Coffee Break 9/23/2019

LAST WEEK IN A NUTSHELL

  • The Federal Reserve announced a 25bp cut in its funds rate, targeting a range of 1.75% to 2%.This confirms the data dependency for potential future acts. As tensions arose, the Fed had to add liquidity into the short-term rate market.
  • On the data front in the US, we note better than expected releases on industrial production, housing data and jobless claims.
  • As monetary easing has so far failed to generate enough pick-up in credit growth, the People's Bank of China has lowered its 1Y Loan Prime Rate by an additional 5bp.
  • Saudi Arabian oil processing facilities were hit, shortly reducing its output by 5.7bbl/d. Oil prices (Brent) surged, hitting $69 per barril, before stabilising around $65. 

 

WHAT’S NEXT?

  • The general debate of the 74th session of the UN Assembly will aim at strengthening multilateral efforts to address climate action.
  • Preliminary September PMIs will be published, shedding light on the health of the global economy. Manufacturing PMIs have been in contraction, while services have remained pretty resilient so far.
  • The UK Supreme Court will announce its ruling on Boris Johnson’s prorogation of Parliament. Brexit rhetoric is improving following comments from Jean-Claude Juncker that "a new Brexit deal could still be reached by the October 31st deadline"
  • ECB President Mario Draghi will deliver his final “Monetary Dialogue” in front of the European Parliament’s Economic and Monetary Affairs Committee Council.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario is moderately constructive in the long-term: we are currently tactically overweight equities vs bonds.
    • There is no imminent recession and recession fears in the US appear exagerated.
    • The main uncertainties for financial markets remain the trade conflict and the slowdown in manufacturing.
    • Economic surprises are now improving - as expectations have been lowered.
    • 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 key countries, including the US. In the euro zone, the European Central Bank announced new quantitative easing measures and cut its bank deposit rate.
    • German and Dutch fiscal policy have started to take over the baton with some stimulus to lauch climate-friendly and growth-enhancing projects.
    • A bottoming-out of the macro data could be tentatively happening in spite of on-and-off trade war rhetoric.
    • The relative equity 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 early-August.
    • Geopolitical issues (e.g. Iran, 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 tactically overweight equities, especially US and EMU equities. We are underweight Europe ex-EMU equities. We are neutral on Emerging markets and Japanese equities. In the bond part, we are underweight duration and 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) is becoming a topic, but implementation may take time. A window of opportunity opened with receding political uncertainty and long-term ECB visibility.
    • 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 a catalyst is missing. 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.