Coffee Break 1/13/2020

LAST WEEK IN A NUTSHELL

  • The US payroll employment rose by 145K, while average hourly earnings slowed to 2.9% YoY. The labour data is consistent with a gradual moderation as the economic expansion cycle continues.
  • Global composite PMIs edged slightly higher thanks to the expanding service sector. Meanwhile, manufacturing PMIs managed to remain above the 50pt threshold for the second month in a row.
  • Tensions between Iran and the US de-escalated, impacting oil prices, which spiked before regaining their previous levels.
  • UK Members of Parliament voted in favour of the Withdrawal Agreement Bill, which now moves on to the upper House of Lords, meaning a Brexit is likely to happen on January 31.

 

WHAT’S NEXT?

  • US President Donald Trump and China’s Vice Premier Liu He will sign the Phase One of a trade deal. Financial markets have already discounted some of the positive news since October.
  • Trade uncertainty is evolving into US presidential election uncertainty. More specifically, the last Democratic primary debate before primary voting kicks off early February.
  • China is due to publish its Q4 GDP growth rate, shedding some light on its ability to mitigate the impact of the trade war. The market expects 6% YoY.
  • The US Q4 2019 earnings season is about to start with major Wall Street banks reporting.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our 2020 scenario is slightly constructive as we expect a bottoming out of the economy but also 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 is about to be signed. The negotiations on Phase Two shall start immediately but Donald Trump has already hinted he may wait until November. A trade deal with 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. formal impeachment process and election run-up are likely to dominate.
    • 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 have gone up and the 2020s start on a positive note. We have left our equities weight drift and are now in a neutral-to-slight overweight range. We are slightly overweight euro zone and have a neutral positioning on all the other major regions. We stay cautious about exposure to government rates in developed countries. We diversify out of low-yielding government bonds via exposure to credit and Emerging markets debt. In terms of currencies, we see less support to USD appreciation as growth differential with others regions should decrease. We keep an exposure to JPY and gold which play their safe haven roles.

 

CROSS ASSET STRATEGY

  • We are neutral equities
    • We are neutral US equities. Equities did perform well since our entry points during the summer but valuation is demanding relative to other regions and its historical average.
    • We are neutral Emerging markets equities. The region has underperformed in 2019, pummelled by the trade war. Our long-term strategic view is positive. The region could offer some upside. A dovish US Fed is a tailwind as the USD weakens somewhat. We are looking for an entry point on the basis of improving fundamentals.
    • We are overweight euro zone equities. The latest macro data show signs of bottoming out in the economy. A window of opportunity on fiscal accommodation is open with longer ECB visibility.
    • We are neutral UK. With the election of Boris Johnson as Prime Minister, a not-as-bad-as-feared resolution of Brexit is within weeks. Investors’ positioning is low. Valuation and the competitive advantage of a weak currency make the country attractive.
    • We stay neutral Japanese equities. Absence of conviction, in spite of Prime minister Shinzo Abe’s fiscal stimulus package announcement.
  • 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 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, which plays its role of safe haven.