Global Weekly: Deal or no deal?

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Despite a string of company results and news flow regarding the US/China trade deal, returns on equity markets this week have been flat. In a volatile environment, we continue to favour an underweight position in stocks, as political and economic risks related to Brexit, the US/China trade dispute and Turkish military action in northern Syria are expected to continue to influence markets in the coming months.

At the beginning of the week, optimism on progress in the trade negotiations, including on topics such as intellectual property protection, farm goods purchases and currency policies, supported the equity market. US President Donald Trump indicated that the first phase of a trade deal had been reached. As part of this deal, the US will halt a scheduled increase in tariffs and China will substantially increase purchases of US farm goods.

During the week, however, new worries around the agreement emerged. China wants further talks to hammer out the details of the first phase before Chinese President Xi Jinping agrees to sign it. According to President Trump, the deal will not be signed before the Asia-Pacific Economic Cooperation summit next month in Chile. Negotiations resulting in a trade peace and confirmed with a deal, will relieve the stock market. In the meantime, continued uncertainty about the US/China trade relationship increases the reluctance of companies to make decisions regarding new capital goods investments.

The earnings season kicked off on Tuesday with the results of US banks and pharmaceuticals companies, including Johnson & Johnson and United Health. It was a strong start. Despite all the headwinds, bank results were, in general, better than expected. The overriding theme in US banking reports so far is the health of the US consumer. Car loans, home mortgages and the credit card business are flourishing. Given healthy US consumer spending, we continue to prefer US stocks over those of other regions.

Bonds – a game of quantitative easing

Winter is coming – or is it still far away? Some investors are growingly worried about the prospect of a recession. Others believe that a recession is still far away, and that a further deterioration in economic growth will only bring more stimulus from central banks – which would, in turn, lead to higher prices for risky assets.

Interest rate movements clearly reflect this uncertainty. The uplift in yields in September, as well as this week’s rise in yields, reflect hopes that geopolitical threats will not escalate, while the fall in rates at the end of September indicated fears that these tensions slowly but surely are strangling economic growth.

The trade war and Brexit are indeed causing uncertainty, but the reaction of central banks seems to be having a positive effect for the moment. Even if geopolitical headwinds would subside in 2020, most economies would still need the support that central banks have started to provide. That said, a calmer geopolitical landscape would make it more likely that we are seeing a mid-cycle correction and that we are not moving towards a global recession anytime soon. Bond yields are currently on a more sideway trajectory. For the time being, however, we think that recent lows will be revisited. Soft leading economic indicators and further monetary easing are likely to be a dominant factor going into 2020, while geopolitical tensions still need to stabilize before they might improve.

Investment-grade spreads have moved sideways in a narrow range since mid-August, allowing corporate bonds to track German Bunds. The ECB will start its asset purchases (quantitative easing) in November with a smaller amount than we expected. But the central bank is explicitly committed to keep on buying until inflation finally hits its target, which ECB-policymakers do not expect before 2021. These asset purchases will continue to support the investment-grade bonds on the ECB’s shopping list directly, while other bonds will benefit indirectly.

Risk premiums in high yield and emerging markets have been more volatile and benefitted from recent hopes that geopolitical tensions might ease. However, the weakness in leading indicators for the service sector bears close monitoring. The reason: once the softness in manufacturing starts spreading to other sectors, thereby affecting the labour market, consumption will certainly weaken. And weaker consumption would cause slower global growth. High-yield markets still look more vulnerable than emerging markets, where leading indicators have recently started to improve.