Global Weekly: Stay the course

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Many economists have revised their forecasts downwards, following continuously disappointing manufacturing PMIs, but especially escalating trade tensions. The US is not only using tariffs against China, but surprisingly also threatening to impose tariffs on Mexico. Whereas economists’ base case scenarios can take sharp turns, the implications for investment portfolios could be smaller because investors should already consider multiple scenarios.

We consider the biggest impact for fixed income portfolios to be that central banks are now practically forced to take a dovish stance (a stance that is supportive to economic growth). Markets indeed expect rate cuts in the US and potentially even renewed asset purchase programmes (quantitative easing) in Europe.

Inflation expectations have declined ever further, pricing in lower growth, adding to the pressure on central banks to ease their policies. Therefore, we keep our positive stance towards duration (inteest rate sensitivity of a bond portfolio). We also maintain our position in inflation-linked bonds. Although they have now become very cheap for a reason, we still believe a position in inflation-linked bonds makes sense in the long run, as central banks' inflation targets remain much higher than current expectations.

Of course, recession risks rise with an escalating trade war. Looking at the US/China trade dispute, it seems we will have to wait until the G20 summit end of June for new insights. In the meantime, it is reassuring to see that the plan for US tariffs on Mexican goods has already been called off after negotiations between the two countries. Unfortunately, some damage may already have been done, as the business environment may have become more uncertain as a result of US/Mexican trade tensions – which also makes the investment environment more uncertain. Furthermore, we cannot rule out that Trump will target Europe more forcefully at some point, and in that respect it is not comforting to know tariffs can be imposed so surprisingly. ‘Luckily’, Trump can be expected to remain focused on China for now.

Europe already has its own problems to deal with. The European Commission is preparing for an excessive deficit procedure against Italy because of its debt level, while Italian coalition partners seem to keep fighting not only Europe but also each other. We acknowledge the spread on Italian bonds will remain volatile. But we consider yields high enough to keep our overweight position. Even if the coalition falls, we think spreads should recover after maybe a short period of turmoil, because any new government resulting from new elections should likely be better for bond investors than the current one. At current yield levels, we think the only risk that could hurt returns in the long run is if Italy were to exit the euro. Even with the threat of Italy issuing so-called mini-BOTs (small value notes guaranteed by the Italian government that can be used for certain payments) that would create a parallel currency, we still consider it unlikely that Italy would abandon the euro. In the end, support amongst the Italian people for leaving the euro is low – and the Brexit saga will probably not help growing this support.

Talking about Brexit: this is a risk that could move to the forefront again, especially if leading candidate Boris Johnson were to be elected as the UK’s new prime minister. Offsetting these risks for euro bonds is the dovish stance of central banks. That spreads on investment-grade corporate bonds widened in May is not surprising given the macro news. But, interestingly, the market has remained relatively healthy with continued new issuance and new issue premiums (NIP) not being particularly high. To us, this proves that demand for investment-grade corporate bonds remains in place. We believe this makes sense in the current rate environment, as the corporate bond market is one of the few places offering some positive yields. We therefore maintain our overweight position in euro investment-grade corporate bonds.

Equities - after the rebound

One week after announcing that the US would impose a 5% monthly increase in tariffs on Mexican goods, the White House declared that it would finally call it off. Good news never comes alone, as China made an announcement of a new stimulus plan in support of its economy to prevent any risk of further cooling. These two developments, however, were not enough to keep the markets on rallying, as major indexes swung between small gains and losses this week.

At industry level, the marked rebound that was initiated at the beginning of June, was fueled by trade-sensitive companies. Also the IT sector, one of the strongest convictions in our allocation, posted the biggest gains, after having been negatively impacted by the regulatory investigation in May into the GAFA firms (an acronym for Google, Apple, Facebook, and Amazon, the four most powerful American technology companies). The rebound was mainly triggered by the increasing belief among investors that the US Federal Reserve would cut interest rates – probably already starting in July. It was also triggered by the announcement of big deals such as the USD 15.3 billion acquisition of the big data company Tableau Software by

Although many economists have revised down their growth scenario for this and next year in the last couple of weeks, analysts have yet to adjust their earnings-per-share (EPS) growth forecasts. In the US, profits are expected to progress by +3.4% in 2019 and +11.4% for 2020, which is unchanged since April. European EPS forecasts experienced a similar trend with profits growth averaging +4.3% in 2019 and +9.3% for 2020. The emerging markets region saw the biggest decline with this year’s earnings growth falling to 4.4% from 6.6% in the same period. This last point strongly supports our latest geographical decision to reduce our exposure on emerging markets.

Heading into the next few weeks, we expect markets to experience higher volatility levels, as we will approach the G20 Summit in Japan at the end of this month.