Etsy Dwek
Macroeconomic overview
- Recent data points towards a moderate rebound in activity. Consumption has remained strong, the labour market is holding up at historical low unemployment levels, the housing market is starting to tick up and the manufacturing sector should benefit from the US/China trade truce. Europe has been surprising on the upside; Germany has continued to show signs of improvement, with manufacturing picking up, though PMIs remain weak. Chinese data is also pointing towards stabilisation, with improvements in money supply and credit growth. The trade truce, together with the recent PBoC’s monetary easing should help support growth above 6%.
- US/Iran tensions heightened after Iran launched more than a dozen ballistic missiles at US forces in Iraq in retaliation for the killing of military commander Qassem Soleimani. Although both countries have backed down since, we may see the risk premium remain elevated. For now, oil prices have responded calmly, as have equity markets, while gold has soared. At the same time, the Democratic-controlled House of Representative has passed a resolution to limit President Trump’s ability to take military action in Iran without Congressional approval.
- The US and China’s ‘Phase one’ trade deal will be signed tomorrow. Both sides have strong incentives to avoid renewed escalation, especially President Trump in a re-election year. Thus, we are much less likely to see reversals moving forward, which should help confidence, but we believe an all-encompassing deal is likely to prove illusive.
- Following the Tories’ win, Brexit should be done by the end of the month so we will move on to the transition period. However, we believe a trade deal by the end of 2020, as PM Boris Johnson has stated, will be difficult. In the meantime, the UK continues to show signs of fragility, and the BoE might need to act, as early as at the end of the month.
- After months of discussions, Spain finally has a government as Prime Minister Pedro Sanchez managed to form a coalition with the unit-austerity United We Can party. The road is unlikely to be smooth however, as in Italy, where the coalition is holding but friction is building. For now, we believe that both coalitions will hold.
- The US dollar benefited from the recent Middle East flare up, but has since stabilised. We believe that some weakness could materialise with improved risk sentiment, but expect broad range-trading for major currencies.
Market outlook
- Equity markets continue to advance on the trade truce and better economic perspectives. Accommodative central banks continue to be an added support, as is recent economic data, which keeps suggesting the global economy may have turned a corner. We expect equities to continue to advance in 2020, though rich valuations could cap returns.
- European assets should benefit in the current environment, and we maintain our overweight allocation for now. Over the medium term, we expect better growth and earnings in the US to support that market. EM equities sold off at the beginning of the year due to the risk off sentiment because of rising geopolitical tensions and a stronger dollar. We believe that selectivity remains key given idiosyncratic stories.
- The Q4 earnings season kicks off, with expectations for a decline in earnings to finish the year, though investors are more focused on 2020 expectations, which should see a bounce from the Q4 2019 low. We believe that earnings growth should show upside surprises in the coming quarter, which should help markets to move higher.
- Sovereign yields fell on Middle East fears, but they soon reversed as Iran’s foreign minister stated the country did not seek an escalation in its dispute with the US. US 10-year yields are around 1.85%, while 10-year bonds are at -0.22%. We believe they can drift a bit higher still in the short- term, but we do not expect a sharp back up given still weak growth and low inflation, as well as accommodative central banks. While we believe yields should be somewhat higher in 2020, we maintain some exposure to core segments as protection.
- Credit spreads in the investment grade space have continue to tighten, and HY has continued to follow, so that the widening we saw in December in the lower credit ratings in the US has reversed. We expect spreads to remain broadly range bound for now, and even absorb some higher yields, and still see little systemic risk. We continue to prefer credit, both in the US and Europe, over sovereign bonds and we prefer investment grade over high yield as we approach the later stages of the cycle, though we still see HY opportunities for now. We continue to see attractive opportunities in EM hard currency debt, where spreads have continued to tighten as well.
- With ongoing uncertainty and market sensitivity to headlines, we expect a challenging road ahead, and we continue to add absolute return, flexible strategies such as liquid alternatives for diversification. We expect risk assets to grind higher and we maintain our exposure for now, but higher volatility and short-term corrections should be expected.
By Etsy Dwek, Head of Global Market Strategy.