Coffee Break 9/30/2019

LAST WEEK IN A NUTSHELL

  • The shift towards more monetary accommodation in September has not yet prevented a further deterioration in the euro zone Flash PMIs, dropping towards their lowest levels since 2012.
  • Opposing the ECB’s super-loose monetary policy, Sabine Lautenschläger has resigned from her position as Executive Board member, confirming that Germany and the ECB don’t always see eye-to-eye.
  • To stabilise the shaky money markets and bring short-term interest rates within its target range, the Fed continued its repo offerings.
  • The price of oil slipped further as Saudi Arabia restored its oil production capacities and agreed a partial cease-fire in Yemen.
  • In the UK, the supreme Court declared Boris Johnson’s decision to prorogue parliament as unlawful. Meanwhile, Jean-Claude Juncker said he was ready to abandon the Irish backstop if Johnson comes up with an alternative

 

WHAT’S NEXT?

  • On the data front, the US job report will be published on Friday. We also expect the ISM manufacturing as well as PMIs from key countries.
  • China will celebrate the 70th anniversary of the People’s Republic during the “Golden week”.
  • The Australian and Indian central Banks will announce their economic policy decisions. Consensus expects rate cuts from both institutions.
  • The US House of Representatives is likely to further move towards launching a formal impeachment process against Donald Trump.
  • Austria is going to the polls for a snap election. Last May, a no-confidence vote in the Parliament had removed the right-wing government led by Sebastian Kurz.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario is moderately constructive in the long-term: We are currently tactically overweight equities vs bonds.
    • Recession fears in the US appear exaggerated, while European growth continues to disappoint.
    • The main uncertainties for financial markets remain the trade conflict and the slowdown in manufacturing.
    • Economic surprises are now improving in the US - 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 banks are 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.
    • 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.
    • A bottoming-out of the macro data could be tentatively happening, led by the US, in spite of on-and-off trade war rhetoric.
    • Outside of the US, and in Europe specifically, September Flash PMIs and Markit manufacturing PMIs keep disappointing. Household confidence however remains supportive.
    • 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 returned from an unlawful prorogation. No-deal risks have fallen recently but are not off the table.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are tactically overweight equities, especially 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 reduced our short USD. 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.