Coffee Break 8/5/2019

LAST WEEK IN A NUTSHELL

  • US representatives travelled to China to pursue trade negotiations… but to little avail. Donald Trump just announced an additional 10% to the already imposed tariffs starting in September. China has already responded it would not be pressured.
  • The US Federal Reserve Bank cut its rates by 25bps, highlighting that it was an isolated move. Some investors, as well as the US President were disappointed by the move.
  • The US Bureau of Labor Statistics published its monthly job report. The domestic job market added 164K, in line with market expectations.
  • The euro zone GDP growth halved in Q2, going from 0.4% to 0.2%, as global economic growth slowdown impacted all regions. Inflation data also cooled, opening the door for the ECB to ease its monetary policy. 

 

WHAT’S NEXT?

  • Final July Market Services and Composite PMI are due in key markets, such as the euro zone, France and Germany. Forecasts are predicting a level of 51.5. Services are resilient but manufacturing is still suffering.
  • Great Britain will publish preliminary YoY and QoQ Q2 GDP growth rates. 1.4% and -0.1% are expected, a sign that the domestic growth is not immune to the “Brexit” saga.
  • The ECB will publish its latest economic bulletin and it is expected to join the Fed in paving way for new stimulus starting in the coming months.
  • China’s July CPI and trade balance will be published. The trade balance has become a highlight given the increasingly trade-unfriendly context and slowing growth. 

INVESTMENT CONVICTIONS

  • Core scenario
    • We have a moderately constructive long-term view but in the short-term, given the current context, we are neutral equities, aware that a lot of positive news have already been integrated.
    • As the business cycle is hit by prolonged uncertainties on trade, central banks have become the first line of defence. The ECB signaled a readiness to resume economic stimulus by September. The Fed has announced a rate cut by 25bps at the last FOMC. Markets had expected more. The USD strengthened on the news.
    • In Emerging economies, Chinese authorities are counteracting the impact of the trade war and slowing global growth by using monetary and fiscal tools. We see preliminary signs of stabilisation.
    • 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 stabilisation in macro data. Economic surprises remain persistently negative and show a regional convergence.
    • As central banks are acting, several have lowered rates, in Emerging markets and in the US.
    • Equities still see outflows while bonds benefit from inflows.
  • Risks
    • The US – China trade conflict is at the top of the list, especially now that in the absence of a deal, Donald Trump has announced an additional increase in tariffs by 10% by September 1st. China has already responded it would not be pressured.
    • 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. Boris Johnson has so far given the European Commission the cold shoulder. His readiness to leave the EU even without a deal is scaring business owners and has weakened the GPB. 

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We stay overall neutral equities. We have a tactical regional bias via a growing overweight US equities vs an underweight Europe ex-EMU equities. We are neutral everywhere else. In the bond part, we are slightly underweight duration and we continue to diversify out of low-yielding government bonds via exposures to credit, preferably by European issuers and Emerging markets debt in hard currency. In terms of currency, we keep a long JPY and an even shorter GBP. We also 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”. Financial markets are supportive with low rates, rising equities and low volatility. The labour market and consumption are strong while inflation is low.
    • We are neutral Emerging markets equities. The US Fed’s dovish stance is a tailwind for the region but the trade war is a major hurdle. Financial markets are supportive as well, but the hard data has room for improvement.
    • We are neutral euro zone equities. We are aware of the restraining factors such as the vulnerability of global trade: Germany is technically in a manufacturing recession. But the European Central Bank is ready to act. The labour market and consumption are still strong.
    • We stay underweight Europe ex-EMU equities. The region has a lower expected earnings growth rate 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 on November 1st. 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 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.