Coffee Break 9/9/2019

LAST WEEK IN A NUTSHELL

  • While further tariff hikes in October and December remain on the table, China and the US agreed to resume trade talks in “early October”.
  • China decided to ratchet up stimulus amid the trade war as the PBOC decided to cut its Reserve Requirement Ratio by 50 bps (100 bps for some city commercial banks) for the third time this year.
  • The US job report for August (+130k) came out just fine: the details were strong enough to keep recession fears at bay while at the same time keeping the Fed on track to ease again later this month.
  • The August PMI’s for key markets, including the US, Japan, China and Europe confirmed the slowdown in manufacturing sentiment, while services are still holding up well.

 

WHAT’S NEXT?

  • ECB president Draghi will give its penultimate press conference based on new macro projections and outline decisions on forward guidance, rates (including tiering) and asset purchases to counter low inflation and slowing growth.
  • On the data front, the US will release consumer-centric data: CPI, retail sales and consumer sentiment.
  • Also in the US, Thursday will see the first Democratic primary debate so far with the 10 leading candidates on stage at once.
  • As for the Brexit, events are expected to continue next week: another vote on whether to call an early general election, likely Royal Assent on the bill aiming to prevent a no-deal Brexit, and the government’s plan to prorogue Parliament.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario is moderately constructive in the long-term. Hence, we are currently overweight equities.
    • Many negative news are now integrated as August was a contrasted month with many political risks arising and a deteriorating macroeconomic newsflow.
    • As the business cycle is hit by prolonged uncertainties on trade, central banks will continue to add futher accommodation.
    • In Emerging economies, Chinese authorities are mitigating the impact of the trade war and slowing global growth by using currency, monetary and fiscal tools.
    • Recession fears in the US are overblown, witness the good resilience of services. Meanwhile, the threat of a protracted stagnation in the euro zone has increased. The “global slowdown” is in fact mostly European.
  • Market views
    • Investors’ positioning on equities is light (negative flows) and the relative valuation vs. bonds is even more attractive after the yield drop this summer.
    • The confidence in the recovery is jeopardised by aggressive trade war rhetoric and a delayed stabilisation in global macro data.
    • Central banksare acting, as rates have been lowered in Emerging markets and in the US.
  • Risks
    • Some risks have (temporarily) receded early-September. There is a window of opportunity before the upcoming Fed’s communication or the next tweet of President Trump.
    • The US-China trade conflict. The new September tariff increase by 15% on USD115 billion worth of Chinese goods is concentrated on consumer goods.
    • Geopolitical issues (e.g. Iran, Kashmir, Hong Kong) are still part of unresolved current affairs. Their outcome could still tip the scales from an expected soft landing towards a hard landing.
    • Political uncertainty in Europe. There is less risk of “No deal” Brexit over the short term, but prolonged uncertainty is scaring.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are overweight equities and have added further to our equity exposure in order to benefit from an improving risk/reward environment. We keep a tactical regional bias via an overweight on US and EMU equities vs an underweight Europe ex-EMU equities. We are neutral everywhere else. In the bond part, we are underweight duration and continue to diversify out of low-yielding government bonds via exposures to credit, preferably by European issuers and Emerging markets debt in hard currency. In terms of currency, we keep a long JPY and a short GBP. We also have an exposure to gold.

 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are overweight equities
    • We are overweight US equities. We think there is still a Trump put in addition to a Fed put, which makes the region a relatively safer choice. Consumption is strong, the labour market remains solid while inflation is in check.
    • We are neutral Emerging markets equities. The US Fed’s dovish stance is a tailwind for the region but the trade war is a major hurdle. The region has underperformed the most year-to-date and could offer some upside.
    • We are overweight euro zone equities. We are aware of the restraining factors such as the vulnerability of global trade, leading Germany to experiene a manufacturing recession. The European Central Bank is ready to act in September. Fiscal stimulus in Europe (Germany, Italy) starts to be discussed, but implementation may take time.
    • We stay underweight Europe ex-EMU equities. The region has a lower expected earnings growth rate and thus lower expected returns than the continent, justifying our negative stance.
    • We stay neutral Japanese equities. Absence of conviction, as there is no catalyst. It seems increasingly likely that the government will stick to its plan and increase the consumption tax from 8 to 10% in October.
  • We are underweight bonds, keeping a short duration and diversify.
    • We expect rates and bond yields, especially German 10Y yields, to stay low - or negative.
    • The ECB will have a new president on November 1st. The nomination of Christine Lagarde is good news for those expecting the dovishness to last beyond the 8-year presidency of Mario Draghi.
    • 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 diversify out of low-yielding government bonds, and our preference goes to Emerging debt in hard currency and EUR-issued corporate bonds.
    • We also have an exposure to gold in order to increase the portfolio hedging.