Coffee Break 1/20/2020

LAST WEEK IN A NUTSHELL

  • The trade agreement phase 1 between China and the US calls for an increase in US manufacturing, energy and agriculture exports. Trade tensions are easing but the bulk of US tariffs on Chinese goods remains.
  • Solid data out of the Chinese economy (e.g. December industrial output and retail sales, GDP growth of 6.1% in 2019) provide a positive start to the Chinese New Year.
  • In line with expectations, German GDP grew 0.6% in 2019, the weakest rate since 2013, as trade disputes, Brexit uncertainty and difficulties in the automotive sector had an impact.
  • Q4 2019 earnings season had a solid kick off with major US banks beating expectations.

 

WHAT’S NEXT?

  • Global flash PMIs should confirm the bottoming process in the global economy.
  • In Japan, Canada and the Euro Zone, central banks are due to announce interest rate decisions. Markets expect rates to remain unchanged.
  • Netflix, Intel, IBM, Johnson & Johnson and Procter & Gamble are among the bellwethers to publish their Q4 earnings reports.
  • US President Trump will stand trial in the US Senate starting on 21 January. He is accused of abuse of power and obstruction of Congress. His majority in the Senate implies that he will likely stay in office.
  • The end of the week will see the New Year’s Day in the Lunar Calendar (Year of the Rat) and local elections in Italy (Emilia Romagna and Calabria).

INVESTMENT CONVICTIONS

  • Core scenario
    • Our 2020 scenario is constructive as we expect a bottoming out of the economy but we also expect lower global expected returns than in 2019.
    • One of 2020’s market drivers will be the US elections on 3 November. We expect global trade uncertainty to transition to a US-focused election uncertainty.
    • Central banks have reached massive accommodation policies. In the US, the Fed is buying Treasury bills to add liquidity into the system but not calling it Quantitative Easing. The accommodative stance is a medium-term tailwind for the global growth/inflation mix and upcoming data should reflect this.
    • In Emerging economies, Chinese authorities are mitigating the impact of the trade war and slowing global growth by using “appropriate” currency, monetary and fiscal tools. China’s central bank cut the banks’ Required Reserved Ratios for the 8th time in 2 years at the beginning of the month.
  • Market views
    • Significant fall in political risks: trade deal Phase One was finally signed. The negotiations on Phase Two shall start immediately but Donald Trump has already hinted he may wait until November. A trade deal between the UK and the EU is the next hurdle in the Brexit saga.
    • There is increasing talk of a EU Banking union and ambitious Climate roadmap. Cyclical and value stocks could benefit from better prospects here.
    • The relative equity valuation vs. bonds remains attractive.
  • Risks
    • The US-China trade conflict. Relations between US President Trump and China will likely always be on edge.
    • Domestic political issues in the US, e.g. Donald Trump will stand trial for abuse of power and obstruction of Congress. Bernie Sanders, Elizabeth Warren and Amy Klobuchar, US senators, but also US candidates to the presidency will have to scale down campaigning to attend the trial to the benefit of Joe Biden and Pete Buttigieg.
    • Geopolitical issues (e.g. Iran, Hong Kong) are still part of unresolved current affairs. These could trigger volatility shocks and attractive entry points.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

Financial markets are off to a good start. The tentative signs of a bottoming out of the economic cycle are turning into a reality. We increased our exposure to Emerging markets equities and are now overweight. We stay overweight euro zone equities as well. Our positioning is neutral Japanese, US and UK equities. We stay cautious about exposure to government rates in developed countries. We diversify out of low-yielding government bonds via exposure to Emerging markets debt as well as Emerging markets and euro zone issued credit. We keep an exposure to JPY and gold which play their safe haven roles.

 

CROSS ASSET STRATEGY

  • We are overweight equities
    • We have become overweight Emerging markets equities. The latest macro data point towards a bottoming out of the economic cycle and budding recovery. Trade tensions have eased. Valuations are attractive relative to the other regions.
    • We are overweight euro zone equities. The latest macro data also show signs of bottoming out in the economy. A window of opportunity on fiscal accommodation is open with longer ECB visibility.
    • We are neutral US equities. US equities did perform well since our entry points during the summer but valuation is demanding relative to other regions and its historical average whereas the country no longer deserves the same safety premium as in 2019.
    • We are neutral UK. The Brexit’s deadline is approaching. The Withdrawal Agreement is now under the scrutiny of the House of Lords. The odds are increasingly in favour of a rate cut by the Bank of England. Valuation and the competitive advantage of a weak currency make the country attractive. Investors’ positioning is low.
    • We stay neutral Japanese equities. Absence of conviction, in spite of Prime minister Shinzo Abe’s fiscal stimulus package announcement. The package is meant to mitigate the impact of the VAT hike, which has dampened consumption and confidence. At least, the labor market stays supportive.
  • We are underweight bonds, keeping a short duration and diversify out of government bonds.
    • We expect rates and bond yields, to creep up very gradually but stay low.
    • Christine Lagarde has begun her tenure as President of the European Central Bank. She faces two major challenges: healing the rift between the policy makers of the governing council and national governments still being reluctant to take over the baton with fiscal stimulus policies.
    • We diversify out of low-yielding government bonds, and our preference goes to Emerging debt, including EM-issued corporate bonds.
    • We also have an exposure to gold, which plays its role of safe haven.