Coffee Break 12/3/2018

LAST WEEK IN A NUTSHELL

  • At the G20 in Buenos Aires US and China agreed on a three month truce in the trade war, giving some time to start resolving the structural issues between the two.
  • Theresa May has actively started to secure parliamentary approval of the “Brexit” agreement prior to the vote scheduled for 11 December.
  • In the US, Fed chair Jerome Powell said that the funds rate was “just below…neutral” after having said a few weeks ago that rates were probably “a long way from neutral”. This suggests that the Fed may not have that much further to go in its tightening process.

WHAT’S NEXT?

  • Purchasing Manager indexes are expected in key countries including the US and the euro zone reflecting manufacturers’ order books and by proxy, the strength of domestic demand.
  • The OPEC meeting will show if Russia and Saudi Arabia - who confirmed at the G20 they would extend output cuts next year - can agree with the US to manage the oil market into 2019.
  • On Friday, the November US job report will be published. While unemployment claims have slightly risen in recent weeks, the labour market is expected to remain tight.
  • In the euro zone, the estimated Q3 GDP growth rate will be released. As expansion is hitting a plateau, forecasts are at 0.2% QoQ and 1.7% YoY.
  • In Germany, while Angela Merkel remains chancellor, there will be a vote to select her successor at the head of her party. Among the contestants, Annegret Kramp-Karrenbauer, a Merkel protégé, stands for continuity and Friedrich Merz, a long-time rival of Merkel, promises more radical change.

INVESTMENT CONVICTIONS

  • Core scenario
    • In the US, we expect growth to be close to 3% in 2018, and to slow down in 2019 due to fading fiscal stimulus, trade policy uncertainty and tightening financial conditions as the Fed maintains its rates normalisation.
    • Outside the US, the economic cycle is less dynamic and hitting a plateau. European momentum is disappointing and policy risks remain.
    • As the US-China relationship appears fractured, China is easing in the face of a slowdown (monetary, fiscal, and currency).
    • The decline in the price of oil should pause the gradual rise in inflation in the US and in the euro zone.
  • Market views
    • US economy remains strong, and does not reveal any economic imbalances. The Fed is however appearing less hawkish and more data dependent.
    • Above-potential growth, the tax reform, buybacks and no valuation excess vs. bonds keep pushing US equities up over the medium term.
    • Based on fundamentals, we see potential for a narrowing divergence between the US and the rest of the world. The various political risks are a headwind.
  • Risks
    • Trade war: The G20 just took place and bought three months of time to resolve the structural issues. In the meantime, higher tariffs and protectionism are slowing down global economies, deteriorate international relations and ultimately corporate margins.
    • Emerging markets slowdown: Emerging markets are among the most vulnerable regions when global growth slows down. The evolution of the USD liquidity is also key for the region due to outstanding debt in this currency.
    • EU political risks: Political pitfalls could fuel euro scepticism further as opinions diverge on a growing number of issues, i.e. “Brexit”, Italian budget, German leadership reshuffle with the coming CDU Party congress and trade negotiation outcome with the US.
    • Domestic US politics: Democrats could slow down Donald Trump’s legislative agenda. Passing legislation will be a result of compromises and “beautiful deals”.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We remain tactically overweight equities. From a regional perspective, we remain overweight US and euro zone equities. We continue to hold a negative view on the UK, due to the unresolved “Brexit” issues, while being neutral emerging markets and Japan. In the bond part, we keep a short duration and a cautious view on Italy.

 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We have kept our equity exposure overweight and still have a constructive medium-term view based on fundamentals. 
    • We are overweight US equities. Economic momentum is less favourable as fiscal stimulus boost is fading. We expect slower, but positive, earnings growth in 2019. Fed hiking is a headwind but the slowdown underway could moderate the Fed’s hawkishness as it is “data dependent”.
    • We remain overweight euro zone equities. Slow growth and political uncertainties are increasingly weighing on the stock market. Conversely, any conflict resolution is a potential trigger for a strong rebound.
    • We remain 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 are neutral Japanese equities. Japanese stocks reflect less domestic risk as “Abenomics” will continue for three more years. The positive economic momentum encouraged us to become neutral on the asset class.
    • We are tactically neutral emerging markets equities. While we believe in the growth of Emerging markets, they are badly hit by the trade war, the developed markets’ slowing growth and the USD strength. 
  • We are underweight bonds and keep a short duration
    • We expect rates and bond yields to keep rising gradually. In addition to rising producer prices, rising wages, fiscal stimulus and trade tariffs could push inflation higher.
    • The expanding European economy could also lead EMU yields higher over the medium term. We expect interest rates to gradually increase. We remain underweight Italian bonds. The ECB remains accommodative, but has confirmed that it will end its QE in December.
    • We have a neutral view on corporate bonds overall as there is little spread compensation for risk. A potential increase in bond yields could hurt performance.
    • Emerging market debt faces headwinds with trade war rhetoric and rising US rates, but we believe spreads can tighten from current levels. The carry is among the highest in the fixed income universe. It represents an attractive diversification vs other asset classes.