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Chief Investment Officer's team, 11.03.2019
Last week printed the first significantly negative performance of 2019 so far. The magnitude remained moderate, with global equities losing 2% across regions.
Last week however saw the return of growth concerns: China communicated lower than expected growth targets for 2019, and the ECB significantly lowered its outlook for both growth and inflation, prompting the buzzword “Japanification” across trading floors. In addition, job creations in the US were much lower than expected in February.
The negative week shouldn’t come as a surprise: markets were a bit optimistic, quickly correcting their undervaluation as good news on the Fed and trade war caught many investors by surprise. This is why we cut our exposure to DM Equities 10 days ago from overweight to underweight: there was very little remaining upside potential, based on our fundamental framework.
Our stance on the recent news is however simple. 6% growth in China is still very supportive, Europe is actually slowing (and we are underweight on the region across asset classes) and monthly job numbers in the US can reverse very quickly (we would wait for a confirmation and don’t find reasons to be overly concerned in the details). We thus are confident in our current recommended positioning.
Asset classes USD % total return, YTD 2019 and week
No sooner had investors thrown in the towel at the December lows, than risk assets staged one of their strongest rallies ever, to catch up promptly with fundamentals and trade at the upper-end of their foreseeable range. And as promptly, risk assets have now started to reverse course.
At the December lows, when talk of impending recession was rife, the all-clear was signaled by a very strong US payrolls number, while last week payrolls increased by a dismal amount. Overall, this points to the continuation of the global soft patch, with the US economy, while still sporting more than decent growth, converging to the sluggish rest-of-the-world. Talk of recession is of course again resurfacing, as manufacturing business confidence sits in contraction territory both in Europe, Japan and China and trade disputes, although by the day seemingly more likely to be sorted out, remain unresolved.
We have shown some prescience by recently trimming down Developed Market equity positioning to increase cash. We want to be able to take advantage of potential opportunities when valuations and fundamentals again intersect at more appealing levels. We also reconfirm the view that recessionary concerns seem to be overblown to us. Following the January Fed pivot, other central banks are following in the footsteps by turning more dovish, both in the Emerging Markets and in Europe. At the same time, the People’s Bank of China continues to press ahead with more stimulus. Usually, easier credit conditions tend to lead business conditions, hence we would expect growth to pick up in the second half, rather than slide into negative territory. Also, labor markets and the service sector remain quite resilient, providing an offset to poor manufacturing conditions.
To be sure, for the shorter term intermarket relationships and technicals are flashing red. Our EM equity and Forex sentiment models have landed in overbought territory, DM equities are not sitting far from fair values, and the S&P500 has hit the resistance level from where it is being pushed back for the fourth time this year. With macro slipping, good news to an extent priced-in and no obvious positive catalysts in sight, we would think that more weakness lies ahead in the immediate future.
The Japanese yen, currently oversold, looks ripe for a rebound, alongside gold. US treasury yields, although rich, can slip further from here if the flight to quality intensifies. Against this backdrop, high-dividend-yielding equities are expected to outperform, and high-beta stocks, which have year-to-date led gains, to sell off harder.
The Trade-Weighted US dollar, again close to resistance level, is no longer overbought according to our Risk Appetite Indicators, nor is its positioning overly crowded. Hence, against our initial expectations, it can rise to new highs for the year following rising market volatility.
Tactical Asset Allocation: simplified positioning
TAA – relative positioning – moderate profile
TAA – YTD indicative performance
Fixed Income Update
From synchronized growth to synchronized slowdown
It has been an eventful week with flux on sentiment from ECB’s downbeat economic assessment and mixed US payrolls report propping demand for safe-haven assets. US Treasuries were key beneficiary with yields dropping 9bps to back to 2.62%. The dovish tone by policymakers in the APAC region on their underlying economic front also triggered a rally, particularly on the Australian and New Zealand bonds pushing yields 13-16 bps lower to 2.02% and 2.05%. The ECB revised down growth and inflation forecasts, stating that the Eurozone growth momentum has weakened substantially. Authorities expect interest rates to remain unchanged “at least through the end of 2019”. Bond yields across the Eurozone dropped between 10bps to 15bps in absolute terms while some of the European HY credit based crossover indices (Markit iTraxx) widened in response to investor sentiment.
On the non-farm payrolls, the US economy added just 20,000 jobs in February, way less than expected. The unemployment rate dropped to 3.8% from 4.0%, indicating the contrasting strength of the household survey, while average hourly earnings rose a better-than-expected 3.4% from last year. US yield curve (30Y minus 5Y) steepened to 58bps for the first time in a year. The focus would turn this week to inflation data prints on the consumer prices, followed by producer prices, and the survey results on inflation expectations. These data are critical to assessing the shape of the yield curve and further calibrate our long-term positioning.
EM: How much can China stimulate? Can India’s curtail on bond purchase sustain?
The authorities have adopted prudent fiscal stimulus and embarked on monetary policy tools to spur credit and growth this year. The Peoples Bank of China Governor Yi Gang has emphasized that China still has some room to lower the reserve requirement ratio (RRR) and that monetary policy in 2019 should "reflect counter-cyclical adjustments" and strike a balance between tightening and easing while considering external factors. The current RRR for larger and smaller banks stand at 13.5% & 11.5% from their peak levels of 21.5% & 19.5% witnessed back in 2011.
The Reserve Bank of India is shortening its support for the bond market, investors’ hopes of relief are reeling under two straight months of declines. According to Bloomberg News, the Reserve Bank of India may buy INR 1.7tn, which is about USD 24bn of debt in the year starting on April 1st as compared to INR 3tn during the fiscal year. The increase in government spending should relax the burden on RBI’s purchases while policymakers keep a close watch on liquidity conditions. With INR stability, benign inflation (below RBI target) we expect bond yields to be well supported ahead of the elections in May.
Emirates NBD has hired banks to arrange fixed income investor meetings before a potential issue of US dollar-denominated bonds. The planned deal would be of benchmark size, Additional Tier 1 perpetual bond not callable for six years.
Fixed Income key convictions
Fixed Income valuations
High-Yield credit protection sought by investors
Most major equity markets last week gave back some of their 2019 gains, on growth concerns (weaker than expected Chinese export data, reduction in manufacturing orders in Germany, a weak US jobs report, ECB Outlook…). Wages ticking higher, with hourly earnings by 3.4% YoY could be seen as pressuring corporate margins. A trade deal is now at least partially priced but would help sentiment. However, China turning into a free market and giving US companies carte blanche, is still some time away. China stimulus to boost the economy was however welcomed, as all eyes are on maintaining the magic 6% GDP growth number which is required with the country’s debt. Q1 corporate earnings are likely the most important fundamental catalyst in the coming weeks. Expectations are low which could help.
The S&P 500 finished the week 2.1% lower with defensive sectors leading over cyclicals. MSCI Emerging Markets printed a negative -2.2% (total return, USD) last week. We still have some upside potential there to our fair values, which is why the segment has our preference, especially Asia. China valuations remain attractive in absolute and relative to some other emerging markets. India should settle down as elections are approaching, and as economic growth and corporate profitability are still fine. Valuations have always been at a premium but the long-term prospects are supportive.
The UAE’s high dividend paying companies in the real estate sector look very attractive as they provide reassurance that dividend payouts are on schedule and at levels equal to previous years. The banks have high payouts too, however most have already rallied as dividends have already been paid out.
Equity recommended regional positioning
Major indices performance (TR, US$) and 2019PE
Global sector performance (TR, US$) and 2019PE
Written By:Maurice Gravier Chief Investment Officer, Maurice G@EmiratesNBD.com
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