Coffee Break 14/10/2019

LAST WEEK IN A NUTSHELL

  • US-China trade talks resumed in Washington. US President Donald Trump sounded optimistic as he met with Vice Premier Liu He at the White House.
  • Following the latest US economic reports, the domestic growth slowed in September. Inflation cooled as shown by the flat US consumer prices and manufacturing activity fell.
  • In China, the “Golden” holiday week ended. While it usually boosts sales, it was disrupted by the Hong Kong protests and the ongoing trade war. Retail and catering sales rose by 8.5% vs. 9.5%, last year.
  • An Iranian tanker was hit by two rockets near the coast of Saudi Arabia, increasing, once again, geopolitical tensions between these two countries. Yet, oil prices were steady over the week.

 

WHAT’S NEXT?

  • The US are scheduled to increased tariffs from 25% to 30% on $250bn worth of Chinese goods. Yet, new tariffs on EU goods should come into effect. 
  • China will release its YoY Q3 GDP growth, as well as trade-related figures, including imports, exports and balance of trade. Forecasts still expect a growth by 5.9% vs 6.2% anticipated.
  • The fourth democratic party debate will be held on Tuesday. Elizabeth Warren and Joe Biden are still the front runners.
  • In the UK, if MP’s have not approved a Brexit-deal by Saturday, or a no deal at all, prime minister Boris Johnson will have to ask the EU for a 3-month extension.
  • Q3 earnings season will kick off, starting with major banks.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario is moderately constructive in the long-term: We are currently tactically overweight equities vs bonds.
    • The main uncertainties for financial markets remain the trade conflict and the slowdown in manufacturing. Developed countries should be able to absorb the new round of tensions though.
    • Central banks are coming to the rescue in the US, Europe and Emerging markets. Their accommodative stance is becoming a medium-term tailwind for a 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. Economic data has yet to turn around.
  • Market views
    • Italy, Germany, and the Netherlands are timidly moving towards fiscal stimulus to take over the baton from the ECB and launch climate-friendly and growth-enhancing projects.
    • Global macro data appears soft, facing on-and-off trade war rhetoric.
    • The relative equity valuation vs. bonds remains attractive, especially with the recent drop in bond yields, and positioning appears light.
  • Risks
    • Market sentiment has already deteriorated sharply. In the US, economic data has shifted from negative to more mixed but political risk has increased. A formal impeachment process against US President Trump looks inevitable. In Europe, downside risks are real.
    • The US-China trade conflict. The United States and China have agreed to resume negotiations in Washington.
    • Geopolitical issues (e.g. Iran, 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.
    • Brexit. A new extension and new elections look more and more likely.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are tactically overweight equities, especially via US and EMU equities. We are underweight Europe ex-EMU equities. We are neutral Emerging markets and Japanese equities. In the bond part, we are underweight duration and diversify out of low-yielding government bonds via exposure to credit, preferably by European issuers and Emerging markets debt in hard currency. In terms of currency, we keep a long JPY, a short GBP and have now a neutral USD stance. 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. Economic growth is however slowing down.
    • We are neutral Emerging markets equities. The region has underperformed the most year-to-date and could offer some upside. A dovish US Fed is a tailwind.
    • We are overweight euro zone equities. We are aware of the restraining factors such as the vulnerability of global trade, and the manufacturing recession in Germany. Fiscal stimulus in Europe (the Netherlands, Germany, Italy) is becoming a topic, but implementation may take time. A window of opportunity opened with receding political uncertainty and long-term ECB visibility.
    • 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. Brexit is a major hurdle.
    • We stay neutral Japanese equities. Absence of conviction, as a catalyst is missing. 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, to stay low.
    • 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.
    • We diversify out of low-yielding government bonds, and our preference goes to Emerging debt in hard currency 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.