Coffee Break 10.09.2018

INVESTMENT CONVICTIONS

• Core scenario
  • With above-potential GDP growth this year and the next, a red-hot labour market, US equities at all-time high and a fiscal stimulus, there is little reason for the Fed to change its tightening path.
  • The economic news flow is picking up in the euro zone and the outlook is also positive, around 2% GDP growth.
  • Trade war risks remain high and are hitting the global expansion via lower confidence.
  • Gradual rise in inflation in the US and in the euro zone, but no inflation fear.
• Market views
  • Solid 2018 earnings and buybacks are supporting equities.
  • The tax reform, buybacks and still attractive valuations vs. bonds have pushed US equities to all-time highs. This is a good opportunity to take some profit and reduce our US overweight.
  • We use the proceeds to increase our exposure to emerging and euro zone equities.
  • The drivers of the USD strength appear now well integrated.
• 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”, Italian budget, US and EU trade negotiations outcomes, and increasing populist and anti-European Union rhetoric in Sweden and Italy.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are overweight equities vs. bonds via a regional split between US, EM and euro zone equities as we expect the trade conflict to remain contained. We keep a short duration, and expect the EUR/USD to find support close to the current levels. We see a stabilisation and possible short-term reversal in the US dollar.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

• We maintain our equity exposure to overweight as we expect the underlying favourable economic 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, but took some profits. 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 impacting other countries negatively are now priced in.
  • We are tactically overweight euro zone equities. The region displays a robust economic expansion and economic momentum appear to have picked-up somewhat while the ECB remains accommodative and is in no hurry to hike rates. The arguably long list of uncertainties appear reasonably priced now (Italian budget, threatening trade conflict on automobiles with the US, “Brexit”, Turkish crisis). 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 in September represents a risk for PM Abe. At its last meeting, the Bank of Japan signalled its readiness to leave yields drift higher, allowing a wider fluctuation range of the 10Y yield around zero percent.
  • We are overweight emerging markets equities. Global growth remains strong for the foreseeable future and emerging markets assets as a whole have already build a risk premium for a tightening US monetary policy, a stronger USD and trade war risks. Contagion from the crisis in Turkey, Argentina and Venezuela should remain contained. Chinese authorities are rolling out policy easing measures.

• 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, but some EM central banks have been forced to do so to mitigate currency stress.
  • 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 the 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 US rates but we believe spreads can continue to tighten from current levels. The carry is among the highest in the fixed income universe. It represents an attractive diversification vs other asset classes.