In early June, Candriam became overweight US equities. Since then, global stock markets have registered a significant performance divergence between US equities and the rest of the world, culminating in an all-time high in US equities. The rise in US assets is underpinned by the strength of the US dollar. We think that the drivers of USD strength are now well integrated: this encouraged us to take partial profit on our US equity overweight and use the proceeds to tactically increase our positioning in emerging market and Eurozone equities.
A good time to take some profit on our overweight US equities. US GDP growth should stay at around 3% this year and next and hence clearly above its potential rate. This has led to a red-hot labour market on which wage tensions are gradually appearing. On top of this, the fiscal stimulus introduced this year should continue well into 2019. As a result, corporate earnings are rising strongly, pushing US equities towards all-time highs.
The drivers of US dollar strength are now priced-in. Given the robust US economy, Jay Powell is pursuing the “beautiful normalization” started by his predecessor Janet Yellen at the Federal Reserve end-2015. In addition, risks to the global economy outside the US, led by country-specific crises in emerging markets (Turkey, Venezuela, Argentina, …) and European uncertainties (Italian budget, Brexit, …) have further reinforced the value of the greenback. A third factor in US dollar strength throughout previous quarters has been the aggressive trade rhetoric, leading to a 10% depreciation in the Chinese Yuan. To our understanding, the Yuan weakness has more than offset the impact of the initial tariffs and is therefore meeting the Chinese policy objectives and – contrary to 2015 – does not constitute a warning signal.
The weakness priced into emerging markets appears overdone. Trade protectionism primarily constitutes a major risk for markets outside the US, as their earnings are driven more by exports. A de-escalation in the trade conflict is likely to see Eurozone and emerging markets recover some of the ground lost in previous months. At current levels, the risk of a trade conflict has, in our view, been sufficiently priced in. In addition, investors are globally short on emerging market equities, outflows have stabilized recently and emerging markets are greatly benefiting from a stabilizing USD.
Economic momentum in the Eurozone is picking up for the first time in 2018. As growth in 2017 surprised on the upside, consensus expectations adjusted sharply to the downside during H1 2018. Candriam expects the economic news flow in the region to pick up during the second half of the year, leading to support for the Euro. Recent indicators, such as the Composite PMIs and German IFO index for the month of August, show that, beyond trade-war fears and policy uncertainties, the robustness of the economic activity remains intact.