16 MAY


Asset Allocation , Topics

Poking the dragon and playing with fire


  • Slower growth but first signs of stabilisation and tentative bottoming-out in some regions.
  • Macroeconomic data still rather weak but, overall, strong labour markets are supportive of consumption. 
  • Central banks are key actors but (geo-)political tensions are high.
  • We feel justified in staying neutral equities in our current positioning, as the Q1 earnings season was stronger than expected, but some downside risks could act as a boomerang (Brexit and the US-China trade war).


Even before Donald Trump became President of the United States, while on the campaign trail he vowed to the American people that he would ensure fairer trade practices with the rest of the world, but mostly China. Trump’s inauguration was in January 2017. In his two years in office, he has already renegotiated NAFTA with Canada and Mexico but nothing new with the European Union or China. With China, it has been an escalating tit-for-tat full-blown trade war and, with the next presidential elections scheduled for late 2020, we wonder what is really at stake here. How shall we navigate the markets? And what conclusions can we come to in terms of asset allocation?

Economic background

Beginning of April, the latest economic indicators suggested that the world economy was bottoming out after a clear fall in growth momentum in 2018H2. The recent escalation in trade tensions between the US and China, though, could delay the expected pick-up in emerging manufacturing activity, in Asia, in particular.
Still, the Chinese authorities remain committed to keeping their economy growing at a solid pace as they have shown in the past: while the US/China rivalry will not disappear anytime soon, growth should hold in China. This is key for the other emerging economies. Asian economies in particular are part of the global manufacturing chain. Their manufacturing sector took a hit with China’s slowdown in winter 2018 but, in recent months, activity has shown signs of stabilization: manufacturing PMIs have improved both in Taiwan and in Korea. Of course, industrial production will not pick up quickly, as firms have piled up inventories in recent months. Still, if growth stabilizes in China, industrial activity in Taiwan and Korea will accelerate … and this would also support commodity-exporting countries.

The US economy surprised, with strong 3.2% growth in the first quarter. The underlying performance was less impressive. The strong growth was due mainly to temporary factors such as stock-building and exports. Consumption, on the other hand, grew less than expected. Business confidence in the manufacturing industry is also declining. The Fed should manage to engineer a soft landing of the economy: facing an uncertain environment (trade war, shutdown,…), it decided to pause in early 2019. With inflation showing little signs of drifting upwards, and with inflation expectations well-anchored, the pause could last a while. Still, as the economy is getting closer to full employment, we believe a rate-cut is not in the offing. Indeed, despite some deceleration, the economy continues to grow solidly and fiscal policy could end up being much less restrictive than many currently fear.

The euro zone performed better than expected in the first quarter, with 1.5% GDP-growth QoQ (annualized) in Q1. Retail sales and construction activities are improving. Manufacturing activity, which disappointed in 2H 2018, should at some point benefit from a more supportive global environment. The service industry is also rather resilient and fiscal policy will provide some support. With a balance-of-risk clearly on the downside, monetary policy will remain accommodative another while.

Equities vs bonds: where do we stand?

Our strategic views dictate a slightly constructive stance on equities. However, the current market context vindicates our decision last March to reduce our risk. As a result, we are neutral equities vs bonds.

   Neural equities vs bonds: explanations

The year-to-date market rebound is making up for the growing disconnect we saw late 2018 between the decent state of the economy and the very poor performance of the stock market. While the market was clearly behind in late 2018, we suspect it is getting ahead of the improvement in economic data and the risk has grown asymmetric. Although markets have anticipated a better economic news flow and should now deliver, signals remain mixed. On the one hand, although we have better economic conditions, low inflation and a strong labour market, the manufacturing PMI has only just recently bottomed out. So we may wonder if the trough is really behind us.

With markets going up, the equity risk premium has decreased but risk remains. A single tweet from US President Trump can be a game-changer, at least temporarily, and the latest tweets were about the failed negotiations with the Chinese president on their trade relations and additional tariffs on imported goods from either side. President Trump was also not shy in blaming his counterpart.

We feel justified in staying neutral equities in our current positioning. The positive momentum can be seen in the positive earnings season. The Q1 2019 earnings season was stronger than expected in both the US and in Europe, where some might say that the bar was low. We are not overlooking the downside risks that could act as a boomerang: 

  • Brexit was merely postponed but not solved;
  • The truce between the US and China that just came to an end before an agreement could be reached.

   What will we do in the near future?

As asset managers, our objective remains constant: find the optimal combination of asset classes at any point in time without taking risks we cannot afford. We are currently neutral equities.

We will consider a reduction of our equity exposure if trade negotiations break down or if the deterioration is so drastic that it is reflected in growth.

We will consider an increase in our equity exposure if the risk/reward compromise improves either because risks have gone down – with an improved geopolitical context and improved macroeconomic data – or the reward has gone up, with higher expected returns.

Regional allocation

In terms of regional allocation, we can add value to the asset allocation strategy by adding weight to – or subtracting it from – regions depending on the potential we see. With its early-2018 tax cut, the US had given its economy and stock market a sugar rush, leaving all other regions to bite the dust: an opportunity for asset managers who had assessed the widening gap, and potential for others to catch up.

We have chosen the following tactical plays:

  • a preference for the European Monetary Union over Europe, ex-EMU
  • a preference for Emerging markets over the US; 
  • a neutral positioning on Japanese equities, due to lack of growth and earnings momentum.

Taking into account at least 3 tangible criteria:

  • an improving economic news flow,
  • more attractive valuations, i.e. below their historical average, and 
  • if and when there are domestic political issues or geopolitical issues, they should not go as far as to distort the economic growth and accompanying valuation.

Sectorial bias: cyclical vs defensive

In line with our current tactical positioning, i.e. neutral equity, we have temporarily reduced our exposure to cyclical sectors by selling some technology names, thereby reducing the risk in the portfolios; nonetheless, our strategy still has a cyclical bias.

Bonds allocation

For the moment, we are not considering increasing our duration.
We have a very limited exposure to high-yield bonds and are keeping some emerging debt (in hard currency), which we think has an attractive carry – assuming at least that the USD does not appreciate much further, otherwise it would increase issuers’ debt burden.
Because of the recent moves in local currency, including the Chinese Yuan, and the strength of the USD, we are more cautious on emerging debt in local currency.


Our key message on currencies is that, with the exception of the Chinese Yuan, closely monitored by the authorities battling a trade war with the US, volatility is at record lows on currencies. It makes it challenging to hold strong directional convictions.

While we remain neutral Japanese equities, we consider the currency to be a good hedge and currently hold Japanese Yen.

We also consider gold a safe haven.