Global Weekly: From bearish to bullish

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In the last couple of weeks there has been a huge sentiment shift from bearish to bullish within the investment community. In this context, equities extended their gains, with both S&P 500 and Dow Jones reaching new highs.

This mood swing was mainly prompted by the likelihood of a partial trade deal between the US and China in the coming weeks, the better-than-expected results of the corporate earnings season, and improving economic metrics suggesting that the global economy may have bottomed, dampening the fear of an economic recession.

This change of mind was confirmed by the latest release of the Bank of America Global Fund Survey. Growth expectations among investors jumped significantly, being the biggest monthly gain since 1994: A majority of fund managers now expects global growth to improve over the next 12 month against a significant majority of fund managers last month expecting a deterioration. This risk-on environment has led investors to add risk to their portfolios, slashing their cash allocation to levels not seen since 2013 and increasing their equity allocation by 20%, according to the report.

The German ZEW Survey (a leading indicator for the German economy) posted similar results. The sentiment about the outlook for the German economy rebounded sharply in November, implying that it might have reached a bottom. Moreover, third-quarter GDP growth expanded 0.1%, beating estimates for a 0.1% decline.

In terms of earnings: despite better-than-expected results in the third quarter, earnings estimates for the final quarter of 2019 have been lowered by analysts. They now expect a flat earnings-per-share growth led by energy, materials and consumer discretionary according to Bloomberg. Heading into 2020, earnings momentum should revert thanks to diminishing geopolitical uncertainty and better-than-expected PMIs.

In the last couple weeks, we saw an upheaval at industry level in the pro-cyclical rotation we were experiencing. This week, however, defensive sectors were the best performers, as yield moved lower with financials, industrials and energy among the laggards. Despite this weekly underperformance, we remain confident that the cyclical sector should continue to outperform in the coming months, as valuation is still very attractive relative to defensive sectors. Also, economic momentum should improve in the coming quarters. As a reminder, we recently closed our underweight position in financials and industrials, moving them to a neutral stance.

Positive sentiment, but for how long?

Now that the US and China are working towards a partial deal in their trade dispute, it is the dominant theme positively driving market sentiment. This is consequently driving interest rates higher.

Especially in the US, there is more positive news on this front, together with economic data looking less weak than markets had feared. This has allowed the US Federal Reserve (Fed) to switch to a data-driven stance regarding the policy rate.

Although this is not helpful for our long-duration position in euro-denominated bonds, we stick to our position for now. Expectations around these trade negotiations have proven wrong many times. It is interesting to see, on this note, that markets are reacting nervously (with rates declining) after Trump warned about escalating tariffs in case an agreement could not be reached. But even if the first part of the deal would be reached, it remains to be seen what the deal actually comprises and how soon any haggling will resurface around the outstanding issues.

We consider the downside risk on our duration position as limited, as we expect the policy of the European Central Bank (ECB) to remain ultra-loose due to the very low economic growth in the eurozone. Germany reported a GDP growth of 0.1% in third quarter. Although the country thereby avoids the technical recession that some market participants may have expected, it is clear that growth remains very low. Also not helpful for the eurozone is that China reported that its economic growth slowed further last month.

With core government bond yields at extremely low levels, we hold on to our preference for Spanish and French paper. These countries are showing solid fundamentals, but their bonds offer a premium over core government bonds such as German Bunds.

We keep a neutral stance towards Italian bonds because of the current yield and certain risks. Italy’s 2020 budget would not trigger a disciplinary procedure, said Pierre Moscovici, the European Commissioner for Economic and Financial Affairs. This is remarkable, as expected deficits of 2.3% and 2.7% in 2020 and 2021 respectively seem a bit high, while they are based on growth assumptions that we think are too optimistic. However, we consider it will be difficult for the current government to keep in control, with Matteo Salvini probably eager to get back in power.

The ECB has just started its new asset purchasing programme at the start of this month. Data for the first week shows that a high share of the purchases has been done in the corporate area (credits and covered bonds). Although it is too early to draw conclusions, it does confirm that the corporate area will again be an important part of the new asset purchasing programme.

Whereas credits benefit from a positive market sentiment, we expect that the ECB policy as a technical driver can protect the asset class, should sentiment (and/or economic data) worsen. This supports our positive view on investment-grade corporate credits.