Coffee Break 2/11/2019

LAST WEEK IN A NUTSHELL

  • The Bank of England unanimously decided to leave rates unchanged, a dovish U-turn ahead of the withdrawal from the EU. The Bank forecasted the slowest rate of growth since the financial crisis, 10 years ago.
  • By the same token, the latest European Commission’s press release showed the large uncertainty of its outlook by mentioning the trade tensions, China’s economy and “Brexit” as sources.
  • France just recalled its Ambassador to Italy, a never-before seen move since WWII, as Italy’s deputy prime minister, Di Maio, met in France with a leader of the yellow vests protesters.
  • US President Trump gave a widely-criticized speech in its latest State of the Union address before a divided Congress. Highlights included the border wall but also the future of international trade relations. Although Donald Trump also mentioned a face-to-face meeting with Mr. Xi before the 2 March deadline, it will not happen.

WHAT’S NEXT?

  • US treasury Secretary Mnuchin and other US officials will travel to Beijing to resume trade talks. Unless a deal is found, the increase in US tariffs on Chinese goods starts on 2 March.
  • On 15 February, the truce between Congress and the US president is ending and another US government shutdown is at stake, unless both parties can agree on a spending bill.
  • In terms of economic data, estimates for Q4 and 2018 GDP growth rates, inflation rates MoM and YoY for January 2019 are due for key countries, including the UK.

INVESTMENT CONVICTIONS

  • Core scenario
    • In Emerging economies, activity continues to soften. Major central banks, including the US Fed, the Bank of England and the European Central Bank, list international trade relations as a source of uncertainty. Hence, a deal must be found. But the measures taken by Chinese authorities to support the economy should result in a GDP growth of around 6% in 2019. Such measures will benefit the broader region. We note that the announced measures will imply more efforts in the future to put public debt on a sustainable path.
    • In the US, we expect a sustained growth, albeit at a slower pace (2.4% on average in 2019 vs. 3% in 2018). The US president is in the midst of several strained relations, including on its home turf and with international trade partners. The deadline with China is coming up But the US president is already hinting at an upcoming “deal”. Meanwhile, the Fed will stay “patient” to ensure a soft landing.
    • In Europe, the economic cycle is less dynamic (on average over 2019, GDP growth is expected to be at 1.4%). Economic surprises keep disappointing. Policy risks is spiralling. But lower oil prices and looser fiscal policies should help the region steer clear from a recession.
  • Market views
    • We have kept our moderately constructive view on equities as we expect the global expansion to continue, albeit at a slower pace. We expect low to mid-level single digit profit growth.
    • We acknowledge that inflationary pressures will remain subdued as oil prices are at low levels. An overall short duration remains warranted as the risk/reward remains unfavourable for most parts of the fixed income market.
  • Risks
    • Geopolitical uncertainties: They could tip the scales from an expected soft landing towards a hard landing.
    • Emerging markets slowdown: Emerging markets are among the most vulnerable regions when global growth slows down. Any fiscal or monetary measures taken to mitigate the impact of the trade war will help in the short term and weigh in the longer term.
    • EU political risks: Political pitfalls could fuel euro scepticism further as opinions diverge on a growing number of issues, i.e. “Brexit”, Italian public finances and social unrest in France and with EU Parliament elections across Europe this May. For now, the trade war initiated by the US has only impacted the euro zone indirectly.
    • Domestic US politics: A divided Congress, the forthcoming budget-related deadlines and dimming global growth prospects will weigh on US exports.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

Anticipating a temporary halt to the current year-to-date rally, we reduced risk by partially taking profit on Emerging market debt in hard currency. In terms of equities, we stay overweight Emerging markets and US equities. We are tactically neutral euro zone equities. We are underweight Europe ex-EMU and neutral Japan. In the bond part, we keep a short duration and diversify out of low-yielding government bonds.
In the bond part, we keep a short duration and diversify out of low-yielding government bonds.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are overweight equities
    • We are overweight US equities. The US Fed is clearly supportive for the domestic economy. It removes the risk of monetary error in the next months. Rates increase should remain contained. Donald Trump’s strained relations at home and abroad are becoming an interference.
    • We have become tactically neutral euro zone equities. Macroeconomic figures are weakening but the labour market stays strong. That will help support consumption. Political uncertainties are a drag. Conversely, any conflict resolution will appease markets.
    • 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.
    • We have neutral Japanese equities. Absence of conviction.
    • We are overweight emerging markets equities. A more dovish Fed is good news for the region. We believe in its economic growth and while they have been badly hit in 2018 by Trump’s re-negotiations, they have been resilient. A deal must be found though.
  • We are underweight bonds and keep a short duration
    • We expect rates and bond yields to rise gradually after the strong decline in recent weeks. The currently low oil price slows down the expected rise in inflation.
    • A slower but still expanding European economy could lead EMU yields higher over the medium term. There is an unfavourable carry on core and peripheral European bonds. The ECB appears accommodative, but has ended its QE in December.
    • Emerging market spreads have tightened in the currently more optimistic context. However, the YTD rally might be on a halt already. Hence, we decreased our exposure and took partial profit.