Coffee Break

Last week in a nutshell

• The US labour market cooled slightly in May, with unemployment steady at 4.2% and accelerating wage growth, the data signals only gradual moderation.
• The ECB cut its deposit rate to 2%, stating it was wrapping up its easing cycle. The euro appreciated and yields rose. Meanwhile Bank of Canada held steady at 2.75%.
• The euro zone inflation ease further as preliminary estimates for May CPI dropped to 1.9%, below the ECB’s target.
• The US economic activity weakened as manufacturing contracted for a third month and the Fed’s Beige Book reported broad economic slowdown, with only 3 of 12 districts showing growth.

Investment convictions

Core scenario

• Global: The global economy is softening, with trade tensions easing after a volatile start to the year. Financial conditions are reshaping the cycle rather than ending it, but uncertainty remains elevated due to erratic policy shifts and geopolitical risks.
• United States: US growth appears increasingly fragile. Inflation is proving sticky, and while markets anticipate rate cuts, the Fed remains cautious. Fiscal expansion and trade policy unpredictability are raising risk premia and pressuring the USD.
• Europe: The euro zone is stabilising, supported by falling inflation and a supportive ECB. Fiscal policy is turning more supportive, especially in Germany, with increased spending on infrastructure and defence. However, the region remains vulnerable to external shocks, including US tariffs.
• Emerging Markets: The region benefit from a weaker dollar, improving fundamentals, and attractive real yields. However, China’s recovery lacks structural momentum, and geopolitical tensions continue to weigh on sentiment. AI development is progressing, but investor confidence lags behind the US one.

Risks

• Inflation via trade and wages: Tariff-induced price pressures and wage growth could stall disinflation, forcing central banks to delay easing. This disconnect between market pricing and policy could trigger repricing across assets.
• US policy uncertainty: Erratic trade and fiscal policies under the Trump administration are undermining confidence in US leadership and the US dollar, with credit markets pricing in a potential downgrade.
• Geopolitical fragility: Tensions in the Middle East and US-China relations remain volatile, with potential to disrupt supply chains, energy markets, and investor sentiment.
• Earnings disappointment: Earnings expectations, especially in the US, appear optimistic and concentrated among Tech megacaps. EPS growth projections are at risk due to weak demand, trade disruptions, and policy uncertainty.

Cross asset strategy

1. While trade tensions have eased, focus has shifted to the US bond market, where rising yields and fiscal concerns are tightening financial conditions. We maintain a flexible, diversified strategy with selective positioning and a focus on visibility.
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 put an emphasis on diversified factors over directional bets.
   • The strategy is overweight US Technology due to AI-driven structural growth.
   • Our views are positive on European infrastructure and defence, supported by fiscal expansion.
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, with risks balanced between inflation and growth concerns.
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 after a slight upgrade to neutral. Fundamentals are improving, and real yields are attractive.
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

With stock markets trading at the upper end of their recent range, we are comfortable maintaining a neutral positioning. Our investment strategy remains patient, diversified, and transition-oriented. On equities, we are 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 investment strategies remain a stabilizing component in an environment still shaped by asymmetric risks and geopolitical uncertainty.