16 OKT

2019

Although there is no denying that the global macroeconomic context is deteriorating, the likelihood of a recession still seems remote and central banks have once again come to the rescue. A compromise on trade between the US and China might materialize, as US President Trump will soon be busier with domestic issues, including a re-election campaign. 

Equities vs. bonds

The latest drop in bond yields has been a key support for equities on a relative basis. Hence, as investors focused on generating the best returns, we still favour equities over bonds.

As the global macroeconomic context is weakening, our strategic longer-term view remains only moderately positive. Our central economic scenario relies on:

  • the pursuit of weak, yet positive, global growth;
  • the unlikelihood of an impending recession in the US;
  • central bank interventions;
  • the absence of inflation.

From a tactical, shorter-term view, as regards the US (the safer region) and Eurozone equities, we are overweight.

There is no doubt that the macroeconomic context is being challenged and that it does not currently offer much support. However, central banks are increasingly accommodative, cutting rates and launching new quantitative easing measures.

Central banks are digging into their toolboxes to help prolong the current cycle and mitigate the impact of disruptive factors like the trade war and other geopolitical uncertainties. 

Equities

US equities still our main conviction

We remain overweight US equities

The trade war is hitting home. US manufacturing PMIs are contracting and US exports are on a downtrend. GDP growth should slow to 1.8% within the next 12 months.

Global trade remains the most significant issue, as tariffs have caused much confusion. There are also no clear conclusions emerging from the latest, mid-October round of trade talks in the White House. For now, uncertainty on US trade policy will keep weighing on businesses, consumers and investors.
In this context, the Fed came to the rescue last month, when it cut interest rates by 25bps. The impact can already be seen in liquidity growth, which has turned upward for the first time this year. US financial conditions are accommodative. 

With an upcoming FOMC at the end of the month, the Fed is currently neither signalling nor ruling out a third cut.

Market strongly (to the tune of 70% or so) expects a rate cut, depending on the data and news flow published in relation to the trade war.

In terms of performance, the US equity market is still ahead but earnings growth is dwindling. With the ongoing impeachment inquiry led by House Democrats and the weight of the trade war, Trump will probably do his best to secure a re-election and thereby a compromise with China.

 

Emerging markets

Less complacency but more synchronization

In emerging markets, there is no shortage of signs indicating a weakening of the macroeconomic picture and simultaneous increase in geopolitical uncertainties. However, the most recent data has been more encouraging, especially in China.

A truce between the US and China would be necessary to really reverse the current trend; it is likely, too, as it would also be in both countries’ best interests.

In terms of valuation, as there is no excess, emerging market equities are attractive.  

The main scenario still includes approximately +6% GDP growth in 2019. 

We remain neutral emerging markets but will continue to closely monitor the region. Chinese equities have been more impacted by the economic slowdown and there is less complacency. More in phase with the economic momentum, a sustained rebound in Chinese equities would need to be supported by a turnaround in economic data.

 

The Eurozone

The equity risk premium is high while risks have lessened

While Europe has contributed its fair share to the geopolitical uncertainty mix, risks have lessened somewhat along with the odds of a hard Brexit. 

The Eurozone economy is slowing but the ECB has blown some new wind into the sails of the equity markets by cutting deposit rates and resuming its quantitative easing with no set date for its end. With negative yields on some local bonds, the Eurozone equity risk premium has increased.

We remain overweight Eurozone equities for now.

Credit and monetary growth should act as a support for equity markets. The most recent corporate bank loan growth data in the region is encouraging, as it looks like the tide has turned on Eurozone liquidity. 

The ECB has encouraged countries to assume their monetary policy fiscal stimulus responsibilities to address the slowing growth. In Italy, the Netherlands and even Germany, the lower central bank-imposed interest charges should increase these countries’ room for manoeuvre as regards fiscal spending. Definition and implementation will take time and there is no sense of urgency at the moment.

 

Negative on Europe ex-EMU 

The UK parliament was prorogued for 5 weeks. There were no sittings in the Commons or the Lords, and hence no debate around either Brexit or other pressing domestic issues. Parliament only recently resumed (Monday 14 October), with a speech by the Queen. 

Negotiations of a Brexit deal have been one of the major sources of uncertainty in the region, on which we remain underweight

The deadline for the country’s due date of exit from the European Union – end of October – is fast approaching. The latest news flow indicates that a deal could be approved by 19 October. The alternative is an extension past 31 October.   

As long as a hard Brexit is avoided, we anticipate positive benefits spilling over onto domestic stocks and the Pound Sterling. We have become neutral GBP, anticipating nothing more positive than a hard Brexit.

 

Bonds and currencies

In terms of bonds and currencies, provided the global economy avoids a recession, the macro-financial backdrop will favour carry.  The highest carry can be found in emerging debt in hard currency. 

We also remain invested in investment grade bonds. The global context, with an easing ECB, remains supportive, despite the strong spread-tightening since the beginning of the year. Carry-to-risk is interesting and the low-yield environment is supportive of credit. We favour EUR credit. 

In the currency universe, we remain long Yen.  We have recently closed our short positions on the USD and the GBP to become neutral. The USD should stop appreciating, especially if the Fed cuts rates and stays accommodative.

We have an exposure to gold, which remains an attractive hedge in a context of low rates and negative yields.