Coffee Break

Last week in a nutshell

• The US budget process continues, stoking deficit concerns and pushing the 30Y Treasury yield to 5.09%, weighing on equities.
• Markets received confirmation of diverging PMIs. US ones rebounded while euro zone services PMI surprised to the downside and Japan’s manufacturing PMI remained weak.
• China's economy gave mixed signals. A strong industrial output print contrasted with weak retail sales and persistent property concerns.
• In the euro zone, modest gains in consumer confidence and Germany’s IFO index signalled cautious optimism.
• US home sales hit a 7-month low and mortgage rates climbed.

Investment convictions

Core scenario

• Global: The global economy is softening but should avoid a hard landing, transitioning from escalation to de-escalation in trade tensions. Easing financial conditions are reshaping, not ending, the cycle.
• United States: US growth is resilient but under pressure. Inflation remains sticky, limiting the Fed’s flexibility. Markets are pricing in several rate cuts, despite cautious Fed messaging.
• Europe: The euro zone economy is fragile but stabilizing. Inflation is declining toward the ECB’s target, creating space for rate cuts. Fiscal policy is turning more supportive, amid ongoing trade-related uncertainty and new tariff threats from the US President.
• Emerging Markets: The region benefits from a weaker US dollar, softer oil prices, and easing global tariffs. China’s rebound lacks structural depth, keeping pressure on authorities to maintain stimulus and engage in trade negotiations.

Risks

• Inflation rise via trade and wages: Tariff-related price pressures or renewed wage growth could stall disinflation in the US and force the Fed to delay or reverse easing expectations. This disconnection between market expectations and central bank actions may lead to repricing across asset classes.
• US economic policy uncertainty: Erratic trade policy and expansionary fiscal policy could undermine the confidence in the US financial leadership and the US dollar.
• Geopolitical fragility: Middle East tensions and China-US relations remain volatile and could disrupt global supply chains, energy prices, and investor sentiment.
• Earnings disappointment: Corporate profit growth is slowing in both the US and Europe, with forward estimates at risk from weak demand and trade disruptions. Markets may be underestimating this deceleration.

Cross asset strategy

1. Although uncertainty remains, markets had initially welcomed the easing of trade tensions and the passing of peak tariff threats. However, attention has now shifted to the US bond market, where surging long-term yields -driven by fiscal concerns and rising supply- are putting renewed pressure on financial conditions. This shift is tempering risk appetite despite previous support from lower rate expectations, a softer USD, and falling oil prices. Our strategy remains flexible, emphasizing regional diversification, high visibility, and selective positioning to navigate this more volatile and yield-sensitive environment.
2. Global equities:
   • Our positioning is Neutral overall, with no particular regional bias due to capped upside without earnings support.
3. Regional allocation:
   • US equities appear fully valued, with markets pricing in a benign outcome on trade and fiscal policy. This limits upside potential and may increase vulnerability to disappointment.
   • Europe and Emerging Markets, while more exposed to trade tensions, could be supported by stronger fiscal responses and more attractive valuations, partially offsetting tariff-related headwinds.
4. Factor and sector allocation:
   • In this environment, we focus on diversified factors and sectors rather than directional bets.
   • We have upgraded the US Technology sector to overweight after it performed in line with the broader US market since we became neutral last summer.
   • We identify opportunities in European infrastructure and defence sectors, benefiting from fiscal support.
5. Government bonds:
   • European sovereign bonds continue to benefit from recession concerns, subdued inflation expectations, and the ECB’s supportive stance. In a multi-asset portfolio, they add valuable decorrelation and serve as a defensive anchor in the event of renewed market volatility.
   • We are Neutral on US Treasuries, reflecting balanced risks.
6. Credit:
   • We maintain a neutral stance on investment grade credit. While spreads are tight and offer limited upside, fundamentals remain solid. Central bank support and low default expectations continue to provide a backstop, but valuations leave little room for error.
   • We retain the slight underweight of the high yield asset class due to strong technicals, but policy uncertainty still limits conviction.
   • We also maintain our allocation to emerging mark debt to a slight underweight, upgraded by one notch, supported by improving fundamentals and attractive real yields.
7. Alternatives play a crucial role in portfolio diversification:
   • Gold remains overweight as a strategic hedge against geopolitical risks and real rate volatility. Demand is supported by central bank buying and retail inflows.
   • We maintain an allocation to alternatives to provide stability and diversification amid ongoing volatility.
8. In currencies, exchange rates will remain a focal point in trade discussions and broader market dynamics.
   • We are overweight defensive currencies (e.g., Japanese yen) and expect USD weakness as growth softens.

Our Positioning

Following a strong equity rally, that started on 7 April, we believe markets have less buffer to absorb the pressure from President Trump’s tariff threats on the European Union and from uncertainties linked to the budget process in the US. We have therefore took some profit on risky assets, also in response to rising US yields. Our investment strategy remains patient, diversified, and transition-oriented. We are positioned neutrally on equities, avoiding regional biases while focusing on sector and factor diversification, especially in segments with a strong earnings stream like US Technology or with fiscal tailwinds like European infrastructure and defence. In fixed income, we favour European duration and core sovereigns given the ECB's supportive stance, while staying neutral on US Treasuries and slightly cautious on high yield. In emerging market debt, we see improving fundamentals and have upgraded our view slightly. Alternatives play a key role in our allocation, with gold held as a strategic hedge. Alternative strategies remain a stabilizing component in an environment still shaped by asymmetric risks and geopolitical uncertainty.