Coffee Break 17.06.2019

LAST WEEK IN A NUTSHELL

  • US consumer and producer prices slowed towards 1.8% YoY in May, increasing the likelihood of a Fed rate cut this summer.
  • Boris Johnson won the first round of the UK Conservative Party leadership contest, way ahead of his competitors.
  • The G20 Finance Ministers and Central Bank Governors Meeting took place in Japan. The IMF’s Christine Lagarde spoke against the use of tariffs.
  • Chinese data revealed that growth risks remain skewed to the downside as trade-war damage is still mounting. New monetary and fiscal stimulus become more likely.

 

WHAT’S NEXT?

  • Public hearings sessions will start in Washington on proposed tariffs on USD300bn of Chinese imported goods. Companies get a chance to ask for exemptions before possible implementation in July.
  • Several Central Banks (Fed, BoE and BoJ) will meet this week. In the US, markets expect no cut this time but a full rate cut at the July meeting. Meanwhile, ECB leaders will gather for a three-day meeting.
  • Flash June PMI and inflation data from the US, Canada, the euro zone, the United Kingdom and Japan will be published.
  • EU heads of state will gather in Luxembourg for another round of talks over European Commission and ECB candidates.
  • Six candidates remain in the UK leadership contest for the Conservative Party. Further contests will take place this week and the new PM is expected to be appointed by 22 July.

INVESTMENT CONVICTIONS

  • Core scenario
    • We have a moderately constructive long-term view but are aware of political pitfalls, in particular the re-ignited trade and technology tussle, which may last longer than initially thought.
    • The political risk premium has increased again but the global economy is growing and seems to have hit its trough last winter.
    • As the business cycle is hit by prolonged uncertainty on trade, central banks have become more dovish, contributing to a fall in bond yields. 
    • In Emerging economies, the measures taken by Chinese authorities to support the economy might be stepped up in order to show their impact.
    • In the euro zone, the economic cycle remains less dynamic: on average over 2019, GDP growth is expected to be at 1.3%.
  • Market views
    • Stabilizing or improving macro data would likely lift global bond yields whereas chilling business activity and the escalating trade conflict will jeopardize confidence in the recovery.
    • The readiness to act of the Fed and the ECB put a floor to the recent decline in equity values.
    • Equity fund flows remain negative in recent weeks: investors are staying cautious in the light of recent trade tensions.
    • European and Japanese equity valuations are below their historical average, whereas US and Emerging markets are close to long-term averages.
  • Risks
    • The US – China trade conflict is at the top of the list. It could further weigh on output growth and trigger further spikes in volatility. We expect this to be a lasting issue, beyond trade.
    • 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 (European institutions, Italian public finances, “Brexit”, limited margin of maneuvre).

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We stay overall neutral equities with a regional tactical bias: overweight US equities vs underweight UK. We are neutral everywhere else. In the bond part, we keep a short duration and we continue to diversify out of low-yielding government bonds via exposures to credit and Emerging markets debt in hard currency. We have decided to take profit on the USD which should stop appreciating. 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are neutral equities
    • We are overweight US equities. We think there is still a Trump put in addition to a Fed put, which makes the region a safer choice.
    • 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. We still have a growth expectation above 6% for China this year.
    • We are neutral euro zone equities. We expect a rise in the equity market but are aware of the restraining factors such as the vulnerability of global trade. The labour market and domestic demand remain decent. Most foreign investors have left the region, leading to a consensus underweight in spite of cheap valuation.
    • 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.
    • 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 and global growth renews with more traction.
  • We are underweight bonds and keep a short duration
    • We expect rates and bond yields, especially German 10Y yields, to rise gradually from depressed levels.
    • A slower but still expanding European economy could lead EMU yields higher over the medium term. There is an unfavourable carry on core and peripheral European bonds. The ECB is accommodative and will add a new TLTRO.
    • 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 US High yield, as a dovish Fed, low inflation and receding recession fears point towards the carry trade.
    • We downgrade the USD as it should stop appreciating.