Coffee Break 7/29/2019

LAST WEEK IN A NUTSHELL

  • Elected as the new Conservative leader and successor to Theresa May, Boris Johnson beat Jeremy Hunt with 66% of the vote. In his victory speech, he vowed to bring a new 'can do' spirit.
  • The ECB president has made substantial changes to its forward guidance by opening the door to monetary stimuli. The EUR fell to its lowest level since May 2017 and hit $1.111.
  • The US advance GDP annual growth rate was published at 2.1%, in line with forecast and below the previous reading of 3.1%.
  • The Q2 2019 earnings season brings positive surprises but mostly because expectations had been previously revised downward. 

 

WHAT’S NEXT?

  • US Treasury Secretary Steven Mnuchin and U.S. Trade Representative Robert Lighthizer are heading to Shanghai for a 2-day meeting. Expectations are high, as US companies are also feeling the pressure of tariffs.
  • Central banks meetings are scheduled, including those of the BoE, Boj and Fed. The latter is expected to cut rates by 25bps by a majority of investors.  
  • On Friday, the US Bureau of Labor Statistics will publish the job report. Current expectations predict the addition of 160K non-farm payrolls (vs the previous monthly reading of 224K).
  • Q2 euro zone GDP and the release of final July manufacturing PMIs for a list of global countries are the main highlights.

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 just signaled a readiness to resume economic stimulus. The Fed is expected to cut rate at the upcoming July FOMC.
    • 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 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, or even improvement, in macro data. Economic surprises remain persistently negative and show a regional convergence. 
    • As Central Banks express a readiness to act, markets have priced in rate cut(s) and are pushing equity values upwards.
    • Equities still see outflows while bonds benefit from inflows.
  • Risks
    • The US – China trade conflict is at the top of the list.
    • 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. 

 

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 are slightly underweight 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 and a short 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 willingness to cut rates 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 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.