Coffee Break 10/7/2019

LAST WEEK IN A NUTSHELL

  • Two big ISM misses on manufacturing and non-manufacturing and slower job creations in the US have led markets to reprice the probability of an end-October Fed rate cut towards 80% (vs. below 40% in the previous week).
  • Speaking about central banks, India’s central bank cut its benchmark repo rate for the fifth time this year. And the Australian RBA cut interest rates for the third time in 2019, pulling both the Australian and the New Zealand dollar lower with it.
  • China celebrated the 70th anniversary of the People’s Republic during the “Golden week”. The holiday usually triggers a boost in retail sales, which remains to be seen in the published data.
  • In the UK, Boris Johnson presented his latest Brexit terms proposals. Odds are in favour of another extension followed by new elections.

 

WHAT’S NEXT?

  • Negotiations between China and the US will resume with face-to-face meetings. Investors hope for a deal but will settle for less tension.
  • On the domestic US political agenda, impeachment inquiries will continue. With 13 months to go to the next presidential election, this adds further uncertainty.
  • On the data front, we expect US and German CPI publications, the preliminary Consumer sentiment survey as well as European industrial production figures.
  • The UK will publish key data on their economic output. New Brexit news are likely to influence markets too.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario is moderately constructive in the long-term: We are currently tactically overweight equities vs bonds.
    • The main uncertainties for financial markets remain the trade conflict and the slowdown in manufacturing.
    • Economic surprises are improving in the US - as expectations have been lowered.
    • Recession fears in the US appear exaggerated, while European growth continues to disappoint and could lead to stagnation.
    • 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 banks are acting, as rates have been lowered in most countries, including the US.
    • Italy, Germany, and the Netherlands are timidly moving towards fiscal stimulus to take over the baton from the ECB and lauch climate-friendly and growth-enhancing projects.
    • Global macro data appears soft, facing on-and-off trade war rhetoric.
    • September PMIs have disappointed and some cracks appeared in household confidence.
    • The relative equity valuation vs. bonds remains attractive and positioning appears light.
  • Risks
    • Some risks have receded since September, including political uncertainties in Europe, particularly in Italy but in the US political risk has increased as the launch of a formal impeachment process looks inevitable.
    • 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. A new extension and new elections look more and more likely.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are tactically overweight equities, especially via US and EMU equities and recently added some protection on European equities. We are underweight Europe ex-EMU equities. We are neutral 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 GBP and have now a neutral USD stance. 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 creeping up slowly.
    • 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.