer sentiment for February recovered.

WHAT’S NEXT?

  • This week, Chinese negotiators will pursue the negotiations on trade in Washington DC.
  • The publication of global flash PMIs for the month of February are expected to stabilise close to the expansion / contraction level of 50 points.
  • The FOMC minutes from the January meeting will shed some light on the sharp change in tone. We are looking for cues in the potential end of the Quantitative Tightening.
  • In Europe, survey readings are due in Germany and in Spain the campaign for the snap elections will start. 

INVESTMENT CONVICTIONS

  • Core scenario
    • In Emerging economies, activity continues to soften. Major central banks, including the Fed, the Bank of England and the European Central Bank, list international trade relations as a source of uncertainty. The measures taken by Chinese authorities to support the economy should result in a GDP growth of around 6% in 2019. Such measures will benefit the broader region. We note that the announced measures will imply more efforts in the future to put public debt on a sustainable path.
    • In the US, we expect a sustained growth, albeit at a slower pace (2.4% on average in 2019 vs. 3% in 2018). The US president is in the midst of several strained relations, including on its home turf and with international trade partners. The deadline with China is approaching, but could be stretched by another 60 days. Meanwhile, the Fed will stay “patient” to ensure a soft landing.
    • In Europe, the economic cycle remains less dynamic (on average over 2019, GDP growth is expected to be at 1.4%). Economic surprises keep disappointing. Policy risks are manifold. But lower oil prices and looser fiscal policies should help the region steer clear from a recession.
  • Market views
    • We have kept our moderately constructive view on equities as we expect the global expansion to continue, albeit at a slower pace. We expect low to mid-level single digit profit growth.
    • We acknowledge that inflationary pressures will remain subdued as oil prices are at low levels. An overall short duration remains warranted as the risk/reward remains unfavourable for most parts of the fixed income market. 
  • Risks
    • Geopolitical uncertainties: They could tip the scales from an expected soft landing towards a hard landing.
    • Emerging markets slowdown: Any fiscal or monetary measures taken to mitigate the impact of the trade war helps in the short term and weighs in the longer term.
    • EU political risks: Political pitfalls could fuel euro scepticism further as opinions diverge on a growing number of issues, i.e. “Brexit”, Italian public finances and social unrest in France and with EU Parliament elections this May. For now, the trade war initiated by the US has only impacted the euro zone indirectly but the US DoC reports on the EU car industry's security threats are due.
    • Domestic US politics: A divided Congress, the forthcoming budget-related deadlines and slow global growth will weigh on US exports.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are overweight equities via the US and Emerging markets. We remain tactically neutral euro zone equities. We are strategically underweight Europe ex-EMU and neutral Japan. 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 overweight equities
    • We are overweight US equities. The US Fed is clearly supportive for the domestic economy. It removes the risk of monetary error in the next months and rates increase should remain contained. Donald Trump’s strained relations at home and abroad are becoming an interference.
    • We are tactically neutral euro zone equities. Macroeconomic figures are weakening but the labour market stays strong and that will help support consumption. Political uncertainties are a drag. Conversely, any conflict resolution will appease markets.
    • 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 have neutral Japanese equities. Absence of conviction, as there is no catalyst.
    • We are overweight emerging markets equities. A more dovish Fed is good news for the region. We believe in its economic growth potential and while they have been badly hit in 2018 by US trade negotiations, they have been resilient.
  • We are underweight bonds and keep a short duration
    • We expect rates and bond yields to rise gradually after the strong decline in recent weeks. The currently low oil price slows down the expected rise in inflation.
    • 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 appears accommodative and could add a new TLTRO, but has just ended its QE.
    • Emerging market spreads have tightened in the current, more optimistic, context. However, we would need new performance triggers for another spread tightening. Hence, we decreased our exposure and took partial profit.