Coffee Break 11/4/2019

LAST WEEK IN A NUTSHELL

  • The Fed cut its funds rate by 25bps for the third consecutive time since July. Going forward, the FOMC may be more reactive to risks leading to weaker growth than those leading to higher inflation.
  • Stronger-than-expected US labour data and positive news flow regarding tariffs pushed Wall Street towards a record high at the end of the week.
  • In Japan, the BoJ kept its interest rate unchanged but adopted an easing bias.
  • European leaders agreed to give the UK a new extension until 31 January 2020 for leaving the EU. Besides, the House of Commons voted for an early general election on 12 December 2019.
  • In the US, the House of Representatives set Donald Trump on a path toward becoming the third president in history to be impeached.

 

WHAT’S NEXT?

  • On the data front, we will learn if the Euro area manufacturing and service PMIs confirm the resilience shown in the better-than-expected Q3 GDP growth at the start of the fourth quarter. 
  • The Bank of England will convene to set its interest rates and publish its Inflation Report. The next meeting is set to take place one week after the snap election on 12 December.
  • The Fed will start expanding its balance sheet again by purchasing of Treasury bills, starting this week at an initial pace of $60 billion per month.
  • The Spanish general election will be held on Sunday. The current prime minister’s PSOE and the conservative PP are the two leaders in the polls but the winner will likely have to form a coalition.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario is moderately constructive in the long-term. We took some profit on our equity allocation via EMU and US equities and are currently tactically overweight equities vs bonds.
    • The main uncertainties for financial markets remain the trade conflict and the slowdown in manufacturing. Developed countries should be able to absorb the new round of tensions though.
    • Central banks are coming to the rescue in the US, Europe and Emerging markets. Their accommodative stance is becoming a medium-term tailwind for a 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
    • After the shift towards a pro-Euro government in Italy, progress in the Brexit resolution means that political risk in the region has fallen. Two major potential growth shocks have become less immediate.
    • Germany and the Netherlands are timidly moving towards fiscal stimulus to take over the baton from the ECB and launch climate-friendly and growth-enhancing projects.
    • Global macro data appears soft, facing on-and-off trade war rhetoric.
    • The relative equity valuation vs. bonds remains attractive, especially with the recent drop in bond yields, and positioning appears light.
  • Risks
    • Slowdown fears. In the US, economic data has shifted from negative to more mixed but political risk has increased. A formal impeachment process against President Trump looks inevitable.
    • 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.
    • 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 recently took profit on our equity allocation via EMU and US equities. We have increased our exposure to Europe ex-EMU equities to neutral, as we still prefer equities over bonds. We are neutral Emerging markets and Japanese 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 hard currency. In terms of currencies, we keep a long JPY. We also keep an exposure to gold.

 

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We are overweight 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 relatively safer choice. Economic growth is however slowing down. The Q3 earnings season shows that the US is experiencing stronger sales growth.
    • 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 some profit on euro zone equities. We took some profit and our positioning is barely overweight. The latest macro data show signs of resilience. Fiscal stimulus in Europe is becoming a topic. A window of opportunity 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 had 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.
    • 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 in hard currency 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.