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Chief Investment Officer's team, 08.12.2019
To some extent, last week was a summary of 2019. The week started with a clear escalation of trade tensions between the US and China, but ended with the message that a deal was very close. More fundamentally, the US November job report was spectacularly positive, with 266.000 jobs being created, well above October and consensus. This obviously bodes well for the US economy as it heavily relies on consumption. Global leading indicators were also well oriented, including a positive contribution from Chinese Caixin PMIs. As the end of the year is approaching, the narrative looks quite simple: there are signs that consumer resilience, as well as the capacity of businesses to adapt, combined with monetary policies, could support the global economy a bit longer, despite the unusual length of the recovery from the global financial crisis. The key risks to this scenario are geopolitical issues, starting with the trade war, and including Brexit. On both topics, the week ahead is important: December 15th is the deadline for new tariffs to be implemented by the US on Chinese exports, and the UK general elections will be held on December 12th.
We will closely monitor these two fronts next week, as well as the major central banks meetings, which together will set the stage for 2020. Our positioning is unchanged for the time being, with a slight overweight in equities, favouring Emerging Markets, and a slight underweight in Fixed Income.
Although anxiety of a recession has taken hold of most investors throughout 2019, risk assets have rallied hard year-to-date, with all major asset classes posting returns significantly above historical averages. Risk assets have been lifted under the expectation that continued stimulus by central banks will translate into improved economic conditions in 2020, partially preempting a better outlook before any solid evidence of it. This is not unusual, considering that asset markets are future-discounting mechanisms.
According to some studies, a multi-asset portfolio skewed towards cyclical assets is about 10% above where it should be, if it were to closely track business confidence, a favorite gauge of the economic cycle. Hence, we suspect that at the minimum high single-digit losses would be on the cards, should the recovery fail to materialize.
Next week will be important for the current bullish state of affairs, since additional tariffs on ‘made in China’ are going to be triggered, unless a so-called phase-one trade deal is agreed upon in between. Uncertainty in this respect is highest, following Mr Trump’s most recent declaration that a deal can wait till after the November presidential election. Also, in the UK voters will go to the ballots for a new political majority to be able to negotiate the next phase of Brexit.
New tariffs and a hung parliament are obvious tail risks, representing the worst outcome possible, boosting gold prices and deflating risk assets. But more benign scenarios are at the core of our base case. While according to the latest polls the Conservative party has more than a fair chance to win, it may be in Mr Trump’s interest to roll the tariff deadline forward. He would be gaining the necessary leeway to further negotiate and make up for the rising challenges after Congress’ approval of Hong Kong pro-democracy bills which have angered Chinese authorities.
As for longer-term concerns related to the possibility of a recession in 2020, it still seems that the delayed effects of the massive bank stimulus implemented globally so far by major central banks should be enough to ward off challenges to the business cycle. We would not agree with this view in case trade tariffs were escalated on both sides, causing an unsustainable tightening of financial conditions.
Actually we hold the view that investors missing out on the current rally will run exactly the opposite risk, by being tempted to step in the market too late, when sufficient evidence of the turning of the cycle has accumulated just in time to see Chinese growth rates ebb towards the end of next year. We expect the support of the more muted domestic stimulus to fade sooner this time as the effects of deleveraging and adverse demographics continue to hold their grip on the Chinese economy.
Fixed Income Update
Last week was eventful, providing a jump-start boost for December with renewed risk sentiment dominating financial markets. The US payrolls report released for November beat all market expectations showcasing a robust labor market. With 266k jobs beating the surveyed 180k together with higher wages fueled the Treasury bond sell-off across the US yield curve. Market implied pricing that the FED would hold on rates are hinting towards a longer-than-expected pause, for now. Worries on the US-China trade-front are now clouded from the steamy momentum of the solid payroll report but could resurface as the additional tariffs on Chinese exports to the US go into effect on December 15.
November payrolls report saw unemployment rate move to 3.5%. Notable job gains occurred in health care and professional and technical services, but also rose in the manufacturing sector. The report reflects a upside tilt due to a one-time event of GM workers returning to work after a 40-day strike, adding 41,300 to automaker headcount following a similar drop the prior month. Average hourly earnings rose by 3.1% slightly above the 3% surveyed. The fact remains is that the employment growth trend has materially slowed this year, and that’s still true and so it’s the directional bias that’s more relevant, in our view. That said, while US economic growth has slowed, signs of macroeconomic trends seem to stabilize and not deteriorate pushing away the prospects for any recession in the foreseeable future.
The Reserve Bank of India surprised markets by maintaining policy rates on hold although markets were anticipating for the continuation to further prolong the YTD trend by pushing rates lower. The RBI said it resisted pressure to ease further following a recent increase in headline inflation. Moreover, inflation is expected to remain elevated and no near-term signs appear for investors to play on the real-rates, accustomed to. The knee jerk reaction was felt across shorter tenor bonds as they tend to be more sensitive and correlated with central bank policy responses. Yields on the 2-year bonds jumped to 5.74% from 5.38% at the close of last week, resulting in a bear-flattening on the yield curve.
EM Asia has dominated the lion share of all the bond sales YTD across Emerging Markets. Primary bond transactions across EM (Hard-Currency) have crossed $680bn so far this year with a few weeks remaining for 2019. Asia ex-Japan contributed to over $355bn of new transactions followed by CEEMEA region at $210bn. Breaking it further, China accounted for over $221bn of sales in a year where Chinese corporate defaults are headed towards record highs. At least 15 defaults since the start of November have pushed this year’s total to 120.4bn yuan and closer to the record high of 121.9bn yuan for 2018.
We enter December with strong year to date gains across most major regional indices, and with all 11 global sectors at double digit returns or more, except energy, with +9%. The year has seen a swing between growth and value and cyclical and defensive assets but looks to end with growth and cyclical assets in the lead by a wide margin. In November, equity performance was modestly defensive as the phase 1 trade deal deadline dominated headlines, and this caused a bit of a reversal from September/October, which saw the outperformance of cyclical sectors. The year to date rally (+21% for global equities) has extended into November. DM equities are up +24% (30th Nov 19) and our year-end fair values have been exceeded. EM have been more volatile +10.2% YTD and haven’t reached our fair values. The UAE (Dubai +11%; AD +7%) leads GCC returns. November was not positive for the UAE markets, but the KSA was up +4%.
The Saudi Arabian Oil Co., “Aramco” placed 3 bn shares, or a 1.5% stake of the company, at SAR 32 ($8.53), at the top of the targeted range for a total of $25.6bn. That exceeds Alibaba’s $25bn IPO in 2014. Largely driven by domestic and regional individual and institutional investor support, demand for the offering was strong at 4.65X and attracted close to $120bn of orders. That places the IPO underwriters on track to exercise the overallotment option of an additional 450mn shares. Aramco’s shares are scheduled to start trading Dec. 11th on the Tadawul stock exchange. The OPEC production cut of 500,000 barrels per day through the end of March is boosting oil prices, a positive for Aramco shares. The IPO proceeds are aimed at supporting investments and deployed domestically to meet the 2030 Vision Plan targets. They will be transferred to the Public Investment Fund, which has already made a number of overseas investments, including $45bn into SoftBank’s Vision Fund and Uber Technologies along with other investments.
Despite beginning last week on a low note, the S&P 500 closed the week higher. A softening trade tone in addition to a big beat on November's employment report improved investor sentiment. On the sector level, Energy (+2%) outperformed with WTI Crude up +7.3% for the week. The UK’s FTSE 100 struggled last week with a stronger sterling and parliamentary elections around the corner, ending the week down -1.45%. The Euro Stoxx 600 remained flat on the week, despite weaker than expected German economic data and risk-off sentiment.
France's digital tax has led Pres. Trump to threaten to tax US consumers of French goods. The threat of anti-French taxes broadens the trade conflict and may force a European response. However, the re-imposition of steel taxes will affect trade and growth more adversely. Firms are reluctant to invest in global supply chains till they are sure of the impact of trade tariffs on margins and cost of goods. Lower global investment is already slowing the global economy.
Written By:Maurice Gravier Chief Investment Officer, MauriceG@EmiratesNBD.com
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A quiet week, a binary context
Markets hold their breath
A week for risk takers
Earlier this year, in our Global Investment Outlook, we expressed concerns on the investment landscape for the next decade, and highlighted the keys to successfully navigate it. We emphasised one in particular: the ability to quickly add or reduce risk, when volatility generates opportunity.Know More
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