14 NOV

2019

The road ahead seems wider and clearer even if only for the next few months. Economic data have shifted from mostly negative to a more mixed state pointing towards stabilisation. Market sentiment has recovered somewhat. Appeasement in the geopolitical world has brought some relief to financial markets. Central banks have reached a state of massive accommodation. It is the right time to take some profit, while staying exposed to a possible stronger year-end rally via derivatives.

Equities vs. bonds

Macroeconomic forecasts seem to confirm a soft landing in 2019 and 2020, with weakening GDP growth but growth nonetheless. Of course, any shock could derail that trajectory but, for now, it seems as if the news flow has provided enough appeasement and visibility for the coming months.

Global manufacturing is stabilising after coming to a standstill in Q3. Similarly, global business confidence has also stopped stumbling and, even though still in negative territory, seems to have troughed. 

Central banks are accommodative. In October, the US Federal Reserve Bank cut its interest rates for the third time since July 2019, although that is expected to be the last for this year. There is a limited risk of a major bond sell-off, as central banks are buying – even if the Fed does not call it QE, but rather “a fine-tuning of its balance sheet”.

In that context, we still favour equities over bonds and our strategic longer-term view remains moderately positive.

Equities

In the previous changes to our strategy, our short GBP was neutralised as the currency stopped depreciating vs major currencies. Our long-term negative stance on UK equities also became neutral. We took partial profit on our US equity and EMU equity overweights to that effect. Moving forward, we now have a neutral positioning, excluding derivatives. We have added options to gain exposure if the year-end rally were to continue. We have also added to our value bias via Eurozone banks.

UK: A window of opportunity

Even though Brexit is not yet resolved, current prime minister Boris Johnson has managed to go further than his predecessor, Theresa May. The House of Commons voted for an early general election on 12 December 2019 and, in the meantime, Eurozone leaders have agreed to grant the UK a new extension until 31 January 2020 for leaving the EU. Nearly 2 million British citizens have registered to vote in the past 8 weeks.

The financial market has been shunned by many investors who lacked the visibility to invest in the region. Today, however, even though the positioning is still low, many of the risks have been priced in. The relative valuation of the UK equity market vs Europe shows a cheapness that makes our recent neutral stance possible.

 

US equities: still our main conviction

We remain overweight US equities

In the US, survey data such as US business sentiment stabilised in October. Also, the downward trend in the manufacturing ISM seems to have troughed. The US Federal Reserve appears to have accomplished a first mission: alleviate most of the recession fears in the US.

During its latest FOMC, the Fed, while vowing to keep financial conditions easy and to support the overall market, is unlikely to do more to increase growth prospects. Those Fed insurance policy rate cuts have had a calming effect on the rate markets. The end of monetary policy could mean the beginning of fiscal stimulus.

Other domestic issues are increasingly gaining in relevance. To name just a few:

  • US president Trump’s impeachment is becoming highly likely;
  • the re-election campaign is about to take centre stage and will certainly be one of the 2020 market drivers, likely to trigger growth shocks and attractive entry points.

Today, the valuation of US equities is still attractive relative to bonds but less so relative to historical levels. The premium on US equities has been well deserved but has less room to grow.

Other regions, with their inherent thematic bias, could take the lead eventually in their economic and financial recoveries, e.g. emerging markets. 

Currently, the end of the Fed’s easing and of share buybacks is likely to be mitigated by Q3 earnings publications, which were stronger than expected. Let’s see what 2020 brings for corporations and earnings growth, and whom it brings to the White House.

 

The Eurozone

We remain overweight EMU equities and appreciate the value of “value” names

Overall, the region has benefited from the reduction in perceived political risk: there is a lower Brexit risk and trade tensions are calming down. 

Economic news flow has also – again – become less negative and the relative improvement is reflected in the equity market. 

The drop in bond yields has also supported the region’s equities, whose risk premium is high. However, as long as interest rates do not progress faster or stronger, there is still room for equities to grow. Our focus is on value and cyclical names, including banks and the automobile sectors. Selection is key and so is understanding and navigation through the value bias of the region.

In the near future, more upside will be conditioned by a more ambitious fiscal plan – which could be a real game changer – and tangible signs of improving growth levels, both in GDP and in earnings.

 

Emerging markets

Targeted monetary and fiscal measures

In emerging markets, and particularly China, the tide might be slowly turning as well. The monetary and fiscal measures taken by the central bank are modest compared to previous years but on target and helpful.

Recently published economic data is more encouraging. 

The valuation of the stock market is relatively attractive compared to other regions and, provided the environment stays “risk on”, emerging equities are expected to deliver. On the other hand, fundamentals will not suddenly become better and political execution risks have not disappeared, as Phase 1 of a trade deal has yet to be signed.

We remain neutral emerging market equities, preferring debt

 

Bonds and currencies

In terms of bonds and currencies, the macro-financial backdrop will favour carry. The highest carry can be found in hard currency-denominated emerging debt.

We also remain invested in investment grade bonds. The global context, with an easing ECB, remains supportive, despite the strong spread-tightening since the beginning of the year. Carry-to-risk is interesting and the low-yield environment is supportive of credit.

In the currency universe, we remain long Yen.

We have an exposure to gold, which remains an attractive hedge in a context of low rates and negative yields.