Coffee Break 7/22/2019

LAST WEEK IN A NUTSHELL

  • The G7 finance ministers met by Paris, France. They agreed on the need for tough regulatory standards for Facebook’s digital currency, Libra, and on the need for a “tech” tax.
  • France has already approved a 3% tech tax, a tax on Tech giants’ local revenues instead of global profits. The White House has threatened to retaliate, deeming the measures unfair to US tech giants.
  • The Zew survey on the current states and outlook of the Euro Area and Germany, the region’s powerhouse industrial economy, show a steady weakening.
  • China published its y-o-y GDP growth rate: 6.2% in line with consensus and down from 6.4% in the previous quarter as the country is hit by the trade war and competition from cheaper suppliers.

 

WHAT’S NEXT?

  • Either conservative MPs Boris Johnson or Jeremy Hunt will be announced as the next Tory leader and prime minister, the odds are in favor of Boris Johnson and further tedious negotiations around the Brexit saga.
  • In terms of data, we expect the July flash PMIs from Japan, Europe and the US as well as the US advance Q2 GDP revisions.
  • The ECB will meet and is expected to adjust its forward guidance. A rate cut by 10bps is forecasted in September by economists. Inflation data came in higher than expected but growth is slow. 
  • The Q2 2019 earnings will continue.

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 increasingly betting on a Fed rate cut at the upcoming July FOMC, resulting in US Treasury yields ticking higher.
    • 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 still expect the economy to grow by 1.3% in 2019.
  • Market views
    • The confidence in the recovery is jeopardized by the delayed stabilizing, or improving, macro data.
    • Hence, the Fed and the ECB expressed a readiness to act. Markets have priced in rate cut(s) and are pushing equity values upwards.
    • Weekly fund flows are positive for bonds with Investment Grade bonds at the top of the list. Equities see modest inflows thanks to the US. Europe, Japan and Emerging markets are registering outflows to various degrees.
    • 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 have an exposure to gold.  

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are neutral equities
    • We are overweight US equities. The region is the “safer” choice, relative to other regions, 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.
    • 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. On the other hand, the government has planned an increase in the consumption tax from 8 to 10% in October.
  • 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.
    • We diversify out of low-yielding government bonds, and our preference goes to Emerging debt in hard currency and EUR-issued corporate bonds.