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Chief Investment Officer's team, 19.02.2019
It was another positive week overall, on the back of a probable extension of the US-China talks on trade. On the macro front however, most readings on monthly indicators pointed to some weakness, especially in the industrial activity side and on capital expenditures as a consequence. Global consumption is however robust, and markets have chosen to focus on the monetary support that these conditions warrant.
With regards to our recommended tactical asset allocation, we started the year by taking profits on DM government bonds to increase both equity and cash. In February, we continue to reduce DM Government bonds to fund an increased allocation to Emerging Market assets, mostly debt. As always, we keep our year-end fair values in mind to guide our action.
Italian voters expressed completed disappointment with traditional parties in the 2018 general elections, bringing unexperienced policy makers to power. The end result is that in the last quarter of 2018 Italy entered a self-inflicted recession. It was caused by the tightening of financial conditions, following the new government’s decision to break with past promises of balance-sheet discipline, and by the related business confidence drop.
After more than 2 years from the Brexit vote, it is still unclear what kind of economically acceptable solution the UK Parliament will be able to deliver, while at the same time the deadline to deliver that solution is looming ominously larger. Businesses are holding investments back and banks are accelerating plans to relocate staff away from London.
President Trump was elected on the promise of making America great again with higher growth sustained by higher investments. So far, the US has outperformed its peers economically. However, in spite of the sizeable tax cuts approved in early 2018 and the permanently increased US debt, investments have continued to drop and the US economy, although resilient, is slowing back towards trend. The recent turn of events is speaking against the fact that “trade wars are easily won”, while the term ‘dysfunctional Washington’ has come up repeatedly with reference to the current administration.
The ensuing, muddled global outlook must have been partly responsible for the latest change of heart by the Fed that in January decided to take a very dovish turn, solid domestic economic numbers notwithstanding. Indeed, the sudden easing of monetary conditions engineered by the Fed, amidst the still unconvincing short-term global data flow, was the decisive factor supporting markets this year.
Markets, caught in the tug of war between long-term growth issues which boosted populist feelings, shorter-term uninspiring economic news flow, global record-low unemployment and very loose Fed policy, are expected to continue to trade sideways, until either side of these opposing forces prevails. Asset valuations, very subdued at the January lows, are no longer depressed, hence the current rally can be expected to stall as soon as multiples catch up with economic reality.
US equities and investment grade credit, alongside EM assets, still seem to have the best potential upside, at least in relative terms, the former given resilient US trend growth, the latter on the combined effects of Fed and PBOC stimulus. In spite of the recent Fed pivot, the US dollar should not weaken dramatically against DM currencies, considering the muted performance of the European, British and Japanese economies. Selective strength of EM currencies against the US dollar must be taken into account, though, as the Fed’s accommodative stance brings back in vogue carry trades by lowering tail risk.
Overall, investors will have to wield patience and buy weakness, and maybe sell excessive strength, in 2019, unless improved macroeconomic conditions support more sizeable upside in risk assets. The lowering of recession risks, which comes along a more supportive monetary backdrop, can for now only put a floor under equities and credit, but is no springboard for new market highs.
Fixed Income Update
Bond markets of late seem to be showcasing some resilience to the global macro backdrop. This has been prominent at the primary issuance with investor demand helping syndicate desks grow primary order books multifold. The successful Sovereign bond transactions from Turkey, Uzbekistan and Indonesia were indeed a good testimony. On the corporate front, the Chinese property developer Shimao Property successfully closed its bond offering despite rising concerns on Minsheng Investment Group.
US economic releases have shown some weakness, against the backdrop of continued turmoil in Washington, with President Trump declaring a state of emergency over the funding of the wall on the US border with Mexico. The US retail sales recorded their most significant drop in more than nine years in December, suggesting a slowdown in economic activity at the end of 2018. December's sharp decline in core retail sales suggested moderation in the pace of consumer spending in Q4. Moreover, Friday’s US Industrial production was also on the weaker side, with a 0.6% drop in January, the first in eight months, in spite of the 0.1% downward revision of the December reading from a 0.3% gain. Production remains 3.8% higher in January than it was a year earlier. The manufacturing sector faces headwinds from slowing global growth, trade tensions and the strong dollar.
On the primary issuance front, Indian first time Eurobond issuer Shriram Transports Finance Company limited (rated BB+ stable by S&P and Fitch) is meeting investors to potentially issue a USD denominated bond while Kerala infrastructure is also considering a Masala bond. Furthermore, Turk Telecom is returning to international debt capital markets with a tenor of between five to seven years of a senior unsecured bond.
With the increased focus on ESG (Environmental Social and Governance) considerations, green bond and loan issuance has soared in recent years, with investor demand far outpacing the supply of green products. ESG investing is estimated to be valued over USD 20 trillion. We have witnessed several EM Sovereigns and regional corporates opting for green bond issuance and benefitting from price discounts.
Global inflation readings are benign and show no signs of a pickup. This has put EM central bankers to respond prompting policymakers to lower rates actively. The Reserve Bank of India’s recent policy response to inflation and other central bankers following suit supports our underlying thesis on domestic debt.
The Central Bank of Egypt cut all policy rates by 100bps and seem to add to further cuts in the coming months. The CBE decision comes on the back of a sharp deceleration in headline inflation in December, helping achieve the previous 13% (+/-3%) target by 4Q18. The central bank remains confident its new 9% (+/-3%) target will be achieved by 4Q20. The window of opportunity is still open for investors looking to participate in the Egyptian T-Bills as we foresee a material drop on yields from current levels. The last CBE auction saw weighted average yields on the 6-months and 12-months at 18.56% and 18.18% respectively.
Written By:Maurice Gravier Chief Investment Officer, Maurice G@EmiratesNBD.com
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