20 JUN


Asset Allocation , Topics

Ageing bull & roadmap to carry

Our central scenario remains slightly constructive: as long as there is growth, there is hope. It is slowing but it is positive; it might even be bottoming before accelerating slightly. Central banks are on the ball and the Fed, which is meeting on 19 June, vows to act appropriately to sustain expansion. The G20 will also meet in a few days and probably appease - or heighten - trade relations between China and the US. 

So what could possibly go wrong? There are downside risks that cannot be ignored, especially in Europe and China.

Where do we stand? Where do we see potential? And what are today’s main risks?

Equities vs bonds

We remain moderately constructive for H2 2019. The global economy is still growing and seems to have hit a bottom last winter. Central banks have become more dovish and the Fed is not just on a break: interest rate cuts are back on the table in the very near future. Valuations are still reasonable and equity flows remain negative, creating opportunities for active investors. We are aware of political pitfalls that are weighing especially on the eurozone. Political risks, rising economic uncertainty as well as the nature of the late economic cycle dynamic will contribute to rising volatility. In terms of positioning, these factors translate into an overweight in US equities vs. underweight UK equities, neutral EMU, emerging markets and Japanese equities. Overall, we are currently neutral on equities. In fixed income, the situation also translates into an overweight emerging debt in hard currencies, and euro high yield.

Equities: which region?

For now, our main preference in terms of region goes to the US.

The US: Trump and Powell put options

In the US, the equity market has recovered better than the others from the sharp deterioration in 2018. Assets seem to be under the wings of both the US President Trump and the Fed Chairman Jerome Powell.
The US President is likely to do whatever it takes to secure his 2020 re-election including via rising stock markets. As for the Fed, it has made a complete U-turn on its monetary policy:

  • In 2018, it raised interest rates 4 times.
  • In January 2019, it announced a break, putting further hikes on hold. 
  • But in early June 2019, Jerome Powell indicated that a cut in interest rates - if deemed necessary depending on the fallout from a deepening set of disputes between the U.S. and its largest trading partners - was possible.

By now, markets are pricing up to 3 Fed funds rate cuts in the next 12 months. In addition, there is no sign of a recession in the short term. In companies’ 12-month forward earnings, we assess more strength in the US equities market than in the EMU region’s or emerging markets’.

All those factors build a strong case for US equities.

The eurozone: a stabilizing but politically challenging situation

In the eurozone, the situation is more nuanced. Some key countries, or key sectors, are in the eye of the hurricane.

In the eurozone, political risk clearly weighs more on the scale: we have Brexit. Three years after the referendum that took place in the UK, the country still has not left the European Union. In fact, Theresa May has just announced that she would step down as Tory leader and Prime Minister. The race is on to find a new leader who will renegotiate the withdrawal terms from the Union - or leave without a deal. We also have Italy. The coalition is struggling to find common ground after all. The unlikely alliance between a right-wing former separatist party and anti-establishment populists finally made it into office in the early summer of 2018. Ahead of the European Parliament elections that took place at the end of May 2019, tensions had increased between the 2 parties vying for seats in the Brussels and Strasbourg-based parliament. The EU parliament elections created a surge in interest among citizens as a higher-than-usual number went to the polls. Besides the newsflow, if we look at positioning and investor flows, the current situation shows that investors are currently avoiding both European equities and the local currency. The upside is that the cheap currency is supportive for economic and earnings growth. If we look at macro data, leading indicators seem to have bottomed out last winter and although timid, we see early signs of stabilization in business activity.

In terms of style, value sectors have lost a lot of ground and are trading at a record discount compared to growth sectors. This discount provides both opportunities and challenges: with a gentle push from positive newsflow and rising rates, the sector could become increasingly attractive.

Leading indicators appear to have bottomed and if history is a reliable guide, eurozone PMI Composite will follow in the footsteps of its predecessor, the China CKGSB business conditions index. Without the gentle push, investors could end up in value traps.

In the meantime, we are maintaining our overweight eurozone equities but hedged.

Emerging markets: a tough bind

Emerging markets, and especially China, are currently in a tough bind. Since Trump became president of the US, he has been renegotiating trade relations he deemed “unfair”. This includes relations with China, which is the largest creditor to the US. Trade war or technology leadership war, the line is getting blurry. Besides the additional tariffs slapped on Chinese imported goods to the US in an escalating tit-tor-tat sequence, the Trump administration has put Huawei, China’s largest smartphone manufacturer, on a trade blacklist, preventing it from entering the US market.  Huawei has a leading role in developing the next generation 5G mobile phone networks around the world and Washington feared that its equipment could serve as a Trojan horse for Chinese intelligence services. The US has urged other countries and suppliers, including US-based suppliers, to distance themselves from Huawei. This includes Google, whose Android operating system runs most smartphones. Trump’s protectionism might lead to a rise in dual supply chains: Western/US-centric vs Eastern/Chinese. In the meantime, China is fending for itself and GDP growth outlook is still above 6% this year. The macroeconomic picture shows a mix of both positive and negative signals. Although the index is relatively attractively valued, some may argue that it relies on the low valuation of domestic and regulated value sectors. Simultaneously, a more dovish Fed along with USD stabilization should support the performance of emerging markets assets. The main threat as mentioned by Christine Lagarde, Managing Director of the IMF at the recent G20 meeting for finance ministers and central bank governors in Japan in June 2019, stems from continuing trade tensions. 

Japan: no catalyst & no comment

We remain neutral in Japanese equities, so far the worst equity market performer this year. The country highly depends on global growth as it lives mainly off of its exports. The currency, on the other hand, has played its safe haven role and appreciated vs the EUR as well as the USD in recent months.

United Kingdom: the Brexit takes it all

We remain underweight in UK equities. The latest GDP figures show the economy contracting by 0.4% in April 2019, the heaviest fall since 2016, mainly due to a sharp downturn in car production, with uncertainty ahead of the UK’s original EU departure date leading to planned shutdowns. There was also widespread weakness across manufacturing in April, given that the boost from the early completion of orders ahead of the UK’s original EU departure date has faded. 3 years after the referendum on 23 June 2016, the government is looking for:

  • a new Prime Minister,
  • a new Tory leader and
  • the Brexit withdrawal terms have yet to be decided.

Bonds and currency

In terms of bonds and currency, providing that the global economy avoids a recession, the macro-financial backdrop favours carry.
The highest carry can be found in emerging debt in hard currency and euro high yield. US high yield is also a good prospect but the cost of hedging wipes out most of the gains for euro-based investors, like us.

In the currency universe, we are long yen and have taken partial profits in the US dollar, which we think will stop appreciating, especially if the Fed cuts its base rates.