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Investment Strategy – February 2019

Strategy and Macro

Asset allocation

In 2018, lots of institutional investors have had an exaggerated reaction. Their herd mentality actually favored the continuation of carry trades during the 3 first quarters of 2018. But Q4 featured a hard landing as risk-off resurrected brutally, pushing nearly all asset classes into negative territory. Consequently, the consensus has shifted to a very cautious stance in a couple of weeks.

On the verge of mini-bubbles burst and of the dramatic collapse of investors’ sentiment. And despite of ongoing markets’ fear, we consider that the several recent adjustments are positive. Indeed, dissipation of speculation and more realistic risk premiums across all asset classes reduce the risks of dangerous bubble formation.

The setback of interest rates and of oil prices is supportive to consumption and housing. The Democrats’ victory will refrain Trump administration from granting additional / extravagant gifts to US private sector at this very late stage of the economic cycle.
We maintain a neutral weighting for bonds and equities
We increase the risks within the fixed income segment
We continue to redeploy ourselves in equities, while maintain a focus on quality

  • End of liquidity profusion provokes a Psychodrama
  • Ongoing de-bubbling and unwinding of carry trades
  • New markets conditions / specificities reinforce short-term trends
  • Towards a stabilization of financial conditions
  • Markets’ growth scare is exaggerated


Macro perspectives

Despite markets’ fears, we neither anticipate a US recession in H119, nor a relapse into – severe – disinflation. Still, a few important / negative changes have taken place over the past couple of months. China is experiencing a significant slowdown, namely of its demand / consumption.

US business surveys and latest European data (for example industrial production in Germany) confirmed the ongoing deceleration of activity. US financial conditions have significantly deteriorated, courtesy of a growing investors’ risk aversion and a widening of credit spreads. For now, the correction in risky financial assets has not proved large enough to potentially impact on consumers, but negative developments on housing is a complementary negative factor to also consider. This bears careful watching.

The deceleration in China is due to continue in Q1 19. The likely adoption of tax reduction for the private sector, which magnitude is not calibrated yet, will only deliver results over the summer at the soonest. The recent acceleration of liquidity injection by the PBoC in the banking sector will only prove successful in rejuvenating some credit growth. However, other significant sources of refinancing, namely the shadow banking system, will remain under constraint / State scrutiny. China remains committed to reduce its global over-reliance on leverage. Therefore, a significant credit-induced stimulation – à la 2016/17 – is unlikely at this stage.

Global inflation developments have been muted. Even in the most buoyant economy, i.e. the US, it does not represent a concrete threat. Further deceleration of inflation in China would become worrisome if confirmed during H1. Beijing will eventually implement bazooka-like measures, including lower policy rates, if the Yuan recovery (hence USD weakness) allows for it. This is conditional to some form of trade truce with Washington.

The expected 2019 slowdown is now confirmed by hard data
In the US, no negative Wealth Effect is expected yet
Watch for additional stimulus in China


Global framework

In its latest yearly review of global geopolitical perspectives (Top Risks for 2019), I. Bremmer the famous CEO of Eurasia group, considers that: ¨The geopolitical environment is the most dangerous it has been for decades… The overwhelming majority of geopolitical dynamics that matter is now headed in the wrong direction¨. He namely considers that the new competition between US and China will become more escalatory.

In the US, institutions remain resilient and should not be put at risks by the unprecedented style / actions of the new President. Trump might well be impeached by the House, but the Senate will most probably not confirm it with the necessary two-third majority. His practical removal from the office is hard to imagine, but the Supreme Court may ultimately be busy coping with issues linked to separation of power, paving the way to a constitutional crisis.

Negative impacts from the trade war have become visible on several countries, among them namely US, China, Germany. This may play a dampening role on Trump assertiveness, when it comes to negotiating with Xi. Both juggernauts are likely to contemplate reciprocal concessions – short-term – to avoid pushing their home country into a risky recession.

Global (geo)political risks remain elevated
But no dramatic spillover to economic development is expected for H1 19

Unusual forced-selling culminated at year-end for several reasons. After a dismal markets’ performance over theyear, many managers developed ¨commercial / marketing¨ window-dressing, in order to present ¨prudent and adequate¨ sort of portfolios. This was reinforced by the traditional tax orientated window-dressing, in order to take advantage of realized losses. Traditional active fund managers also took a beating because of very large clients’ redemptions. All this happened in a period well-known for poor seasonal liquidity conditions, due to banking regulation and proprietary traders ¨holidays¨. The predominance of algorithmic trading reinforced this negative trend, short-term.

Very specific markets’ conditions at year-end prevailed
Most of them will gradually evaporate over Q1



  • Equities
  • Cash
  • Fixed Income
  • Alternative investments




The 2018 USD supports are vanishing

The USD should embark on a gradual long-term bearish trend as the Fed is close to its terminal rate, the fiscal impulse is fading and growing market concerns about twin deficits should push the USD lower. While the USD decoupled from the widening twin deficit last year, this is unlikely to be repeated.

The chances of a more damaging fight over the debt ceiling are rising. The debt limit is suspended until next March. The Treasury currently has $300bn in cash and, allowing for the usual surge in income tax receipts in April, funds won’t run dry until a few more months after. But in the absence of a deal to raise the debt ceiling by July, there would be a risk of the Treasury missing a payment on the national debt.

The USD long positioning remains stretched, any unwind should be sharp.


A great ECB achievement but at what price?

The ECB just confirmed its QE program end. Some might argue that it comes too late, others that it comes too early. In any case, the ECB has shelved its unconventional tool without distorting markets. Despite a moderate upbeat economic scenario, the ECB remains extremely cautious. The autopilot is now replaced by the data-dependent stance. In case of an economic accident, the ECB first line of defense should be the forward guidance on rates. Some rate action towards the end of 2019, as liquidity facilities, look plausible. Political risks stay elevated, but well known and already discounted in the EUR.

Some weeks ago, the BoJ was still optimistic about future policy change. Now that prospect seems to have evaporated. Not that much things have changed. Sure, Q3 looks a disaster but Japan was hit by a natural disaster. So, why the BoJ is not worried with yields back below zero. The reason comes from outside. The Fed and, more importantly, the ECB are trying to normalize. So, the BoJ could gradually allow policy to drift in a slightly less accommodating direction. The JPY is appreciating against the USD and Kuroda is now trying to talk down normalization expectations to limit the currency fallout.

The Swiss National Bank (SNB) maintained its ultra-loose policy unchanged. It lowered its growth and conditional inflation forecasts for 2019 and 2020. The policy normalization may not happen for a few years. It looks ever more likely that it is going Japanese. No rate hike could be expected before March 2020. The SNB will wait after the ECB starts hiking rates before doing so. The CHF remains exposed to safe-haven flows even if it looks expensive.


EMFX in a stable USD world

In a stable USD environment, this will benefit to all the EM currencies, but with different sensitivities. Fist of all, the CNY will remain a key player. The PBoC has just started easing its policy.

However, the announced RRR cut of 1 percentage point is not going to affect the USD/CNY materially as it is not a direct interest rate cut. Then, high beta currencies, which have been sharply hammered by the USD and US yields spikes last year, should benefit for a less restrictive US monetary policy going forward at a time those currencies are offering substantial real yields. Lastly, Central and Eastern Europe currencies should do well in USD terms, but unlikely to be a meaningful outperformer in the EM FX space.

  • The USD peak is behind us
  • The EUR and JPY remain inexpensive
  • EM currencies become attractive again





  • CAD



The Fed quantitative tightening kicked in

The Fed’s balance sheet contracted by $373bn in 2018 and has already shrunk by $396bn since September 2017 i.e. a 9% decline. At its peak, the balance sheet was $4.5tn. For now, at least, it is set to continue at a pace of $50bn per month. If it continues at the same pace over the next 6 months, it will have declined by another 7.5%.

The evidence that wage pressure is finally picking up in the US nearly 10 years after the recovery began.

This only remains a harbinger of a potential pickup in inflation. However, core inflation increasingly looks like it has peaked out in this cycle. US money supply and credit related data are also increasingly giving signals of an inflation slowing. M2 growth slowed from 7.5% in October 2016 to 3.9% in November 2018. Bank loans growth also slowed from 8.4% in May 2016 to 4.4% in November 2018. Even if credit aggregates are more relevant than monetary ones, both need to be considered. The ongoing Fed balance sheet contraction means that money-supply data should not entirely be ignored.

Given the recent financial market turbulence and uncertainty caused by the ongoing government shutdown there will be a Fed pause in Q1, but in an environment of respectable economic growth, rising wage and a stable core inflation, we still look for tighter monetary policy.


An already well discounted scenario

Investors have already well discounted this challenging landscape it in the fixed income space. The rising credit stress suggests that the monetary tightening cycle end in the US is nearing. The Fed “dot plots” forecasts still suggest a 50 bps hike this year and another 25 bps in 2020. This looks unlikely given the recent financial conditions tightening fueled by widening credit spreads and correcting risky assets. This has attracted the attention of the Fed, as confirmed by the latest Powell’s comments.


Credit spreads have also fairly repriced the risks

In such a context of financial conditions tightening, credit spreads need to be watched closely. BBB-rated bond and US HY spreads have risen since early October. Also, US Leveraged Loan indices have declined to their lowest level since July 2016. The EUR investment-grade and high yield corporate bond spreads have risen from their lows reached in early 2018. They look both fairly valued again. According to S&P Global data, valuations are already providing, from AA to BB-rated bonds, enough compensation to cover default rates.


De-risking flows already materialized

The past year also ended with reports of credit markets tightening up as it suddenly became difficult, if not impossible, to issue high yield bonds or leveraged loans. Thus, hat a single high-yield deal by a US corporate occurred in December. The last time was in November 2008.

  • The US long-end yields are discounting a too pessimistic scenario
  • Credit spreads are fairly valued
  • We increase our Emerging and HY exposure



  • US Treasury, Investment Grade, High Yield,
  • Hybrid/Sub, Emerging hard currency,
  • Emerging local currency


  • German Bund, CH Bond, Inflation, Peripheral
  • Peripheral,



Downward revisions in earnings growth estimates for 2019 and ad-justment of stock valuations

The fourth quarter of 2018 was an adjustment period on earnings growth estimates for 2019, with an acceleration in December. Investors have been very complacent throughout 2018, focusing on the 25% increase in profits over the first nine months in the United States thanks to the tax reform.

But the trade war and the undermining of multilateralism resulted in lower overall macroeconomic data in the fourth quarter and growth estimates for both macro and micro 2019 were revised downward.

In the United States, for the 4th quarter of 2018, the consensus on September 30 was based on a 16.7% increase in profits, whereas today this rate has been reduced to 11.4%. Same trend for 2019: the consensus was around 10%-12% at the end of September compared to 5%-7% currently. According to Factset, profit growth is estimated at +7.4% in 2019 (+10.4% at September 30) and +7.3% according to Lipper. We believe that we are coming to the end of this readjustment process and stock markets should stabilize when the consensus will agree on a growth range.

In previous cycles, the evolution of PE ratios was in line with that of GDP. Since early 2018, the PE ratio of the S&P 500 has contracted, while US growth has remained on a positive trend: 1) in the first half of 2018, the contraction was linked to the normalization of the Fed’s monetary policy and the reduction of its balance sheet, and 2) in the second half of the year, it was due to profit growth revisions for 2019. The stock markets therefore seem to have anticipated a large part of the economic slowdown and the normalization of the Fed’s monetary policies. We therefore observed significant revisions to earnings growth estimates for 2019 and a contraction in stock valuations. All we needed was a major “clean-up”, which was observed in December: outflows from active equity funds/ETFs have been historically very high. These outflows coincide with the extreme fear levels of investors’ sentiment indicators. In conclusion, we do not fear a bear market: the current levels of valuations (15x 2019 for the US, 12x for Eurozone and 14.5x for Japan) are in line with a scenario of a global slowdown. A trade agreement between the United States and China, as well as a US Federal Reserve being “patient”, are positive factors for global stock markets.

However, volatility will not disappear: commercial, technological, (geo)political and social conflicts will be present in the coming years with the rise of populist and nationalist forces. The next European elections this spring should confirm this trend if we refer to the polls.

A stable dollar and a trade agreement between the United States and China will favor emerging stock markets.

We believe that China is waiting for a trade agreement with the United States which is slowing down dangerously before lowering policy rates. The Chinese stock market fell by 25% in 2018 and stock valuations are on very low levels at 9.6x 2019 for the CSI 300 and 7.7x for the HS China Enterprises.

The Chinese stock market is a momentum market and therefore has a significant catch-up potential when the authorities will react brutally. Chinese equities have good support in the medium to long term: the gradual increase of their weights in global indices. This configuration would be positive for the metal sector benefiting from a reflation process.

In Asia, India remains interesting. The departure of Indian central bank governor Urjit Patel eases tensions with the government. Under Modi’s firm hand, the Indian economy is in transformation. In Latin and Central America, the two largest countries, Brazil and Mexico, are led by new populist and nationalist governments.


  • Switzerland, Emerging, China, Value
  • Discretionary, Staples, Health Care


  • US, Europe, Japan, UK, Energy
  • Large & Small/Mid Caps, Growth
  • Industrials, IT, Financials,
  • Telecommunications, Utilities,


  • Materials



Oil. If nothing justified a $100 per barrel for Brent, the $48 was also unfounded

At the end of September 2018, Brent was trading at $86 a barrel, and the consensus was boggling with certainty at a price of $100 because of supply concerns (Iranian oil exports stopped). A few days later, a radical change with expectations of lower demand due to an economic slowdown in 2019 and the Brent was touching $48 mid-December. Not very serious all that ! The price of oil is political and/or geopolitical. For the next few years, there is enough supply to meet the increase in demand, coming mainly from emerging countries. Americans, Saudis and Russians can produce more. Venezuela can potentially return to the market with 2 million barrels/day.

The Saudis and Russians need high stable prices to guarantee a balance of their budget, around $75. Americans, Norwegians, Brazilians and British need prices at least $50-$55 to cover production costs. And consumer-countries and economists do not want a price over $80. In short, we are keeping our estimated price at $70-$75 for 2019.


Gold is shining again

The environment is favorable for gold:
In 2017, cryptocurrencies were an alternative to gold for Asian investors. Not anymore today. The volatility in equity and bond markets restores attractiveness to gold, which is less volatile. The USD index is stabilizing. So, in the short term, speculators are covering their short positions. And finally, gold continue to play its full hedging role in a diversified portfolio when times are tough.


  • Energy, Precious metals, Real Estate


  • Industrial metals
  • Hedge Funds


  • Soft commodities


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