Coffee Break 29.10.2018

INVESTMENT CONVICTIONS

• Core scenario
  • In the US, we still expect growth to be close to 3% in 2018, but to slow down in 2019 to 2.6% due to fading fiscal stimulus and higher rates.
  • Outside the US, the economic cycle is less dynamic, but the momentum is set to accelerate into 2019. The euro zone’s recent PMI did not live up to the market’s expectations, though the German Ifo comforted us in our moderately optimistic scenario of a 2% growth this year.
  • As the US-China relationship appears fractured, China is easing its policy mix to mitigate the slowdown and trade tensions. This support should play out in the coming months and help to stabilise the bulk of the emerging economies.
  • Gradual rise in inflation in the US and in the euro zone, but no inflation fear.
• Market views
  • US economic momentum remains strong but does not reveal any economic imbalances.

  • The tax reform, buybacks and no valuation excess vs. bonds keep pushing US equities up over the medium term. 

  • Based on fundamentals, we see potential for a narrowing divergence between the US and the rest of the world. The various political risks are a headwind.
• Risks
  • Trade war: the latest IMF estimates showed that higher tariffs and protectionism could slow down global economies more than expected, deteriorate international relations and ultimately corporate margins. Even the US Fed mentions it in its last committee statement.
  • Emerging markets slowdown: the evolution of the USD liquidity is key for emerging countries due to outstanding debt in this currency.
  • EU political risks: there is a growing number of issues: “Brexit”, Italian budget, German regional elections and trade negotiation outcome with the US.
  • US mid-term elections: after the mid-term election, on 6 November, tail risks of either a tax reform 2.0 and larger deficits (too hot) or the willingness to repeal the tax reform (too cold) could destabilise markets in either way.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We have tactically increased our equity exposure to overweight via the euro zone, as equity markets reached an attractive technical entry-point. From these levels, equity markets should rebound. From a regional perspective, we remain overweight euro zone and US equities, while being neutral on emerging markets and Japan. We continue to hold a negative view on the UK, as the probability of a hard “Brexit” has increased. In the bond part, we keep a short duration and a cautious view on Italy.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

• We have tactically increased our equity exposure to overweight and still have a constructive mid-term view based on fundamentals.
  • We are slightly overweight US equities. From a mid-term perspective, the improving earnings growth and the positive impact of Donald Trump’s tax reform and deregulation are a support for the asset class but volatility will increase ahead of the mid-term elections.
  • We have slightly increased our overweight on euro zone equities. The region displays a solid, although easing, economic expansion and is attractively valued. Political uncertainties are accumulating, but are already priced in.
  • We remain 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 approaching.
  • 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 have become neutral on the asset class.
  • We are neutral emerging markets equities. We are looking for lower technical levels to step in again. 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 strong 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. In this context, global monetary tightening is progressive. With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to keep rising over the medium term. 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 remains accommodative, but has confirmed that it will end its QE in December. Mario Draghi sees rising protectionism as a major source of uncertainty.
  • We have a cautious 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.