Coffee Break 8/19/2019

LAST WEEK IN A NUTSHELL

  • The US President decided to delay more than half of the 10% tariffs hike until December 15th. For the first time since the launch of the trade conflict in early-2018, Donald Trump (implicitly) recognised a potential negative impact from tariffs on the US economy.
  • For the first time since 2007, US 10y yields have briefly fallen below the 2y yield. This segment is one of the market-based recession indicators and reflects expected lower short term rates in the near future.
  • Despite public stimulus, Chinese industrial production was the weakest since 2002 and retail sales and fixed-asset investment slowed somewhat, all suggesting signs of slower growth.
  • The results of primary round elections in Argentina were a negative surprise and could put the bail-out from the IMF at risk. The political situation in Argentina has nevertheless a limited regional spillover risk.
  • In Europe, the German economy contracts by 0.1% in Q2. Manufacturing weaknesses, trade tensions and Brexit uncertainties were to blame. Talks about some fiscal stimulus (e.g. a green new deal) increased.
  • The Italian Senate appears less in a hurry than Matteo Salvini to debate on new elections.

 

WHAT’S NEXT?

  • On August 23rd, the annual Fed symposium in Jackson Hole will start. This year’s fairly vague theme of “Challenges for Monetary Policy” leaves ample room for central bankers to reassure financial markets.
  • Italy will also be under the spotlight with PM Conte due to address the Senate.
  • In terms of data, the August flash PMIs, from the US, the euro zone and Japan will be published.
  • At the end of the week, world leaders are gathering for the G7 summit in Biarritz (France).

INVESTMENT CONVICTIONS

  • Core scenario
    • We have a moderately constructive long-term view and have tactically added some equity exposure after the steep decline following the trade war escalation.
    • As the business cycle is hit by prolonged uncertainties on trade, central banks have become the first line of defence. The ECBsignaled a readiness to resume economic stimulus by September. The Fed has announced a rate cut by 25bps at the last FOMC but there is likely more to come.
    • In Emerging economies, Chinese authorities are mitigating the impact of the trade war and slowing global growth by using currency, monetary and fiscal tools. There are preliminary signs of stabilisation.
    • Recession fears in the US are overblown but the threat of a protracted stagnation in the euro zone has increased.
  • Market views
    • The confidence in the recovery is jeopardised by the delayed stabilisation in macro data. Economic surprises remain persistently negative and show a regional convergence.
    • Central bank sare acting as rates have been lowered in Emerging markets and in the US.
    • Equities registered the strongest outflows for 2019 while bonds benefit from inflows. Credit markets remain resilient.
  • Risks
    • o The US-China trade conflict is at the top of the list, especially now that in the absence of a deal, US President Trump has announced an additional tranch of tariff increases, starting September 1st, with more to follow in mid-December. China has responded it would not be pressured and has let its currency slide. As a result, companies don’t know where to produce, invest, hire or source.
    • Geopolitical issues (e.g. Iran) are still part of unresolved current affairs. Their outcome could still tip the scales from an expected soft landing towards a hard landing.
    • Political uncertainty in Europe remain, especially in the UK. Boris Johnson has so far given the European Commission the cold shoulder. His readiness to leave the EU even without a deal is scaring business owners and has weakened the GPB. 

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We stay overall neutral equities and are ready to add some equity exposure in order to benefit from a better risk/reward after a sharp correction since end-July. We keep a tactical regional bias via a growing overweight US equities vs an underweight Europe ex-EMU equities. We are neutral everywhere else. In the bond part, we are underweight duration and we continue to 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 and an even shorter GBP. We also have an exposure to gold, which we recently added to, in order to increase the portfolio hedging as it is unprecedented in the post-WWII era that the two biggest economies are in a trade (and wider) fight.

 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are neutral equities
    • We are overweight US equities. The region is the “safer” choice, relative to other regions, as the Fed has “pivoted”. The labour market and consumption are strong while inflation is in check.
    • We are neutral Emerging markets equities. The US Fed’s dovish stance is a tailwind for the region but the trade war is a major hurdle. Financial markets remain relatively resilient, but the hard data has room for improvement.
    • We are neutral euro zone equities. We are aware of the restraining factors such as the vulnerability of global trade. As a result, Germany is experiencing a manufacturing recession. But the European Central Bank is ready to act in September. The labour market and consumption are still supportive.
    • 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.
    • We stay neutral Japanese equities. Absence of conviction, as there is no catalyst. It has to be seen if the government sticks to its plan increasing the consumption tax from 8 to 10% in October.
  • We are underweight bonds, keep a short duration and diversify.
    • We expect rates and bond yields, especially German 10Y yields, to stay low - or negative.
    • 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.
    • 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 diversify out of low-yielding government bonds, and our preference goes to Emerging debt in hard currency and EUR-issued corporate bonds.
    • We also have an exposure to gold in order to increase the portfolio hedging.