LAST WEEK IN A NUTSHELL
- Trade tensions eased somewhat, with officials in Beijing appearing to moderate their responses to the US’s 10% tariff threats on additional USD200bn of Chinese goods
- Several ministers left the UK government over PM May’s softer Brexit proposal, weakening the GBP
- The DOJ antitrust division appealed the AT&T–Time Warner merger, risking a second defeat
- The Q2 earnings season started with a mixed bag of bank earnings
- The Q2 earnings season will gather steam as US banks and tech heavyweights are set to report
- As Jerome Powell is due to deliver his semi-annual Monetary Policy Report, we will learn how the risks to the upbeat outlook have changed
- Geopolitical and trade related news will be dominated by the summit between Presidents Donald Trump and Vladimir Putin, and by the China-EU summit
- The US Commerce Dept is due to start hearings to investigate if auto imports pose a national security threat or not, impacting Canada, Japan, Mexico and the EU
- G20 Finance Ministers and Central Bank Governors meet at the end of the week to assess global financial stability
- Core scenario
- Trade war risks eased somewhat but remain high, hitting the global expansion, which remains self-sustained and not easy to derail
- US growth accelerates towards 3% as consumer comfort rise further, but outside the US the growth cycle may have peaked.
- Gradual rise in inflation in the US and the euro zone, but no inflation fear.
- US Fed monetary normalisation is progressive, other central banks are in no hurry to tighten.
- Market views
- A solid earnings season represents an upside risk as investor sentiment is dragged down by “trade fatigue”
- Valuations are less stretched after the recent correction.
- Credit is expensive, leaving little room for improving fundamentals.
- US equities are supported by the tax reform, buybacks and still attractive valuation vs. bonds.
- The implementation of higher trade tariffs and the possibility of wider protectionist measures represent a key risk
- Risks to our core scenario show that markets are switching between two “opposite” risks: inflation fear and recession fear.
- Drifting too cold (a shock on growth or fear of recession in one key region) or too hot (an unexpected acceleration in inflation) will trigger higher volatility.
RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY
We are overweight equities vs. bonds via US and EM equities as we expect the trade conflict to remain contained. We keep a short duration, and expect the 1.15-1.25 range on the EURUSD to hold
CROSS ASSET VIEWS AND PORTFOLIO POSITIONING
- We maintain our equity exposure to overweight as we expect the underlying favourable background to prevail in spite of aggressive trade conflict rhetoric
- US growth re-accelerates and global growth momentum outside the US is expected to continue, albeit at a slower pace.
- We are overweight US equities. The improving earnings growth and the positive impact of Donald Trump’s tax reform and deregulation are a support for the asset class. In addition, valuations are no longer too expensive. “America first” policy is likely to impact other countries negatively.
- We are neutral on the euro zone. The region still displays a robust economic expansion but uncertainties have risen recently (new Italian government, potential trade conflict on automobiles with the US, weaker activity indicators). By ending its QE at the end of the year, the ECB remains accommodative and is in no hurry to hike rates. We prefer small and mid-caps to large ones as they are somewhat sheltered and are more sensitive to domestic demand and less FX sensitive.
- We are 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. “Brexit” means “Soft Brexit” as of late but negotiations remain a risk.
- We are underweight Japanese equities. Japanese stocks show a weakening earnings momentum. In addition, the leadership vote of the LDP party by September represents a risk for PM Abe. On the positives, the accommodative policy mix remains good news for Japan.
- We are overweight emerging market equities. Emerging equities currently face headwinds from a strong USD and trade war rhetoric but benefit from strong global growth and attractive relative valuations integrating a risk premium. Our preference goes to EM Asia, the cornerstone of the high weighting of the tech sector (28%).
- We are underweight bonds and keep a short duration
- We expect a gradual rise in inflation, but no inflation fear.
- Global monetary tightening is progressive. Outside of the US, other developed market central banks are in no hurry to tighten.
- With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to resume their uptrend. In addition to rising producer prices, rising wages, fiscal stimulus and trade tariffs could push inflation higher.
- The overall improvement in the European economy could also lead EMU yields higher over the medium term. The ECB remains dovish in its QE plans and is opposed to a strong euro. Political uncertainties in Italy could delay the ECB tightening, but not derail the end of QE.
- We have a neutral view on credit overall but prefer EU to US in both Investment Grade and High Yield. Spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
- The emerging market debt faces headwinds with trade war rhetoric, a strengthening USD and rising Treasury yields 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.