Coffee Break 14/01/2019

LAST WEEK IN A NUTSHELL

  • Stock markets and risky assets advanced further last week as US-China trade talks in Beijing were unexpectedly extended to a 3rd day. The Chinese Vice Premier will follow up with a meeting in Washington at the end of this month.
  • US and EU Trade Representatives met in Washington. Considered as a follow-up of the July meeting between Juncker and Trump, the parties are committed to avoid a trade war.
  • The last FOMC minutes showed that some members only reluctantly agreed to the last interest rate hike given the lack of inflationary pressures, confirming potential flexibility going forward.
  • The US December CPI was released at 1.9%, in line with expectations.

WHAT’S NEXT?

  • The UK parliament will vote on the withdrawal agreement negotiated between Theresa May and the European Commission.
  • Corporate earnings season will start in the US with the potential to partially restore or shake investor confidence in the current context of slowing global growth.
  • The partial US government shutdown will cause a delay in the publications of economic data: an unfortunate timing for the US central bank which has highlighted its data addiction.
  • In the euro zone, the November industrial production report is expected as well as Germany’s 2018 GDP reading. A small contraction of the GDP growth in Q4 cannot be ruled out after last week’s industrial production reports.

INVESTMENT CONVICTIONS

  • Core scenario
    • In the US, we expect growth to continue albeit at the slower pace of 2.4%. The fiscal stimulus is fading and there are trade policy uncertainties but business activity is dynamic. The Fed will stay pragmatic and stick to economic data to ensure a soft landing.
    • Outside the US, the economic cycle is less dynamic. Policy risks remain. The euro zone economy is expected to growth by 1.4%. Fiscal policies will loosen in several countries and should help the region steer clear from an abrupt slowdown.
    • The US-China relationship is under strain although both countries have agreed to a short-term truce. China is further easing to mitigate the impacts of the growth slowdown but at the cost of increasing public debt.
    • The decline in the price of oil should pause the gradual rise in inflation in the US and in the euro zone.
  • Market views
    • The US economy remains decent, and does not reveal any strong economic imbalances.
    • 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: higher tariffs and protectionism are slowing down global economies, deteriorate international relations and ultimately corporate margins. China and the US have agreed on a short-term truce in this trade war. As the US wants to stay ahead of the game, especially in the Tech sector, the trade war is unlikely to evaporate any time soon.
    • Emerging markets slowdown: Emerging markets are among the most vulnerable regions when global growth slows down. Any fiscal or monetary measures taken to mitigate the impact of the trade war will weigh on their budget.
    • EU political risks: Political pitfalls could fuel euro scepticism further as opinions diverge on a growing number of issues, i.e. “Brexit”, Italian finances and social unrest in France and with EU holding Parliament elections this May. The trade war initiated by the US has only impacted the euro zone indirectly.
    • Domestic US politics: a divided Congress, not to mention the current government shutdown, the forthcoming budget-related deadlines and dimming global growth prospects will weigh on US exports while the Fed normalisation is already affecting residential investments.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We remain moderately overweight equities. From a regional perspective, we remain overweight US and euro zone equities. We continue to hold a negative view on the UK, due to the unresolved “Brexit” issues, while being neutral emerging markets and Japan. In the bond part, we keep a short duration. Our fixed income preference goes to Emerging markets.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

  • We have kept our equity exposure overweight and still have a constructive medium-term view. 
    • We are overweight US equities. Economic momentum faded but remains positive. We expect slower, but rising, earnings growth in 2019. Fed hiking is a headwind but the slowdown underway could moderate the Fed’s hawkishness as it is “data dependent”.
    • We remain overweight euro zone equities. Slow growth and political uncertainties are increasingly weighing on the stock market. Conversely, any conflict resolution is a potential trigger for a strong rebound.
    • 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.
    • We are neutral Japanese equities. Japanese stocks reflect less domestic risk as “Abenomics” will continue for three more years. The cyclical economic momentum is becoming less favourable.
    • We are tactically neutral emerging markets equities. While we believe in the growth of Emerging markets, they are badly hit by the trade war, the developed markets’ slowing growth and the USD strength. 
  • We are underweight bonds and keep a short duration
    • We expect rates and bond yields to rise gradually after the strong fall in recent weeks. In addition to rising producer prices, rising wages and trade tariffs could push inflation higher.
    • The expanding European economy could also lead EMU yields higher over the medium term. We expect interest rates to gradually increase. We remain underweight Italian bonds. The ECB remains accommodative, but has ended its QE in December.
    • The interest-rate differential between the US and Europe will remain high but should gradually reduce, on the long part of the curve, to begin with.
    • We have a cautious medium term view on corporate bonds overall but we see tactical opportunities in this asset class.
    • 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.