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Chief Investment Officer's team, 26.01.2020
One week ago, Emerging Market equities were the best performing asset class of 2020, with DM Government bonds being the only negative one. Last week reversed the hierarchy, as the coronavirus epidemic combined with the perspectives of a week-long market closure in China for the new Lunar year. EM stocks lost 2.4%, and defensive assets outperformed.
A deadly virus is a serious matter, and market reaction shouldn’t come as a surprise, even more so as signs of excessive optimism were building in the first weeks of 2020, lifting some markets close to our year-end fair values. Looking beyond this initial reaction, the key questions are whether the impact will be temporary, and regional, or the beginning of a global disruption. It is too early to draw a conclusion, but we wouldn’t panic yet, given the current mortality of the virus, the magnitude of the responses from the Chinese authorities and the WHO, as well as comparisons with the 2003 SARS outbreak, which, in terms of market impact, turned-out to be eventually mostly temporary and regional.
At the same time, last week’s economic data brought signs of stabilizing manufacturing activity, and encouraging growth numbers in Emerging Asia. The Q4 earnings season is also overall positive. This won’t be enough in the scenario of a severe global pandemic, and sentiment is by definition vulnerable, but it’s again too early to adjust the fundamental narrative, and we keep our positioning unchanged.
Risk assets have been running hot for a while delivering a stunning performance in 2019. The current year is off to a good start as well and signs of short-term overheating are to be seen a bit everywhere. Global equities are clinging close to all-time highs in spite of their 28% total return for 2019, credit spreads could hardly get any tighter and sentiment indicators from the put-call ratio, to the proportion of stocks in a bull trend point to overbought conditions. The corona virus outbreak could be the trigger for investors to dial down their growth expectations and adjust their positioning accordingly. We do not expect the end of the current rally, but would rather remark that this bull market seems to be needing a breather before resuming its run.
The corona virus negative newsflow is gaining momentum and headlines are likely to become gloomier before they improve. SARS, a corona virus itself, spread between 2002 and 2003, causing at the time a retracement mainly in EM equities. According to some reports this virus has similarities to SARS, seems to be less lethal, so far casualties are mostly elderly people, but also more infectious, having already spread to four continents. The past template was that markets found a bottom when the epidemic reached its peak, while this epidemic has just started and markets suffered losses only last week following a great run.
Irrespective of spreading concerns about a pandemic, there are grounds to believe that risk assets had run slightly ahead of themselves, discounting a brighter outlook of which there is not yet much evidence. The flash business confidence surveys released Friday are a case in point of a mixed release. The manufacturing sector, though improving, remains in contraction territory across all regions, both in Europe and in the UK according to the Markit survey, and in the United States as per forecast of the ISM survey. While the most forward looking indicators of business surveys point to forthcoming improvements, for now economic momentum is far from showing the same exuberance as markets.
Meanwhile safe-haven assets continue to be supported and we are tempted to conclude that they will continue to be well bid in the short term. Gold is in a well-defined up-trend and could briefly breach its previous high at $1,611.4/oz. to reach even $ 1,700 as the virus-related newsflow intensifies. The yen is not far from the bottom of its range against the US dollar and momentum on US 10-year Treasury yields has again turned negative.
Overall we would tend to maintain a constructive bias for the medium term predicated on central bank liquidity supporting the business cycle and the expectation of positive earnings surprises. Short-term headwinds represented by overbought markets and an epidemic which eventually is going to be contained will be resolved in interim volatility and a buying opportunity.
Fixed Income Update
The flight to safety on the back of heightened virus-concerns has pushed yields lower across the board. The benchmark US Treasuries have rallied, pushing yields to 1.67% or 13bps lower over the week. Moreover, the fed funds futures are now signaling a 29bps of policy ease for this year by the FED. The UK Gilts and Germany Bund yields also tumbled to 0.56% and -0.33% respectively against the global backdrop of uncertainties and broader ramifications towards growth propelled by Wuhan’s coronavirus.
In an ominous signal that EM Debt is becoming expensive, the Macaulay duration for the Bloomberg Barclays EM Debt Index is at its highest level (6.39) in the last five years meaning, it takes that long for future cash flows to equal the price paid to own the bonds. However, the Option Adjusted Spread of the index is still a long way from the five-year low of 211 achieved in Jan 2018, indicating that EM Debt could still deliver decent returns subject to sufficient tailwinds.
The Kingdom of Saudi Arabia priced a blockbuster deal last week while issuing USD 5bn in three tranches. The 7/12/35 year tranches were priced at T+ 110/135/180, respectively, taking GCC primary issuance to a total of USD 5.8bn for the week. The pace of EM debt issuance will temper this week as the Chinese markets are away for the Lunar new year, and the Coronavirus scare has affected the pace of the roadshows in the region. In terms of deal pipeline, Indian utility Adani Electricity Mumbai Limited and Russia’s Sovacom bank have begun their roadshows for possible bond sales this week.
Bank Indonesia maintained policy rates on hold at 5.00% for the third consecutive meeting. The policymakers have cited better prospects on economic growth outlook with both external and internal conditions picking up. The projected GDP growth for Indonesia has also seen an upward revision towards the 5.3% level. The Sovereign Eurobond yields by Indonesia have staged a strong rally in the last twelve months tightening by over 135bps to current levels of 2.79%. The cost to insure against Indonesia’s default has also reached its lowest level to 62bps. Indonesia has a Sovereign rating of BBB with a stable outlook.
Amid concerns in the domestic Indian bond market of record borrowing by the government to fund its budget deficit and drive economic growth, Reserve Bank of India has doubled the limit for investments through voluntary retention route. This is a separate category formed to lure longer-term foreign investors in domestic bonds as it seeks to keep yields in check. The central bank hopes that the new step in addition to the Fed like “Operation TWIST” will cap the long-term yields.
Most global equity indices ended the week lower. US indices ended a long winning streak though the benchmarks are still within 1.3% of their record highs set recently and Q4 earnings, largely financials so far, have surprised to the upside. The coronavirus has spooked investors with Mainland China and Hong Kong stocks faring the worst and fuelling demand for havens in government bonds and gold. Hotel and airlines shares are suffering in China with healthcare the only positive sector. Energy stocks suffered globally with crude oil having its worst week since July as the widening virus outbreak threatened to disrupt travel. European and UK indices went up on Friday as data signalled that German manufacturing has bottomed out and that the UK economy has turned a corner. For the week however, the Stoxx 600 closed close to flat (-0.21%), with the ECB leaving key monetary policy unchanged.
Most of the major banks in the UAE have performed positively in 2020 led by the Islamic banks (+7% YTD) as investors await Q4 results and dividend announcements. Dividend yield for the banks varies between 5-6% and current data is supportive of UAE bank outperformance continuing. According to a report from Emirates NBD Research, gross loan growth in the UAE was 2.2% m/m in December 2019, the biggest monthly rise in more than five years. Annual loan growth rose to 6.2% y/y from 4.1% y/y in November. Bank deposits also rose in December, up 2.8% m/m and 6.5% y/y. Both residents’ and non-residents’ deposits increased.
Sustainability goes mainstream with this year’s agenda at Davos supporting “purpose beyond profit“. The World Economic Forum also announced “the first neutral and public traceability platform” capable of visualizing blockchain-based supply chain data from multiple companies and sources. It aims to help businesses across industries respond to consumer demands for ethical and environmentally friendly products. There was a focus on cyber security with the doing away of passwords, to be replaced by better authentication. A council to govern digital currencies globally is also to be formed
Tesla crossed the $ 100bn market cap with shares up 125% in the last 3 months, not only boosted by higher production in the US but as it increased presence in China, which is the fastest growing EV market globally. We see 2020 as the watershed year for electric vehicle adoption and focus not only on the passenger car sector but buses, trucks and eventually aircraft. Shared mobility is synchronous with EVs and whilst fewer people will buy cars, the replacement cycle will ensure viability for the next few decades. The streaming market leader Netflix is facing competition, with tech and media giants such as Apple, AT&T, Comcast and Disney launching video platforms online. Netflix plans to boost its spending on content by 20% this year, to about $12 bn. Netflix delivered upbeat results aided by tax benefits. It added 8.76 mn customers last quarter largely outside the US. Overseas growth has helped offset a slowdown at home. However, what remains worrying is long-term debt which stands at almost $15 bn.
Written By:Maurice Gravier Chief Investment Officer, MauriceG@EmiratesNBD.com
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Another week, another rally
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