Coffee Break 11/18/2019

LAST WEEK IN A NUTSHELL

  • China’s industrial output grew significantly lower than expected. As the trade negotiations with the US drag on, Beijing is increasingly expected to announce further supporting measures.
  • Q3 output in Germany grew by 0.1%, keeping a recession at bay. Berlin is resisting pressure for fresh stimulus measures.
  • According to Jerome Powell’s congressional testimony, the US economy is a “star”, with low probability of a recession, as consumer spending offsets the manufacturing slowdown.
  • The Q3 earnings season revealed a mixed picture: earnings are above estimates but below their 5Y average whereas actual sales are above both, revealing higher costs and tighter margins.

 

WHAT’S NEXT?

  • In the US, impeachment hearings will continue and so do the Democratic primary candidates debates. Elizabeth Warren, Joe Biden, Pete Buttigieg and Bernie Sanders are leading the polls.
  • Preliminary PMIs from key countries, including the US, Germany, Japan and France, will be published. This will give a good assessment on the tentative bottoming out of the global economy.
  • The Fed will release the minutes from its last FOMC during which a 3rd consecutive rate cut was decided and Christine Lagarde, ECB president, is scheduled to speak.
  • In the UK, the country is preparing for the December 12th general elections. PM Boris Johnson and Labour party leader Jeremy Corbyn will lock horns in their first televised debate.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario is moderately constructive in the long-term. We took profit on our equity allocation via euro zone and US equities, and are tactically overweight equities vs bonds via derivatives.
    • The main uncertainties for financial markets remain the trade conflict and the slowdown in manufacturing. Rolling back existing tariffs would clearly be good news for global trade perspectives and accelerate the bottoming out of the output cycle.
    • Central banks have reached massive accommodation policies. For instance, in the US, the Fed is injecting liquidity into the funding markets, i.e. repo operations, and started buying Treasury bills to add liquidity into the system. The accommodative stance is becoming a medium-term tailwind for the global growth/inflation mix.
    • In Emerging economies, Chinese authorities are mitigating the impact of the trade war and slowing global growth by using currency, monetary and fiscal tools.
  • Market views
    • Decrease of political risks: increasing probability of trade deal between the US and China, low risk of a hard Brexit and shift towards a pro-Euro government in Italy.
    • Current strong momentum with a rotation in favour of value/cyclicals/commodities and out of crowded momentum and low vol stocks. There is a possibility of a continuation of the rally towards year-end on the basis of a kind of “bullish” capitulation rally on improving hopes.
    • On the other hand, fundamentals will not suddenly become better and political execution risks have not disappeared as neither a Brexit deal nor a Phase 1 trade deal are signed yet.
    • The relative equity valuation vs. bonds remains attractive.
  • Risks
    • The US-China trade conflict. The United States and China are working on drafting an agreement, but China doubts if a long-term trade deal is possible with President Trump.
    • Domestic political issues in the US (e.g. formal impeachment process and election run-up) are likely to dominate. These could trigger growth shocks and attractive entry points.
    • Geopolitical issues (e.g. Iran, Hong Kong, Chile) are still part of unresolved current affairs. Their outcome could still tip the scales from a soft landing towards a hard landing.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

After increasing our allocation to equities in 2 steps, early August and early September favouring the US and euro zone equities, we have now taken some profit. Our positioning is neutral (excluding derivatives). Including derivatives, we are overweight equities to benefit from a possible pursuit of the year-end rally. We still favour US and euro zone equities. We are neutral Emerging Markets, Japanese and Europe ex-EMU equities. We remain cautious about exposure to government rates in developed countries. We diversify out of low-yielding government bonds via exposure to credit and Emerging markets debt. In terms of currencies, we keep a long JPY and an exposure to gold as hedges.

 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are overweight US equities via derivatives
    • We are overweight US equities. As equities did perform well since our entry points during the summer in spite of the economic slowdown, we have neutralized our exposure. However, the region remains a relatively safe choice and as a market melt-up cannot be excluded on rolling back existing tariffs, we added a derivatives exposure.
    • We are neutral Emerging markets equities. The region has underperformed year-to-date and could offer some upside. A dovish US Fed is a tailwind as the USD weakens somewhat.
    • We have taken profit on euro zone equities. We took profit and our positioning is now overweight via derivatives. The latest macro data show signs of resilience. A window of opportunity on fiscal accommodation is staying open with more ECB visibility.
    • We have become neutral Europe ex-EMU equities. We approach a resolution of Brexit but political noise ahead of the December election obscures the plausible outcomes. Valuation is attractive and positioning is low. Many non-European investors have shun Europe so far but could look twice as the balance of risks improves. 
    • We stay neutral Japanese equities. Absence of conviction, as a catalyst is missing. It has to be seen if household consumption can resist the increase of the VAT rate from 8 to 10% that took place early-October.
  • We are underweight bonds, keeping a short duration and diversify out of government bonds.
    • We expect rates and bond yields, to creep up very gradually but stay low.
    • Christine Lagarde has begun her tenure as President of the European Central Bank. She faces two major challenges: healing the rift between the policy makers of the governing council and national governments still being reluctant to take over the baton with fiscal stimulus policies.
    • We diversify out of low-yielding government bonds, and our preference goes to Emerging debt and EUR-issued corporate bonds.
    • 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 also have an exposure to gold in order to increase the portfolio hedging.