LAST WEEK IN A NUTSHELL
- Bond yields have increased on better than expected economic news in the US and a Fed President willing to walk the gradual tightening path. Inflation expectations have remained stable and the yield curve has steepened.
- The collateral victim of higher US yields have been World ex-US risky assets as the USD strengthened.
- The September US job report confirmed the exceptional health of the US economy as the unemployment rate fell to a 48-year low at 3.7%, whereas wages have remained flat. In contrast, September PMIs showed a less dynamic growth momentum outside the US.
- The initial draft budget of Italy’s populist government is based on optimistic economic premises but declining medium-term deficit targets open up space for negotiation with the European Commission.
WHAT’S NEXT?
- In the current context of higher bond yields, US consumer and producer price inflation reports will attract investors’ attention.
- The IMF and World Bank annual meetings as well as a G20 Finance Ministers and Central Bank Governors gathering are likely to be focusing on rising trade tensions and WTO reform.
- After the annual conferences of the Conservative and Labour parties in the UK, “Brexit” will be back at the top of the agenda.
- The Brazilian presidential elections start in earnest as Jair Bolsonaro and Fernando Haddad will compete in a second round scheduled on 28 October.
|
INVESTMENT CONVICTIONS
- Core scenario
- Solidly anchored and accelerating US expansion. Hence, the Fed maintains its tightening path.
- Outside the US, the economic cycle is less dynamic but the momentum is set to accelerate into 2019.
- As the US-China relationship appears fractured, China is easing its policy mix to mitigate the slowdown and trade tensions.
- Gradual rise in inflation in the US and in the euro zone, but no inflation fear.
- Market views
- Risks
- Trade war: higher tariffs and protectionism could slow down global economies more than currently expected, deteriorate international relations and ultimately corporate margins.
- Emerging markets slowdown: the evolution of the USD liquidity is key for emerging countries due to outstanding debt in this currency.
- EU political risks: political pitfalls could fuel euro scepticism as opinions diverge on a growing number of issues, i.e. “Brexit”, Italian budget, German regional elections, trade negotiations outcome with the US.
RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY
We are overweight equities vs. bonds via a regional split between US, EM and euro zone equities as we expect the global expansion to continue in spite of (geo)political tensions. We keep a short duration.
CROSS ASSET VIEWS AND PORTFOLIO POSITIONING
- We maintain our equity exposure to overweight as we expect the underlying favourable economic background to prevail in spite of the aggressive trade rhetoric and a two-speed world economy.
- US growth re-accelerates and global growth momentum outside the US is expected to continue, albeit at a slower pace.
- We are overweight US equities. The improving earnings growth and the positive impact of Donald Trump’s tax reform and deregulation are a support for the asset class. “America first” policy impacting other countries negatively are priced in now.
- We are overweight euro zone equities. The region displays a solid, although easing, economic expansion. We prefer small and mid-caps to large ones as they are less FX sensitive. However, political uncertainties are accumulating.
- We are 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. The separation from the EU is due in 170 days but the outcome of “Brexit” negotiations are still unclear.
- We are neutral Japanese equities. Japanese stocks reflect less domestic risk as “Abenomics” will continue for three more years. PM Shinzo Abe show a more positive economic momentum and so we remain neutral on the asset class.
- We are overweight emerging markets equities. Global growth remains decent for the foreseeable future and emerging markets assets as a whole have already incorporated a risk premium for a tightening Fed, a stronger USD and trade war risks.
- We are underweight bonds and keep a short duration
- We expect a gradual rise in inflation, but no inflation fear.
- Global monetary tightening is progressive. Outside of the US, other developed market central banks are in no hurry to tighten, but some EM central banks have been forced to do so to mitigate currency stress.
- With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to keep rising. In addition to rising producer prices, rising wages, fiscal stimulus and trade tariffs could push inflation higher.
- The expanding European economy could also lead EMU yields higher over the medium term. The ECB will remain accommodative but will end its QE in December 2018. Mario Draghi sees rising protectionism as a major source of uncertainty.
- We have a neutral view on corporate bonds overall but prefer EU to US in both Investment Grade and High Yield. A potential increase in bond yields could hurt performance.
- Emerging market debt faces headwinds with trade war rhetoric and rising US rates but we believe spreads can tighten from current levels. The carry is among the highest in the fixed income universe. It represents an attractive diversification vs other asset classes.
Topics
Highlighted
Authors
Resources
Article 173
SFDR