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Chief Investment Officer's team, 09.06.2019
Last week, global equities gained a spectacular +4% in Developed Markets and +1% in Emerging Markets. Fixed income was positive across all segments with more than 1% weekly return, as US 10 year yields fell to 2.1%. Gold also printed a significant price increase of +2.7%.
There was no fundamental good news behind this sea of green, it was indeed the opposite: global activity data was clearly below expectations, especially leading indicators in both manufacturing and services, and US employment figures. In May, the US economy added only 75k jobs, when the consensus was expecting 175k, after +224k in April (revised down) and the average hourly earnings also grew less than expected. This negative backdrop justified rising expectations for a policy response and triggered verbal signals from Fed officials for a cut in rates, propelling markets. As we wrote last week: “The key economic risk is a collapse in business confidence, which would lead to a slowdown in activity. From a market point of view, the key two questions are: What is already priced in? When will it trigger a response from Central Banks and potentially fiscal stimulus?”
Markets are quick to jump to a conclusion, but the questions remain unanswered for now. Weaker growth is not the same thing as a recession in terms of implications, and we would need more data and more clarity on the trade front before taking action. In the meantime, we remain defensively positioned and closely watch fundamental developments and valuations.
Gold bugs must be warming up to the idea that the yellow metal could be in for a bull run, following the swoon in risk assets and the tariff anxiety at the forefront of investors’ minds. Gold has recorded two back-to-back quarterly gains and is expected to appreciate further as it catches up with consensus forecasts of three Fed rate cuts for 2019 and one seen to occur in 2020.
Should the Fed indeed slash rates by so much and so quickly, one would have to cope with a recessionary scenario, if history is any guide. Since gold is a good end-of-cycle hedge, it tends to outperform stocks when equity fatigue sets in and the economy deteriorates, the key question is whether investors will be confronted with a recession in the next quarters, or rather see things look up again as trade uncertainties subside.
One may well be under the impression that the outlook for safe haven assets should be particularly bright, with global real rates collapsing and yield curves in the major economic areas sinking deeper in inversion territory. The so far resilient business confidence in the global services sector has dropped to new lows for the year and last Friday’s bad jobs report in the US points to a downshift in the country’s economy to a below-trend rate.
Indeed, gold could fleetingly break past key resistance levels and reach a year high around the $1,400/oz area, but for it to consolidate positions would require that geopolitical risks take a turn for the worse and current expectations of future rate cuts become reality. We deem it unlikely that Mr Trump shifts to an all-out confrontational stance failing to strike a last-minute deal with trade partners. It would be most counterproductive for a 2020 reelection bid.
If our baseline scenario plays out, when trade tensions eventually fade and confidence rebounds, gold bugs will be left scrambling for the exit door, even as equity investors will be reducing their hedges and adding to risk.
While stocks can look through near-term uncertainty and get a fillip from the prospect for lower policy rates, we see little scope for long-dated US Treasuries to weaken significantly until hard data starts to improve. The US economy, although resilient as compared to the rest of the world, is softening and we don’t see catalysts at the moment for the negative momentum in economic surprises to reverse course any time soon. On top of this, major global central banks, buying insurance against geopolitical tensions, are expected to remain in easing, or at worst neutral mode, putting a lid on Treasuries’ potential upside.
US 10-year Treasury yields are likely to remain depressed and continue to signal a more pessimistic growth outlook than US equities, trading only a few percentage points from their all-time highs.
The MSCI AC World Index gained 3.6% last week in US dollar terms led by developed markets (+4%) while emerging markets (+1%) were still affected by the trade context. After being closed for Eid holidays, GCC markets have reopened Sunday to reflect lower oil prices and we expect the MSCI rebalancing to continue this week as active funds reposition to include the new entrants to the EM Index from the KSA.
U.S. equities registered their best weekly performance of 2019, with the S&P 500 gaining 4.4%. This snaps four consecutive weeks of negative returns. Equity-market downside is limited by the carrot of easier monetary policy, but the upside is constrained by continuing trade war rhetoric and we expect range bound trading in the near term. Our fair value model for the S&P 500 at 2825 end 2019 at 16.5X forward earnings and 5% earnings growth should hold. Any rate cuts could support valuations at a higher multiple but lowered global growth forecasts and the effects of trade tariffs remain constraints to raising estimates.
Selectivity should generate outperformance and high-quality growth stocks should continue to do well, with the caveat that the companies are not overly dependent on external markets, invest and innovate and maintain leverage at reasonable levels. Global companies that operate in diverse geographies have the advantage of tiding over market cycles in the long term but with trade tariffs escalating we prefer US multinationals that have a sustainable domestic base of consumers with foreign markets aiding but not forming the bedrock of their growth. The forced end of the era of 'globalization' may be ushering in a new period of 'slowbalization', with a shift to a lower volume of exchange of goods and services across borders.
The Reserve Bank of India “RBI” has cut its benchmark repo rate for the third time this year as it seeks to reverse the country’s sharp economic slowdown and also signaled the possibility of further easing. The monetary policy committee voted unanimously to lower the rate by 25 basis points to 5.75% bringing it to its lowest level since late 2010. The RBI also cut its GDP growth forecast for the current April-to-March financial year to 7% down from its previous forecast of 7.2%, with bellwether indicators, such as car sales, pointing to continuing weakness in April and May. The slowdown in growth prospects follows weak investment activity, consumption demand and slowing external trade. The Sensex index is trading close to a record high after gaining 10% year to date. The rate cut is positive for Indian equities in the mid to long term though we think the market may take a breather in the short term post the recent rally. Concerns around rising defaults (by a large NBFC) led the market lower at the end of last week. Policies meant to clean up $190 billion of stressed bank loans will be crucial to reviving economic growth during the BJP led NDA government’s second term. The focus now shifts to the monsoon and the government budget. Key risks are any sharp escalation in oil prices, a below normal monsoon and a higher fiscal deficit.
Written By:Maurice Gravier Chief Investment Officer, MauriceG@EmiratesNBD.com
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The price of uncertainty - 26 May 2019
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