Coffee Break 4/8/2019

INVESTMENT CONVICTIONS

• Core scenario
  • We have an unchanged, moderately constructive, long-term view, but acknowledge the sharp market rally since the start of the year, which took place in a slowing growth environment.
  • The political risk premium has decreased and central banks have become more dovish.
  • Macro data is improving in China, weakening in Europe and stabilising in the US but economic surprises are still negative. We are waiting for an actual improvement of economic data or a more tangible, positive outcome on the trade war front. Q1 earnings will be worth watching to gauge the extent of the slowdown.
  • In Emerging economies, activity continues to soften and the measures taken by Chinese authorities to support the economy should result in a GDP growth of around 6% in 2019.
  • In the US, we expect growth to be at a slower pace than in 2018. The Fed will stay “patient” to ensure a soft landing.
  • In Europe, the economic cycle remains less dynamic and continues to disappoint (on average over 2019, GDP growth is expected to be at 1.2%). Looser fiscal policies should help the region steer clear from a recession.
• Market views
  • Equity fund flows have been negative in recent weeks despite positive performance of markets.
  • The Corporate sector itself remains a large buying source via buybacks, but the “black-out“ period during the Q1 earnings reporting has started.
  • Equity valuation is now at “fair” levels and spread compression also reveal that risk/reward has become less attractive than at the start of the year.
  • European and Japanese equity valuations are below their historical average, whereas US and Emerging markets are back to long-term averages.
  • A downshift after the recent advance and / or better macro data would present an opportunity to put money back to work and increase the risk budget again.
• Risks
  • Geopolitical issues are still part of unresolved current affairs. Their outcome could still tip the scales from an expected soft landing towards a hard landing.
  • International trade relations remain a source of uncertainty. They could further weigh on output growth and trigger spikes in volatility.
  • Persisting slowdown in Europe and Emerging markets in spite of easing measures.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are neutral equities. We took some profits in recent weeks as our overweight stance in previous months enabled us to benefit from the recent market recovery. From a regional perspective, all regions have been neutralised, with the nuance of a preference for EMU equities over Europe ex-EMU due to the unresolved “Brexit” issues. In the bond part, we keep a short duration and diversify out of low-yielding government bonds.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

• We are neutral equities
  • We are neutral US equities. We expect slower, but positive, earnings growth in 2019. Equity valuations have recovered as stock prices rose and earnings expectations were cut. A divided Congress and forthcoming budget deadlines represent a risk.
  • We are overweight euro zone equities. Macroeconomic figures are weakening but domestic demand remains solid, as shown by the Services PMI. Most foreign investors have capitulated and valuations are cheap despite the rebound.
  • 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.
  • We are neutral Japanese equities. Absence of conviction, as there is no catalyst.
  • We are neutral Emerging markets equities. The Fed pause is a tailwind for the region but Chinese growth is the key driver: monetary support and fiscal easing should ensure a growth target above 6%. Trade conflict is not resolved, even though the risk of new tariff hikes has decreased.
• We are underweight bonds and keep a short duration.
  • We expect rates and bond yields, especially German and US 10Y yields, to rise gradually.
  • A slower but still expanding European economy could lead EMU yields higher over the medium term. There is an unfavourable carry on core and peripheral European bonds. The ECB is accommodative and will add a new TLTRO.
  • Emerging market debt has an attractive carry but growth fears due to trade war rhetoric represent potential key risks.
  • We diversify out of low-yielding government bonds, and our preference goes to US High yield.