Global Weekly: Equity: Different speed in the US and Europe

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Over the past weeks, we have been confronted with two-faced equity market performances. The US market has been making an all-time high based on solid underlying fundamentals, whereas Europe lagged behind due to lingering concerns on geopolitical tensions with regards to Turkey and US trade tariffs. In the meanwhile, the earnings season has gradually come to an end, signaling that the majority of companies is in quite good shape.

European and emerging markets have been dominated by developments related to Turkey and the US trade tariff discussions. Especially, the European financial sector bears the brunt of potential contagion effects coming out of Turkey. Throughout the week, we have seen these effects gradually abating, following announced actions from Turkish authorities and the recognition that contagion out of Turkey should be manageable.

The recent earnings season confirmed that most companies are in relatively good shape, with the majority of earnings coming in ahead of expectations. From a regional perspective, it was also clear that the US is leading over Europe and emerging markets with a more pronounced earnings growth and less under shootings on expectations. Combined with the uncertainty around Italy and Turkey, this explains the outperformance of the US versus Europe and emerging markets and also reinforces our overweight position in the US within our portfolios.

On a country and company level, we have recently seen a number of challenges coming out of Germany. Next to the more company specific issue of Bayer on the Monsanto acquisition last week, we saw clear signals this week of a trade tariff hangover for the German car industry. Continental for example is foreseeing a growth slowdown in the second half of the year, based on less buoyant demand from China.

Bonds: Policy is here to stay

As most investors expected, the release of the minutes of the August Fed policy meeting had a dampening impact on markets, with little actionable news revealed. As long as there is turmoil in emerging markets and Italy and the Fed continues tightening its monetary policy, US assets and the US dollar will obviously continue outperforming all other asset classes. Such a rosy outlook for the US economy carries the risk of negative US surprises and that could prevent 10-year US treasury yields from rising sustainably above its key resistance of around 3.05%. As such, it also questions the stamina of record speculative short positioning in US treasuries.

Within the eurozone, the spread between Italian and German government bond yields has regained focus, as Italian Deputy Prime Minister Matteo Salvini accused the EU’s budget rules for the collapse of the bridge in Genoa last week. Accordingly, investors should not expect a quiet process when the 2019 budgets will be discussed in both Italy and Spain, as the respective governments remain fragile. Especially Italy may look to compromise the spending rules, which could fuel internal Euro-area tension and hence keep spreads at elevated levels.

In the meanwhile, rating agency Fitch is due to review Italy’s credit rating on 31 August. A one-notch downgrade by Fitch would not put Italy's investment-grade status at risk. It is also likely that the rating agencies might not change their views until after clarity emerges on the nation’s budget plans.

On Friday at the Jackson Hole Symposium, Fed Chair Jay Powell will address "interest-rate policy in a changing economy", which financial markets will be following closely. Investors would probably like to know whether the Fed still thinks unwinding of the balance sheet is uneventful or whether negative spill-overs of tighter US dollar liquidity - seen for instance in emerging markets - is of any concern to the Fed.