Coffee Break 8/6/2018

INVESTMENT CONVICTIONS

• Core scenario
  • Trade war risks eased somewhat but remain high, hitting the global expansion, which remains self-sustained and not easy to derail.
  • Growth of around 3% is expected in the US economy, while economic outlook in the euro zone is also positive but at just over 2%.
  • Gradual rise in inflation in the US and in the euro zone, but no inflation fear.
  • The Fed is on a progressive normalisation path but being criticised by Donald Trump for doing so.
• Market views
  • The solid Q2 2018 earnings season is coming to an end and is still supporting equities.
  • Leading indicators are under close watch, including PMI and ISM. PMI are stable for the euro zone, strong in the US and recently weakening in China on a month-to-month basis.
  • Markets believe fundamentals will stay supportive.
  • US equities are supported by the tax reform, buybacks and still attractive valuations vs. bonds.
• Risks
  • Trade war: higher tariffs and protectionism could slow down global economies, deteriorate international relations and ultimately corporate margins.
  • Slowdown in Emerging markets: the tightening US monetary policy and a stronger USD could impact some emerging countries. China’s slowdown is also still at stake and this risk could resurface in the coming months if the implemented easing measures do not work out.
  • EU political risks: euro scepticism could continue to rise as opinions diverge on a growing number of issues: “Brexit”, US and EU trade negotiations outcomes, while populism is creeping back in some countries.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are overweight equities vs. bonds via US and EM equities as we expect the trade conflict to remain contained. We keep a short duration, and expect the 1.15-1.25 range on the EUR/USD to hold.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

• We maintain our equity exposure to overweight as we expect the underlying favourable background to prevail in spite of the aggressive trade conflict rhetoric.
  • 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. In addition, valuations are not too expensive. “America first” policy is impacting other countries negatively.
  • We are neutral euro zone equities. The region still displays a robust economic expansion but uncertainties have risen recently (new Italian government, threatening trade conflict on automobiles with the US, weaker activity indicators). By ending its QE at the end of the year, the ECB remains accommodative and is in no hurry to hike rates. We prefer small and mid-caps to large ones as they are somewhat sheltered and are more sensitive to domestic demand and less FX sensitive.
  • 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 outcome of the “Brexit” negotiations are unclear and the issue remains a risk.
  • We are underweight Japanese equities. Japanese stocks show a weakening earnings momentum. In addition, the leadership vote of the LDP party by September represents a risk for PM Abe. The Bank of Japan met last week and kept its policy steady as widely anticipated.
  • We are overweight emerging market equities. Emerging equities currently face trade war rhetoric but benefit from strong global growth and attractive relative valuations integrating a higher risk premium than other assets.

• 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.
  • With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to resume their uptrend. In addition to rising producer prices, rising wages, fiscal stimulus and trade tariffs could push inflation higher.
  • The overall improvement in the European economy could also lead EMU yields higher over the medium term. The ECB remains dovish in its QE plans and is opposed to a strong euro. Political uncertainties in Italy could delay the ECB tightening, but not derail the end of QE.
  • We have a neutral view on corporate bonds overall but prefer EU to US in both Investment Grade and High Yield. Spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
  • The emerging market debt faces headwinds with trade war rhetoric and rising Treasury yields 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.