Coffee Break 1/6/2020

LAST WEEK IN A NUTSHELL

  • We start the year with records, the S&P500, the Nasdaq and the Dow Jones indices set new high records last week, posting annual performances of respectively 29, 35 and 22%.
  • The euro zone manufacturing PMI remains in contraction territory but showed some stabilisation in Germany and posted a better reading for the region as a whole. On the opposite side, US’s factory activities slowed and missed consensus expectations.
  • As expected and in order to boost the economy, China’s central bank lowered banks deposits threshold (also called Required Reserve Ratios) by 50 bp, allowing the banking sector to lend more money.
  • The FOMC minutes were in line with Jerome Powell’s previous commentary suggesting that monetary policy was in the right place. The bar is high for any future changes of direction over the next year, i.e. rate hikes are very unlikely for 2020.

 

WHAT’S NEXT?

  • The trade deal with China remains the key event in a near future, Donald Trump announced a signature of a phase one trade deal mid-January. We might have more details about the content during the week.
  • In terms of economic data, we expect global services PMIs, flash CPI for the euro zone and the US and euro zone labour data.
  • After a significant rise at the beginning of December, oil prices seemed to stabilise last week to finally resurge because of an escalation of tensions between Washington and Tehran as top Iranian Military Leader was killed in an US air strike.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our 2020 scenario is slightly constructive as we expect a bottoming out of the economy but also lower global expected returns than in 2019. Rolling back existing tariffs would clearly be good news for global trade perspectives.
    • One of 2020’s market drivers will be the US elections on 3 November. The trade uncertainty is transitioning to election uncertainty.
    • Central banks have reached massive accommodation policies. In the US, the Fed is buying Treasury bills to add liquidity into the system. China’s central bank keep cutting the banks’ Required Reserved Ratios. The accommodative stance is a medium-term tailwind for the global growth/inflation mix and upcoming data should reflect this.
    • In Emerging economies, Chinese authorities are mitigating the impact of the trade war and slowing global growth by using currency, monetary and fiscal tools, avoiding excessive measures like in 2015.
  • Market views
    • Significant fall in political risks: increasing probability of trade deal between the US and China, remote risk of a hard Brexit, increasing talk of a EU Banking union and ambitious Climate roadmap.
    • Cyclical and value stocks are benefitting from the extension of the year-end rally on the basis of a kind of “bullish” capitulation on improving hopes.
    • The relative equity valuation vs. bonds remains attractive.
  • Risks
    • The US-China trade conflict. China doubts if a long-term trade deal is possible with President Trump.
    • Domestic political issues in the US (e.g. formal impeachment process and election run-up) are likely to dominate. These could trigger growth shocks and attractive entry points.
    • Geopolitical issues (e.g. Iran, Hong Kong, Chile) are still part of unresolved current affairs. Their outcome could still tip the scales from a soft landing towards a hard landing.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

Having taken profit during this pivotal week for financial markets, our positioning remains slightly overweight equities. Many uncertainties are cleared up, e.g. the likelihood of a global recession, a hard Brexit, a full-blown trade war, Fed and ECB monetary policy forward guidance. We are slightly overweight euro zone and have a neutral positioning on all the other major regions: US, Emerging markets, Europe ex-EMU and Japan. We stay cautious about exposure to government rates in developed countries. We diversify out of low-yielding government bonds via exposure to credit and Emerging markets debt. In terms of currencies, we see less support to USD appreciation as growth differential with others regions should decrease. We keep an exposure to JPY and gold as hedges.

 

CROSS ASSET STRATEGY

  • We are neutral equities
    • We are neutral US equities. Equities did perform well since our entry points during the summer but valuation is demanding relative to other regions and its historical average.
    • We are neutral Emerging markets equities. The region has underperformed in 2019 and could offer some upside in the medium term. A dovish US Fed is a tailwind as the USD weakens somewhat.
    • We are overweight euro zone equities. The latest macro data show signs of bottoming out in the economy. A window of opportunity on fiscal accommodation is open with longer ECB visibility.
    • We are neutral UK. With the election of Boris Johnson as Prime Minister, a resolution of Brexit is within weeks. Investors’ positioning is low. Valuation and the competitive advantage of a weak currency make the country attractive.
    • We stay neutral Japanese equities. Absence of conviction, in spite of Prime minister Shinzo Abe’s fiscal stimulus package announcement.
  • We are underweight bonds, keeping a short duration and diversify out of government bonds.
    • We expect rates and bond yields, to creep up very gradually but stay low.
    • Christine Lagarde has begun her tenure as President of the European Central Bank. She faces two major challenges: healing the rift between the policy makers of the governing council and national governments still being reluctant to take over the baton with fiscal stimulus policies.
    • We diversify out of low-yielding government bonds, and our preference goes to Emerging debt and EUR-issued corporate bonds.
    • 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 also have an exposure to gold in order to increase the portfolio hedging.