Coffee Break 15.07.2019

LAST WEEK IN A NUTSHELL

  • In his bi-annual testimony to the House of Representatives, Jerome Powell reiterated that the central bank would act appropriately as “crosscurrents” are weighing on the economic outlook.
  • In spite of the stronger than anticipated inflation data in the US, which lifted government yields, markets are not calling into question the anticipated Fed rate cut.
  • The European Parliament's leadership announced the assembly will soon vote on Ursula von der Leyen's nomination to lead the EU Commission.
  • The IMF urged European policy makers at national and central levels to be ready to respond with more aggressive measures if risks materialize, including fiscal stimulus.

 

WHAT’S NEXT?

  • China will publish its y-o-y GDP growth rate. Consensus expects a reading of 6.2%.
  • The Euro Area and Germany, its biggest exporter, will publish their ZEW economic sentiment indexes. A good gauge for the level of optimism that analysts have about the expected economic developments.
  • In the US, the Q2 2019 earnings season will start with 58 out of 500 companies due to report. Earnings growth is a crucial contributor to the extension of the business cycle.
  • The G7 will meet in Paris, France. One of the top items on the agenda is cryptocurrencies and how can be ensured that they are regulated from money-laundering to consumer-protection rules.

INVESTMENT CONVICTIONS

  • Core scenario
    • We have a moderately constructive long-term view but are aware of the manifold (geo)political pitfalls.
    • As the business cycle is hit by prolonged uncertainty on trade, central banks are open to easing measures. The market is betting on a Fed rate cut at the upcoming July FOMC.
    • In Emerging economies, the measures taken by Chinese authorities to counteract the trade war and slowing global growth are slowly yielding results: we see tentative signs of stabilization.
    • In the euro zone, the economic cycle remains less dynamic. We expect the economy to grow by 1.3% in 2019.
  • Market views
    • Stabilizing - or improving - macro data would likely lift global bond yields whereas chilling business activity and the escalating trade conflict will jeopardize confidence in the recovery.
    • The Fed and the ECB expressed a readiness to act. Markets have priced in rate cut(s) and pushed equity values upwards. Mario Draghi is also mentioning additional stimulus measures unless conditions improve.
    • Weekly equity fund flows are negative for Europe, less so for Emerging markets and positive in the US.
    • US valuation are above long-term averages, Emerging markets and EMU are getting close, UK and Japanese are below their historical average.
  • Risks
    • The US – China trade conflict is at the top of the list, especially because the issue goes beyond trade to technology leadership and because the intensity of the conflict varies in an erratic way between meetings.
    • Geopolitical issues (e.g. Iran) 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 remain, especially in the UK with Brexit and the ongoing prime minister and Tory party leadership election and the upcoming Euro Area leadership transition at the European Union’s level.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We stay overall neutral equities with a regional tactical bias: overweight US equities vs underweight Europe ex-EMU. We are neutral everywhere else. In the bond part, we keep a short duration and we continue to diversify out of low-yielding government bonds via exposures to credit, preferably by European issuers and in EUR, and Emerging markets debt in hard currency. In terms of currency, we keep a long JPY position and added exposure to gold as a hedge. We also decided to reduce our exposure to GBP and increase our exposure to the SEK.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are neutral equities
    • We are overweight US equities. The region is the “safer” choice as the Fed has pivoted. The labor market is staying strong. Consumption should hold.
    • We are neutral Emerging markets equities. The US Fed’s willingness to cut rates is a tailwind for the region but the trade war is a major hurdle. We still have a growth expectation above 6% for China this year.
    • We are neutral euro zone equities. We are aware of the restraining factors such as the vulnerability of global trade: Germany is currently the Achilles’ heel of the region. While some sectors appear undervalued, they are rightfully so as investors end up momentarily with little upside.
    • We stay 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. A “Brexit” is increasingly probable.
    • We stay 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 stay low - or negative.
    • The ECB will have a new president starting 1 november 2019. 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 US Fed represents a tailwind. Trade uncertainty and idiosyncratic risks in Turkey and Argentina are headwinds. o We diversify out of low-yielding government bonds, and our preference goes to Emerging debt in hard currency and EUR-issued corporate bonds.