Coffee Break 10/21/2019

LAST WEEK IN A NUTSHELL

  • UK Members of Parliament have not yet approved Prime Minister Boris Johnson’s new Brexit deal with the European Union.
  • European products, such as Airbus planes, French wine, Italian cheese, and Scottish whisky, will be more expensive to export to the US as the country slapped tariffs on US $7.5bn worth of EU goods.
  • China’s economy expanded by “only” 6% in Q3 2019 compared to last year; the slowing is a side-effect of the ongoing trade war and cooling investments.
  • In order to re-build its reserves and fine-tune the liability of its balance sheet, the Fed started buying Treasury bills last Tuesday at an initial pace of $60bn a month.

 

WHAT’S NEXT?

  • The British PM has asked the European Union for an extension of Article 50, which the EU has to accept, or crash out with no deal as he had threatened in the past. 
  • It will be Mario Draghi’s last European Central Bank meeting and press conference. He enters history as being a central banker who never hiked interest rates.
  • On the data front, key countries will publish their flash PMIs, a timely barometer of how the global economy is performing. The German IFO business climate and the US final October Michigan sentiment survey will also be published.
  • Canadians will vote for the 2019 Federal election on Monday. Justin Trudeau’s party could lose its majority in the parliament.

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. Developed countries should be able to absorb the new round of tensions though.
    • Central banks are coming to the rescue in the US, Europe and Emerging markets. Their accommodative stance is becoming a medium-term tailwind for a global growth/inflation mix.
    • In Emerging economies, Chinese authorities are mitigating the impact of the trade war and slowing global growth by using currency, monetary and fiscal tools. Economic data has yet to turn around.
  • Market views
    • Germany and the Netherlands are timidly moving towards fiscal stimulus to take over the baton from the ECB and launch climate-friendly and growth-enhancing projects.
    • Global macro data appears soft, facing on-and-off trade war rhetoric.
    • The relative equity valuation vs. bonds remains attractive, especially with the recent drop in bond yields, and positioning appears light.
  • Risks
    • Market sentiment has already deteriorated sharply. In the US, economic data has shifted from negative to more mixed but political risk has increased. A formal impeachment process against US President Trump looks inevitable. In Europe, downside risks are real.
    • The US-China trade conflict. The United States and China have agreed to resume negotiations in Washington.
    • Geopolitical issues (e.g. Brexit, 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.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are tactically overweight equities, especially via US and EMU 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 exposure to credit, preferably by European issuers and Emerging markets debt in hard currency. In terms of currency, we keep a long JPY.

 

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. Economic growth is however slowing down.
    • 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. Implementation of Brexit itself and upcoming elections still bring a lot of uncertainty. 
    • We stay neutral Japanese equities. Absence of conviction, as a catalyst is missing. It has to be seen if household consumption can resist the increase of the VAT rate from 8 to 10% early-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.