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Chief Investment Officer's team, 09.02.2020
After a volatile and overall negative January, last week saw a revival of risk appetite. Economic data sent positive signals, should it be global PMIs or the spectacular number of jobs having been created in the US in January. In China, reports of a potential vaccine came together with significant stimulus and tariffs cuts. This was enough to send equities more than 2% higher, and trigger some profit-taking on Gold and Government bonds.
Our stance for the coronavirus is unchanged. Our baseline scenario is for a severe, but transitory impact on the economy, which should be limited in time (the first quarter), geography (Asia) and sectors (tourism…). Global markets seem to agree. But there is no certainty yet. We watch for two key risks: the first one is the fatality rate, which hasn’t risen. The second one is the global disruption which could result from Chinese factories remaining closed in February. The visibility hasn’t improved on the latter, and time is not on our side, especially as some risk assets are already not very far from our year-end fair values, with no margin of safety. We haven’t revised our global scenario yet, as we still think that growth should rebound after an initial Q1 shock, but are beginning to worry about what is priced-in by some cyclical assets, especially in Developed Markets. It’s probably more optimism than complacency, and it is not necessarily irrelevant, but seeing new all-time highs in US and European stocks could set the stage for some volatility ahead on any adverse development.
The rally in 10-year Treasury yields sparked early last week by a surprisingly strong US business confidence release was cut short by mounting concerns related to the adverse impact of the novel coronavirus on the global economy. On the surface the January Purchasing Manager surveys should provide a good reason for optimism, signalling the continuation of the positive momentum building in business activity late last year. The Global Composite PMI climbed for the third consecutive month, while its manufacturing sub-index managed to stay in expansion territory, potentially hinting to the subsiding of the headwinds plaguing the sector since early 2018.
Although corporate sentiment is the most forward looking gauge for the overall status of the economy, this time it could happen to be backward looking, as the January surveys preceded the outbreak of the virus and their improvement could be mainly a sign of relief from the trade deal agreement between the US and China. The novel coronavirus has so far caused a demand shock by hitting harder the retail and tourism service-related sectors and the Asian economies. Supply disruptions could soon compound the damage as Chinese manufacturing activity will only be partially restarted this week in an attempt to curb the spreading of the epidemic. This ties in with forecasts that the epidemic is unlikely to peak before February-end, a reason for the central authorities to be erring on the side of caution.
Positive business sentiment readings could thus be followed by worsening figures in a pattern that should see a painful Q1 economy-wise followed by some relief in the subsequent quarter. From this perspective, the drop in US Treasury yields may not be over, with the Fed on hold, no signs of inflationary pressures and clouds gathering on the horizon. The global recovery is once more likely to be delayed, though not jeopardized, thanks to powerful stimulus measures and the relatively short duration of the shock if authoritative forecasts about the epidemic and past episodes are anything to go by.
We reiterate the view that in the meantime gold could gain further steam and spike briefly towards $1,700/oz, alongside further dollar strength, contrary to our initial projection for 2020, as EM FX and the euro bear the brunt of shorter-term uncertainty. The degree of the economic damage will dictate the drawdown to be suffered by global equities, though investors tend to look through short episodes of disruption in business activity. The current level of cross-asset positioning and valuations, in the upper band of its historical range, suggests markets will not be immune to further adverse developments and investors should brace themselves for a bumpy ride.
Fixed Income Update
It will take a lot more than a bumper job report to move the treasury yields upwards. There is a downside bias to the yields with coronavirus spread affecting investor sentiments more than any robust macro data could. On Friday, the treasury curve bull flattened by 5 to 7bps led by the long end of the curve. In an ode to volatility, the 10-year benchmark yield has oscillated between 1.87% and 1.51% in the last one month. We believe that only a strong inflation scare (highly unlikely) or a definitive declaration from the health authorities on the control of the contagion could take the yields higher than the current levels.
Looking at indices, the riskier sub-asset class segments such as US HY and Global HY stole the march over their safer counterparts such as Global Treasuries or IG Credit as spreads tightened for the HY indices. EM Debt was up by 0.24% while GCC debt ended the week flat. However, we would advise investors to be more cautious and not to increase exposure to Global HY sector as the effect of the virus scare on HY bonds may be outsized given that the energy sector now represents 20% of this sub-asset class now as compared to 4% in 2003 during the SARS outbreak.
Meanwhile, China’s local sovereign bonds have rallied relentlessly, pushing the benchmark 10-year yield to its lowest levels since early 2015. PBOC has boosted liquidity in the system through its reverse repo actions to contain the economic fallout of the virus outbreak.
The EM Central Banks had some tricks up their sleeves last week to surprise investors. Bank of Russia cut their policy rates for the sixth straight time to 6% while announcing a high possibility of another cut in the next meeting. India’s central bank kept the policy rates on hold but announced a range of measures spurring a local bond rally. It added long-term repo and targeted credit support as new tools to its arsenal. The LTRO will focus on the 1-3 year maturities, which would sharply reduce the funding costs for banks at those maturities. RBI lowered the cash reserve requirement for commercial banks for extending credit to automobiles, housing and lending to small businesses for six months until end-July. Indian Sovereign curve bull steepened because of these announcements.
Last week’s EM primary issuance totalled USD 5.6 Bn. Indian Railways tapped the bond markets with their longest ever maturity bond sale by issuing a 2050 security at 3.95% coupon. Turkey issued 5-year and 10-year USD bond tranches that currently trade at a discount in the secondary market. This week we can anticipate issuance by India Infoline Finance Ltd (Ba3/-/-), which began its roadshow for its maiden USD bond.
Equity markets, led by the US, reacted positively to China’s announcement of tariff cuts and a potential coronavirus cure. Global equities are now largely building in the impact of supply chain disruption and slowing global growth in Q1 from the coronavirus outbreak. We would recommend selectivity in developed markets as most of the positive catalysts look priced in. The US indices, notched record highs on a revival of bullish investor sentiment and the strong Q4 earnings season For the week the major US indices finished higher; the Dow Jones: +3%, S&P 500 +3.2%, and the NASDAQ Composite +4%. Defensive sectors are starting to gain traction with healthcare and utilities gaining. In earnings, approximately 65% of S&P 500 companies have reported, with an average growth of 0.7% for EPS and 3.4% for sales, according to FactSet Research. Earnings have exceeded expectations by a large margin, adding a fundamental underpinning to market performance. Company guidance and updated analyst estimates should continue to drive the market narrative. It is necessary, as high market multiples put the onus on earnings to drive stock prices. European equities shared similar optimism, with the Stoxx 600 and FTSE 100 up 3.3% and 2.5% respectively for the week.
Coming back from an extended lunar holiday, the domestic China CSI 300 index partially recouped a selloff of -7.9% last Monday, ending down -2.6% for the week. The MSCI China is -0.5% year to date as the larger cap China stocks were not affected by the Virus sell-off. Alibaba and Tencent remained resilient. Valuations on China equities remain attractive, as is growth.
We think healthcare companies focused on developing vaccines and cures for the coronavirus should continue to perform well. Some are using gene editing, and others are using tested viral medicines to start clinical tests. Most of the large-cap biotech and pharma companies are multi-dimensional in their product cycle and are not just bets on one viral outbreak. Biogen was up +26% and Gilead +9% last week. We would position for the long term in many of the leaders in the viral and gene-editing space. Connected healthcare too is seeing a rally.
Tesla's taken up as much news space as the viral outbreak. The stock is up 200% since 1st October 2019. The Trading value was $170bn last week, three times as much as Apple and five times as much as Microsoft. The $135bn valuation looks stretched, at a 500,000 delivery target for 2020, higher than BMW and GM who deliver 10mn cars annually. That’s a valuation of $367,000 per Tesla, $17,000 per BMW, and $6,400 for GM. However, Tesla is the iconic first mover of the EV revolution, while other automakers are speeding up to catch-up.
Year to date UAE markets are flat whilst the KSA has moved in line with oil prices (-4%). In the UAE, DXB Entertainments surprised positively on its Quarterly EBITDA with cost optimization plan, in spite of lower visits at 2.6 million and 62% occupancy at Lapita Hotel in FY 2019. The 250 room Legoland Hotel is on target for delivery in H1 2020. A new pricing strategy was implemented on October 2019 to encourage multi-park visitation.
Written By:Maurice Gravier Chief Investment Officer, MauriceG@EmiratesNBD.com
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Spreading but not yet peaking
Another week, another rally
A geopolitical start to 2020
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