Coffee Break 4/23/2019

LAST WEEK IN A NUTSHELL

  • China has been implementing stimulus measures to bolster growth dented by the domestic deleveraging and the trade war with the US. After positive development on credit growth and exports, the latest data in retail sales, industrial production has also surprised on the upside.
  • Several analysts raised their 2019 forecasts for China’s GDP growth after it came in at a higher-than-expected 6.4% for Q1. Longer term, structural factors will slow the country down, but the cyclical upswing is good news for the global economy and risky assets as a whole.
  • Germany cut its GDP growth forecast for 2019 for the second time in just 3 months: from 1.8% to 1% and now from 1% to 0.5%. European flash PMIs for April PMIs were lackluster as Europe typically lags China in a rebound. Under the surface however, details were actually better as new orders improved.
  • The EU Commission and the US are likely to start trade talks. The EU Commission’s objective is to seal a deal that covers industrial goods only, eliminating tariffs on both side and above all, leaving agriculture out.

WHAT’S NEXT?

  • The euro zone will publish its flash Consumer Confidence revealing households’ assessments of their past and future financial situation and their expectations about the general economic situation.
  • In the US, we will find out about the Michigan Consumer Sentiment, and household’s inflation expectations. The country will also publish its first estimate of its GDP growth rate for Q1 2019 (consensus expects 2% annualized QoQ).
  • The US and China will meet in 2 rounds of meetings as they try to wrap up a trade deal. The objective is now to sign by late May/early June. President Trump needs a deal as sentiment among US businesses regarding international trade is deteriorating.

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.
    • In Emerging economies, the measures taken by Chinese authorities to support the economy are starting to bear fruit and the GDP data just surprised on the upside.
    • 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 ahead of the earnings season.
    • The corporate sector remains a large buying source via buybacks, but the “black-out“ period during the Q1 earnings reporting stretch 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 stay neutral equities as a whole. We have tactical tilts on regions though as we see more potential for a catch up in specific regions’ macroeconomic data and equity valuation. In our selection, we take into account dovish central banks, fading recession fears, low rates and low inflation but acknowledge the rally in risky assets since the start of the year. 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 decent. Most foreign investors have left the region, leading to a consensus underweight. Valuation remains cheap and below historical average despite the recent 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. EMU yields higher over the medium term. 
    • 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, as a dovish Fed, low inflation and receding recession fears point towards the carry trade.