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Chief Investment Officer's team, 08.04.2019
Investors must have been pleased by the string of positive economic surprises across countries last week, from retail sales and industrial output in Europe, to business confidence in EM Asia and the labor market report in the United States. It is still a matter of green shoots, first glimpses of improvements which will have to persist for stocks to cling on to their current levels and eventually make new highs for the year.
In this respect the FOMC March minutes to be released this week will play a pivotal role. Market participants, following the Fed’s dovish U-turn from restrictive to accommodative in a couple of months, will be eager to know what caused the dramatic shift. The recent inversion of the US yield curve, alongside the circa 60% market-implied probability of a rate cut expected by the end of this year, point to growing concerns about the outlook.
Treasury-inflation-protected securities, or TIPS, are making new historical highs, anticipating that the Fed will be on hold for long, to avoid nipping the fragile growth in the bud. More exotic markets, like cryptocurrencies, are celebrating as well, coming back to life with +20% in a week. They must be sensing as well that central bank money will keep on flowing, boosting the case for alternative currencies versus fiat money. Developed economies in need of perennial monetary support may be throwing the seeds for glorious days ahead for the cryptocurrency markets.
Asset classes USD % total return, YTD 2019 and week
Global growth is being moderately upgraded and is rebounding from the slump it suffered in the last quarter of 2018. It seems that the economy is starting to stabilize, following the Fed pivot and the policy measures in China. The International Monetary Fund is soon going to issue the spring update to its global outlook and Christine Lagarde, IMF Managing Director, although expressing concerns about the solidity of the business cycle, said that “the bottom for 2019 growth is either now or soon”. Investors looking for further signs of improvement will have to watch out for manufacturing data, since the industrial sector remains exceptionally weak outside of the US.
With the aging of the cycle, more and more stimulus money needs to be spent to keep the system going. And commodities, which usually perform very late in the recovery and like plentiful liquidity, have year-to-date responded as per textbook, being the best performing asset class. Commodity benchmarks have been propelled higher by Brent crude (+30.8%), and base metals, in particular nickel (22.3%) and iron ore (+26.3%). Gold (+0.8%) is lagging badly, in spite of central banks coming to the rescue. Investors must be expecting that policy support will spur growth, hence the divergence between industrial commodities and gold seems set to continue.
Buying of gold by Central banks could change the picture, however, looking at least 12 months out. China has expanded its gold reserves for the fourth straight month and governments worldwide in 2018 bought the second-highest amount of gold on record. Should inflows continue at this rate, gold could break above $1,400 and settle at $1,450, according to some estimates.
End of cycle or not, commodities won’t be on fire anytime soon. US core inflation is expected to cling to a tepid 2% annualized rate in 2019 and clear the 2% hurdle by a modest margin only by 2020. In Japan deflationary pressures remain a concern, while there is more and more talk of the Japanification of Europe, where stagnation and persistently low yields are the ECB’s nightmare.
Continued reflationary efforts on the other hand work well for equity markets, the embodiment of asset inflation against a backdrop of ‘missing-flation’ everywhere else. Trend growth and lack of price pressures are enough for stocks to be rerated and aiming at new highs for the year. With the Fed expected to remain on hold in the next 12 months and the economy possibly about to bottom out, the outlook for the asset class seems more promising. Yet, in the short term, investors will have to put up with more volatility. Developed market equities are overall trading at about fair value and money has been flocking to emerging stocks, no longer under-owned. Unless fundamentals improve substantially, buying on weakness rather than chasing market momentum would be the better option.
Tactical Asset Allocation: simplified positioning
TAA – relative positioning – moderate profile
TAA – YTD indicative performance
Fixed Income Update
Investor’s euphoria drives market performance: Risk-on mood drove risky asset prices higher on the back of a strong U.S. labor report that eased concerns about an economic slowdown, while optimism that a trade deal between the US and China was drawing closer also lifted sentiment. US benchmark yields are holding stronger at 2.49%, while yields on the German bunds and UK Gilts improved to 0.002% and 1.11% respectively. On the US yield curve front, the thirty years minus the five years continued its flattening trend to 59bp, while the difference between the ten-years minus the three-month bills steepened from sub-zero to positive 6bp. President Trump once again expressed dissatisfaction with the current course of monetary policy. “I think they should drop rates and get rid of quantitative tightening,” Trump told reporters, referring to the Fed’s policy of selling securities to unwind its balance sheet, a stimulus put in place during the financial crisis. “You would see a rocket ship. Despite that we’re doing very well.”
Emerging markets bonds hold onto gains: Norway’s $1 trillion sovereign wealth fund (SWF) is said to cut government and corporate bonds from emerging markets in an overhaul of its $310 billion fixed-income holdings. The decision announced on Friday by the Finance Ministry highlighted that the fund would cut its exposure on bonds from ten emerging market countries in its index, including Mexico, South Korea, Russia and Poland, and will also be limited in its investments in emerging markets outside the index, such as Brazil and Indonesia. However, the SWF will still have some leeway to invest up to 5% of its bond portfolio in emerging markets (about $15 billion). It currently owns about $28 billion in such investments, with the biggest holdings in South Korean and Mexican debt.
RBI policy responses in line with expectations: The Reserve Bank of India cut interest rates by 25bp to 6%. The RBI targets inflation at 4% lowered its forecast for consumer price growth and said underlying pressures could ease given the recent slowdown. The RBI also downgraded its growth projections to 7.2% from 7.4%. “With the inflation outlook remaining benign, the RBI will address the challenges to the sustained growth of the Indian economy, while ensuring price stability on an enduring basis,” Governor Shaktikanta Das told reporters. He added that there is the need “to strengthen domestic growth impulses by spurring private investment, which has remained sluggish.”
Fixed Income key convictions
Fixed Income valuations
Chart of the week: US Yield Curve
Year to date, the S&P 500 has risen 15%, and the Nasdaq Composite 20%. Friday capped another positive week of trading with a jobs report, which largely met expectations and an upbeat tone by President Trump on the U.S.-China trade talks. Most of the good news now seems to be factored in, hence, this pace of gains cannot continue. The MSCI World ACWI is up 14.5% YTD. US cyclical sectors (Tech +21.5%; Industrials +16.4%) have received a boost from the Fed’s decision to end rate hikes in 2019. Our US earnings growth target for 2019 remains unchanged at 5% and price to earnings multiple at 16.5X for 2019 year end. The S&P 500 +2.1 % last week, at 2892, is above our fair value of 2825. Select pockets of outperformance will be driven by Q1 earnings but we wonder what could drive the market higher? The China US trade deal boosts hopes of US companies giving upward guidance. The Energy sector is one that could receive a positive rerating on cost synergies and high earnings growth and as it is lagging the rise in oil prices. In Europe consumer staples remains amongst the top-performing sectors this year. The tone in European industrials however, remains cautious, with continued issues in the auto sector. European stock markets shook off weaker-than-expected German industrial data, with both the STOXX 600 and FTSE 100 ending the week 2.5% higher.
EM equities have underperformed DM markets this year, in spite of a robust performance from Chinese and Indian markets. We are close to an inflection point in markets as the performance gap between the U.S. and the rest of the world is bound to narrow. EM equities are looking for direction, which could come from dollar weakness or a turnaround in the Chinese economy. China’s manufacturing sector resumed growth in March, following three consecutive months of contraction. Employment in the sector also grew and new export orders moved back into expansion territory. These are hopeful signs that the Chinese government’s fiscal stimulus is becoming effective. India is progressing towards becoming one of the most data-rich countries in the world. Individual data is captured through its JAM trinity (Jan Dhan “bank” accounts, Aadhaar identification cards and smart phone user data). Corporate and small sector data capture has been enhanced with the goods and services tax. This, has the power to become a primary source of wealth generation as it creates new modes of business activity,
For stock investors on the lookout for income, there is nothing more attractive than growing dividends. GCC market performance too, has been strongly driven by companies with high dividend yields as this is seen as a sign of healthy cash flows. Whilst banks, real estate and petrochemical companies have so far been the leaders on yields, Adnoc Distribution’s announcement of higher dividends catapults it to the top position. The broadening of the market in the UAE, which has limited consumer companies, is important to provide depth and volume.
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, MauriceG@EmiratesNBD.com
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