Coffee Break 11/12/2019

LAST WEEK IN A NUTSHELL

  • Heavy trade news flow dominated markets as tariff increases announced in August may be suspended, shipments of agriculture products may resume and “some” tariffs may be rolled back.
  • Global manufacturing and services PMIs came out better than expected, albeit at weak levels. The global output cycle may be bottoming during Q4, in particular if no new tariffs are to be imposed.
  • The EU Commission cut its growth forecast for the 19 countries within the euro zone to 1.1%in 2019 (from 1.2%) and to 1.2% in 2020 and 2021 from 1.4%.
  • The UK Parliament was suspended ahead of the 12 December general election. The Tory party is leading in the polls and the likelihood of a No Deal crash-out looks remote.
  • In Spain, the general election occurred under the cloud of Catalan crisis and did not resolve political uncertainty. The PSOE of Prime minister Sanchez won the most seats but has to form a coalition.

 

WHAT’S NEXT?

  • More news on the trade front are expected as substantive issues must be resolved before Presidents Trump and Xi could sign a Phase 1 deal (in December). Phase 2 is not yet on the agenda. 
  • A key highlight will be Fed Chair Powell’s testimony to Congress’ Joint Economic Committee and his appearance before the House Budget Committee.
  • On the data front, the US and EU Industrial Production and CPI are expected. In addition, the German Q3 GDP release could show the economy falling into a technical recession.
  • Central banks of Mexico and New Zealand will announce their latest monetary policy decisions.
  • In Washington, the first public hearings as part of the impeachment inquiry will be taking place. Meanwhile, US President Trump will meet President Erdogan of Turkey.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario is moderately constructive in the long-term. We took profit on our equity allocation via euro zone and US equities, and are tactically overweight equities vs bonds via derivatives.
    • The main uncertainties for financial markets remain the trade conflict and the slowdown in manufacturing. Rolling back existing tariffs would clearly be good news for global trade perspectives and accelerate the bottoming out of the output cycle.
    • Central banks have reached massive accommodation policies but the rate-cut cycle is coming to an end. The accommodative stance is becoming a medium-term tailwind for the global growth/inflation mix.
    • In Emerging economies, Chinese authorities are mitigating the impact of the trade war and slowing global growth by using currency, monetary and fiscal tools.
  • Market views
    • Decrease of political risks: increasing probability of trade deal between the US and China, low risk of a hard Brexit and shift towards a pro-Euro government in Italy.
    • Current strong momentum with a rotation in favour of value/cyclicals/commodities and out of crowded momentum and low vol stocks. There is a possibility of a continuation of the rally towards year-end on the basis of a kind of “bullish” capitulation rally on improving hopes.
    • On the other hand, fundamentals will not suddenly become better and political execution risks have not disappeared as neither a Brexit deal nor a Phase 1 trade deal are signed yet.
    • The relative equity valuation vs. bonds remains attractive.
  • Risks
    • The US-China trade conflict. The United States and China are working on drafting an agreement, but China doubts if a long-term trade deal is possible with President Trump.
    • Domestic political issues in the US (e.g. formal impeachment process and election run-up) are likely to dominate. These could trigger growth shocks and attractive entry points.
    • Geopolitical issues (e.g. Iran, Hong Kong, Chile) are still part of unresolved current affairs. Their outcome could still tip the scales from an expected soft landing towards a hard landing.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We continue to take profit on our equity allocation via euro zone and US equities. We have increased our equity exposure in two steps, early-August and early-September and have now a neutral positioning excluding derivatives. We have added options to gain exposure if the year end-rally were to continue. Overall, we still prefer equities over bonds and have an overweight exposure on US and EMU equities. We are neutral Emerging Markets, Japanese and Europe ex-EMU equities. We remain cautious about exposure to government rates in developed countries and diversify out of low-yielding government bonds via exposure to credit, preferably by European issuers and Emerging markets debt. In terms of currencies, we keep a long JPY and an exposure to gold as hedges.

 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are overweight US equities via derivatives
    • We are overweight US equities. As equities did perform well since our entry points during the summer in spite of the economic slowdown, we have neutralized our exposure. However, the region remains a relatively safe choice and as a market melt-up cannot be excluded on rolling back existing tariffs, we added a derivatives exposure.
    • We are neutral Emerging markets equities. The region has underperformed year-to-date and could offer some upside. A dovish US Fed is a tailwind as the USD weakens somewhat.
    • We have taken profit on euro zone equities. We took profit and our positioning is now overweight via derivatives. The latest macro data show signs of resilience. A window of opportunity on fiscal accommodation is staying open with more ECB visibility.
    • We have become neutral Europe ex-EMU equities. We approach a resolution of Brexit but political noise ahead of the December election obscures the plausible outcomes. Valuation is attractive and positioning is low. Many non-European investors have shun Europe so far but could look twice as the balance of risks improves. 
    • We stay neutral Japanese equities. Absence of conviction, as a catalyst is missing. It has to be seen if household consumption can resist the increase of the VAT rate from 8 to 10% that took place early-October.
  • We are underweight bonds, keeping a short duration and diversify out of government bonds.
    • We expect rates and bond yields, to stay low.
    • The ECB has a new president since 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.
    • We diversify out of low-yielding government bonds, and our preference goes to Emerging debt and EUR-issued corporate bonds.
    • Emerging market debt has an attractive carry and the dovish stance of the Fed represents a tailwind. Trade uncertainty and idiosyncratic risks in Turkey and Argentina are headwinds.
    • We also have an exposure to gold in order to increase the portfolio hedging.