Coffee Break 15/04/2019

LAST WEEK IN A NUTSHELL

  • The IMF cut its 2019 growth projections for the global economy from 3.5% to 3.3%, led by advanced economies but forecasts for China were revised upwards to 6.3% (+0.1%).
  • Chinese data (on exports, money supply, credit, prices, foreign reserves) came out better than expected, suggesting that the recovery is on track.
  • The price of oil rose for a sixth consecutive week as tight global crude output is offsetting concerns that slower economic growth will weaken demand.
  • The EU Summit agreed on a “Brexit” extension "only as long as necessary" and "no longer than 31 October”. Hence, the threat of a no-deal “Brexit” has been postponed for 6 months.

WHAT’S NEXT?

  • Additional signs of stabilisation in Chinese growth prospects will be scrutinised in retail sales, industrial production and GDP data.
  • Preliminary April PMIs will reveal to what extent better Chinese data helps stabilising the economic outlook for Europe, on which consensus is very negative.
  • The Japanese economy minister will be visiting the US for trade talks.
  • Q1 earnings season is picking up steam as Netflix, IBM and Johnson & Johnson will report in addition to US banks.

INVESTMENT CONVICTIONS

  • Core scenario
    • We have a moderately constructive long-term view, but acknowledge the sharp market rally since the start of the year, which took place in a slowing growth environment.
    • The political risk premium has decreased and central banks have become more dovish making a U-turn or even stalling the normalisation of their monetary policy.
    • We take some comfort from improving macro data in China, bottoming out in Europe and stabilising in the US but economic surprises are still negative.
    • Q1 earnings is on-going and under watch to gauge the extent of the slowdown.
    • In Emerging economies, the measures taken by Chinese authorities to support the economy are starting to bear fruit and the GDP should be around 6% in 2019.
    • In Europe, the economic cycle remains less dynamic but macro data could be reaching its trough. On average over 2019, GDP growth is expected to be at 1.3%.
  • Market views
    • Equity fund flows remain negative in recent weeks despite positive performance of markets: investors are staying cautious.
    • The corporate sector remains a large buying source via buybacks, but the “black-out“ period during the Q1 earnings reporting has started.
    • European and Japanese equity valuations are below their historical average, whereas US and Emerging markets are back to long-term averages.
    • Improving macro data in China and Europe would likely alleviate upward pressure on the USD, downward pressure on inflation expectations and lift global bond yields
  • Risks
    • Geopolitical issues are still part of unresolved current affairs. Their outcome could still tip the scales from an expected soft landing towards a hard landing.
    • International trade relations remain a source of uncertainty. They could further weigh on output growth and trigger spikes in volatility.
    • Persisting slowdown in Europe and Emerging markets in spite of easing measures.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are neutral equities. We have some regional tactical tilts to take into account dovish central banks, fading recession fears, low rates and low inflation. We favour Emerging markets equities over US equities and we favour euro zone equities over Europe ex-EMU. We stay neutral Japanese equities. In the bond part, we keep a short duration and diversify out of low-yielding government bonds.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are neutral equities
    • We are underweight US equities. We expect slower, but positive, earnings growth in 2019. Equity valuations have recovered and are now at fair value as stock prices rose and earnings expectations were revised downwards.
    • We are overweight Emerging markets equities. Chinese growth is the key driver: monetary support and fiscal easing should ensure a growth target above 6%. Trade conflict is not resolved but the peak in tariffs is likely behind us. The Fed’s pause is a tailwind for the region.
    • We are overweight euro zone equities. Macroeconomic figures are bottoming out and domestic demand remains solid. Most foreign investors have left the region, leading to a consensus underweight. Valuation remains cheap and below historical average despite the rebound.
    • We are underweight Europe ex-EMU equities. The region has a lower expected earnings growth and thus lower expected returns than the continent, justifying our negative stance.
    • We are neutral Japanese equities. Absence of conviction, as there is no catalyst. The region could catch up if the news flow around international relations improves and global growth renews with more traction.
  • We are underweight bonds and keep a short duration
    • We expect rates and bond yields, especially German 10Y yields, to rise gradually from depressed levels.
    • A slower but still expanding European economy could lead EMU yields higher over the medium term. There is an unfavourable carry on core and peripheral European bonds. The ECB is accommodative and will add a new TLTRO.
    • Emerging market debt has an attractive carry and the pause in the Fed tightening represent a tailwind.
    • We diversify out of low-yielding government bonds, and our preference goes to US High Yield.