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Investment Strategy – September 2018


Vision and pro-activity

US business cycle has been particularly buoyant of late. Growth and inflation largely outperform that of developed countries. The US no longer flirts with deflation, rightly considered to be the worst evil for a democratic society. For sure, part of the momentum is due to the spectacular Trump tax stimulus. But still… the US is the sole economy which actually emerged from the Great Financial crisis (2008-9) with healthy financial and private sectors, whose competitiveness and profitability actually outperform inter-national peers.

This success is largely due to the Fed, which opted for a visionary approach to monetary policy last decade i.e. financial repression. In short, it consists of imposing negative real interest rates, in order to restore health to banks and provide cheap funding to corporate and governments. US central bank engaged first and boldly in this unconventional monetary policy. For the couple of last years, it has been attempting to gradually exit from it. Other G20 central banks followed the Fed through, mildly and with significant delay, namely the ECB. Most emerging countries refrained from doing it.

US is thriving, while G20 countries keep on lagging


Trade-related risks remain quite significant

Our baseline view remains that trade tensions will fade in time as the damage of escalating trade tensions becomes evident to the White House. Despite President Trump’s claim that he is a free-trader, he appears to be a protectionist at heart and clearly views commercial relations in terms of winners and losers. Given this perverse view of trade, the risks of a damaging trade war are not as low as they should be. Just like the past few weeks, geopolitical developments and trade war tensions between the US and China as well as the ongoing negotiation between the US and Canada regarding a revamp of NAFTA will remain the main drivers.



Fears of a boom and bust cycle are genuine

Trump wants outright growth whatever the ultimate cost will be. He imposed his Cabinet to base its policies and forecasts on a 3%+ sustainable growth rate over the next years. In a way, he pursues the same cyclical (and electoral) objectives as Burns, with a 2020 deadline in sight. But, so far, he has definitely not used similar means of action. For sure, the acceleration of expansion is well advanced in 2018, essentially thanks to fiscal hyperstimulation. This process, very late in the cycle, may well interrupt the ¨Great Moderation¨ – in place since a decade – if not provoke the end to the business cycle. In such a scenario, the temporary phase of inflation ¨irritation¨ would in no respect be comparable to hyperinflation à la 70’s / 80’s.

Recession probability indicator for US economy

Source: Guggenheim model

Under Burns (Counselor to President Nixon & Chair-man of the Federal Reserve 1970-1978), it took a couple years of lax policy to generate runaway inflation.

Structural forces will keep a lid on US inflation.

US administration is rather looking for a) drawing a future line in the sand to Powell, and b) designate a convenient scapegoat, ahead of the eventual growth slowdown in 2019.

Trump doesn’t represent a peril for Fed independence. It is premature to denounce his intrusion in monetary policy

Ongoing economic policy raises the odds of a boom and bust cycle

USD and US Treasury yields will not be impacted – at least in 2018 – by this ¨noise¨


In 2018, only very few assets managed to deliver positive returns

In short, if investors did not invest markedly in certain US equities or in expensive US high yield, they probably are in negative territory year to date. Even a correct / positive view on oil was hard to turn into capital gains, as related assets (oil equities) are still at pain.

The blame is often on passive investing vehicles, quant funds and algorithms. This was even a topic at the yearly conclave of central bankers (Jackson Hole). The whole issue is on liquidity, which may actually dramatically dry, if ETF managers were forced to sell in a crisis. Passive investments are accused of ignoring fundamentals, favor herd instinct and cause systemic risks… According to JPM only about 10% of US equity investment is now done by traditional, discretionary investors. This is not new. This is probably a tail risk to consider in portfolio construction, by including a significant portion of portfolios in cash, US sovereign bonds, gold and actively managed vehicles…

The raging bull USD devastated peripheral markets which are potentially dependent from US funding and interest rates’ level. Political factor / risk i.e. trade war also played a role in discouraging investors. Beyond the surface (i.e. highly commented pressure on TRY, RUB) outflows also concerned equity markets in South-East Asia, where Trump tariffs may eventually weigh on trade. It seems exaggerate.

US long sovereign bonds still provides diversification. But a structural regime shift is possible moving into 2019
It would put serious tensions on markets
Window of opportunity is opening for emerging assets




  • Cash
  • Alternative investments
  • Equities


  • Bonds



Local developments are the main drivers for now>7h2>

The USD is tracking a firmer course overall as markets eye potential trade conflicts with China, the EU and Canada while EM FX tensions remain front and center for investors.

The EUR remains better offered following stall around the 1.17 area. The USD is gaining by default to an ex-tent but US-EU trade tensions remain an obvious background concern for investors after the EU’s offer for zero tariffs on industrial goods trade with the US was rebuffed by the White House. Fitch downgraded Italy’s long-term outlook and will update ratings in mid-October. External pressure may prompt the Italian government to keep fiscal policy in line with EU rules.

Events in Italy and Turkey have played their role in sending the CHF higher, but the threat of further Russian sanctions have also played. The Swiss National Bank said that their policy of negative rates and FX intervention are still in play. The EUR/CHF is near 1.1250, where it was in August 2017, and where the SNB started intervening and could do it again.

The GBP was served a dose of reality on two fronts, with EU Brexit negotiator Barnier “savaging” (in the words of one paper) PM May Brexit plan and former Foreign Minister Johnson taking aim at the PM for her negotiating position. It is hard to see where PM May goes from here; her basis for negotiating Brexit with the EU is unworkable with Brussels and unacceptable to a significant part of her own party.

As widely expected the RBA held the official rate steady at record low 1.5%. The statement did not change much. The central bank maintained its positive view on economic growth and is forecasting growth rate a bit above 3% in 2018 and 2019. Similarly, the monetary institution remains worried about the out-look for household consumption as household income has been growing slowly, while debt levels are high. Regarding inflation, Governor Lowe maintained its forecast of 1.75% for 2018.

It has been a volatile period for USD/CNY, which reached a high of 6.9376 as trade tension continued, and the divergence in monetary policy between the US and China be-came more apparent. The resumed trade talks did not produce any result. The strength of the US economy has emboldened the Trump administration to press on, at a time when recent PMIs and the July activity data show the Chinese economy is slowing. Chinese authorities, having al-lowed the yuan to weaken in response to the trade escalation, have now signaled that they are unwilling to let the currency slide further beyond the 6.95–7.00 level last seen in late 2016. The reintroduction of a 20% margin requirement for forward transactions, setting yuan fixing on the stronger side.


  • USD


  • EUR, CHF


  • GBP, JPY



Central banks are maneuvering

The Fed continues to suggest monetary policy is accommodative and that it expects to maintain its policy of gradual rate hikes. We interpret this as one 25 bps rate rise per quarter. Indeed, the growth backdrop remains very strong with the economy expanding by 4.2% in 2Q18. Tax cuts are supporting consumer spending and are boosting the profitability of US corporates. Headline inflation may be close to a temporary peak, but core measures should continue grinding higher. Consequently, we look for both September and December hikes from the Fed. We expect modest policy tightening in 2019 – just two rate hikes. Economic activity is likely to slow in 2019 as the lagged effects of tighter monetary policy and the stronger USD act as a brake while the fiscal stimulus support will gradually fade. Trade protectionism could also increasingly weigh on sentiment and spending, so medium-term inflation fears should recede progressively.

Thanks to its June announcement of an anticipated reduction of the monthly purchasing program to €15bn after September and an end by the end of 2018, the ECB has put itself on autopilot. In fact, as long as there are no real accidents in the economy or inflation developments, the ECB can lean back and relax. Even though wage increases in several countries have still not found their way into higher core inflation and trade tensions or Italian fiscal policies bear the risk of increasing uncertainty, the underlying solidity of the Eurozone recovery should comfort the ECB to stay on autopilot. With the QE end in sight, the market focus will shift to the timing of the first rate hike. Here, ECB president Draghi was very clear: interest rates will re-main unchanged at least through the summer of 2019.

The Bank of Japan continues to play a game of moving closer to ending its QE while pretending it is doing exactly the opposite. The last BoJ rate decision in July involved a modest tweak to the language while at the same time loosening the yield target for Japanese government bonds. 10-year JGB yields have been trading consistently above zero for some weeks now, and 0.1% has become the de facto new target. The forward guidance is contained. Coupled with a slight softening of the BoJ’s commitment to keeping JGB yields at about zero, the July statement was, in fact, slightly more hawkish. It would be better for them to come clean and just admit that QE is happening at a fraction of the pace it used to, that will inevitably have to be wound down at some point. By the way, this would be a lot easier to achieve their 2% inflation target.

The Swiss National Bank is maintaining its ultra-loose monetary policy. At its June meeting, the SNB left its main policy rates unchanged in negative territory. The SNB also reiterated its willingness to intervene as needed in foreign exchange markets. Given the open-ness of the Swiss economy and its dependence on the EU for trade, the SNB worst nightmare is too strong an appreciation of the CHF. The SNB believes the franc is “highly valued” and that it is still considered a safe-haven asset by investors. Indeed, when global risks increase, the CHF value tends to increase drastically, especially against the EUR. Turkey’s crisis illustrated this tendency clearly. Consequently, we do not expect anything new from the SNB at its September meeting, apart from a strong emphasis on the Swiss franc’s value. We don’t expect a rate hike before the ECB starts raising its own rates. Given that the ECB is not expected to hike after the summer of 2019, the SNB won’t hike before December 2019.

Over the past couple of years, we have witnessed a pronounced flattening of the US curve, where the US 10 years — 2 years yields spread have moved from 125 bps at the beginning of 2017 to currently around 20 bps. It is well known both in academia and in financial markets that an inversion of the yield curve over the past 50 years has been able to predict a recession in one to two years time. Hence, the inversion itself can impact how the market is pricing its Fed funds expectations and in the end also impact actual monetary policy. If the curve were to invert, the Fed would probably be more reluctant to hike rates.

We do not forecast an inversion of the yield curve in treasuries his year. Furthermore, we continue to hold the view that 10 years treasury yields will not move above the 3%-3.25% level over the next 12 months. The yield curve will be very flat and we should expect a lively discussion whether this is a signal that a new US recession is getting closer or not. European and Swiss government rates would remain depressed and in their past 12 months ranges.


Credit markets under different pressures

US High Yield (HY) spreads have remained very stable even in the recent volatile period. The gap with their US Investment Grade (IG) peers, around 250 bps, is less than half of what it was a decade ago. Only based on this metric the US HY market looks expensive, so investors should favor IG bonds instead. However, as we have expressed many times in the past, the overall credit market has morphed, and the quality has shifted to the downside. The BBB segment rep-resents now more than 45% of the credit universe, com-pared to less than 35% 10 years ago, while the CCC segment has decreased from 16% to 12%.

Apart from having more duration and credit risk than a decade ago, the IG credit market will face challenging refinancing period ahead. The debt has ballooned over the past 10 years as companies rushed to fund at ultra-low yields. US IG companies have issued more than $1’400 bn bonds last year compared to a cyclical low of 850 in the 2010-2011 period and 1’100 in 2009 after the financial crisis. At the same time, HY issuance has remained steady around $350 bn penalized by the debt crisis, the oil price collapse and companies stress in 2014-2015. The overall credit market has become more homogeneous.

The ongoing financial stress across EM, increasing trade tensions and the Chinese credit market repricing – on the back of higher defaults -, have all resulted in a significant EM HY spread widening. It is above the 525 bps over US Treasuries, that is a 170 bps widening since April 2018.


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


  • Investment Grade


  • German Bund, Inflation
  • Peripheral, Emerging local currency,/li>



The winner is … the United States

The year 2018 is clearly the year of the US with records broken on both levels and longevity for the S&P 500, Nasdaq and Russell 2000. The positive performance of the S&P 500 is mainly due to 8 stocks: Amazon, Microsoft, Alphabet, Apple, Netflix, Mastercard and Visa.

Some investors are considering the end of the US bull market because of its age (10 years) and historic levels beaten, an easy shortcut since the 2 dominant and undisputed parameters that explain the stock market indices evolution – expectations of earnings growth and stock market valuations – remain favorable.


The current secular bull market re-mains valid

In the US, the rise in profits was exceptional with +24% in the first half, supported by the tax reform (tax rate passing from 35% to 21%), which has provided $ 1.5 trillion in tax relief for individuals and businesses, and a program to ease administrative burdens. The tax reform has also resulted in an acceleration of stock repurchase programs, estimated at $ 850 billion in 2018, and a substantial increase in dividends. Despite a rise of 4.2% of US GDP in the 2nd quarter and oil, inflation remains contained and the US 10-years stays below 3%, justifying the current stock market valuations. We do not perceive a bubble situation. Within 12 months, an environment of low inflation and rising profits will remain favorable to equities.

However, we should see in 2019, a growth recession, that means a more moderate increase in earnings, not a con-traction. US profits are expected to rise by 20% in the second half of the year. Analysts expect +10% in 2019 and 2020.

One of the principles of Finance 101 (10 principles of US household finance planning): if corporate profits go up, stocks rise, if profits fall, stocks fall. Simple.

Another question often comes up: will the US stock market fall if Donald Trump is destitute ? The answer is no. Trump is a master in show and communication, trying to convince Americans that the US is running out without him, but the good economic fundamentals will stay. Mike Pence would keep Donald Trump’s 2 strong measures, the tax reform and the easing administrative burdens program. And it should calm the game in the trade war, without letting go in the fields of technology and national security.


No secular bull markets for the other stock markets

We talk a lot about the US, because 1) economic and stock market performances are exceptional, 2) US equities ac-count for 65% of the MSCI World and 3) there are no (or few) equivalent companies in the world to those in technology / new economy.

European indices are not in the same configuration, and the performances are very heterogeneous. Since March 2009, the beginning of the US bull market (+331% for the S&P 500 and +540% for Nasdaq), European indices have recorded 2 bear markets, in 2011 and 2015, with corrections between 25% and 30%. Since March 9th, 2009, the DAX has recorded a performance of 240%, while the CAC 40 has increased by 117%, the FTSEMIB by 64% and the IBEX by 39%.

The US stock market is better hedged from external shocks and the US banking sector has been strengthened during the financial crisis, while in Europe, banking nationalism has resisted, governance has not changed, the Greek and Cypriot crises have weighed, the Italian banking sector remained fragile, the Russian invasion in Ukraine and international sanctions against Russia have affected some export sectors, immigration resulted in the emergence of populism (Italy, Poland, Hungary), US sanctions against Iran have forced European companies to go out of a promising Iranian market and the Turkish crisis is affecting Spanish, French and Italian banks. In the Trump’s trade war, Europe is the weakest link because it is not organized to fight back with one voice.

The Nikkei recorded in 2018 the same performance as the Euro Stoxx. But the problems are different. Japan has evolved into a “war” zone between North Korea and the US, and then the US-China trade conflict. In recent months, the yen has appreciated 8% vis-à-vis the renminbi.

The stock market valuations (PERs) are logically higher in the US, a little less in Japan and attractive in Europe. But if we adjust them to the profit growth (PEG ratio), the result is slightly different. The comparison with the rise in equities in 1999-2000 is nonsense: stock market valuations are lower, companies have great earnings and balance sheets are full of cash.


Central banks’ liquidity withdrawal has a painful impact on EM

Argentina, Venezuela, Turkey are in crisis. The Brazilian real reflects the worry of the October elections. The Indian rupee falls and the Chinese macro figures dis-appoint. The profits of European companies exposed to emerging markets, and Chinese in particular, were below expectations.

Emerging stock markets are vulnerable to central banks’ liquidity withdrawals, while developed country stock markets are more resilient.

Withdrawing cash is not the only factor, even if it is dominant. There is also the USD strengthening, the Chinese economic slowdown and the rise in oil that weighs on the most vulnerable economies and oil-importing countries like India. China is also in an over-all indebtedness reduction, resulting in liquidity reduction.


  • Europe, Switzerland, Japan, Emerging
  • Small/Mid Caps, Value
  • Discretionary, Financials, Health Care


  • US
  • China
  • Large Caps
  • Growth
  • Staples, Industrials, IT, Materials, Energy


  • UK
  • Telecommunications, Utilities

Alternative Investments

Gold, a poor performer

It was thought that gold would outperform in 2018 with the trade war, with a possible currency war, with geopolitics and with the debacle of emerging assets. The contrary has occurred: the ounce of gold fell by 8% in 2018.</p

Historically, gold prices have been negatively correlated with the US dollar and real rates. The USD appreciation partly explains the gold price decline. On the other hand, since the beginning of 2017, the relationship between the gold price and US real interest rates has changed: it is no longer so obvious to see gold prices rising when real interest rates drop, and vice versa.

First, an important point to understand the following: 60% of gold demand – excluding central banks – come from China and India.

<p<So, gold perform poorly due to:

1) Demonetization in India, to “bancarize” the Indian economy, makes gold less attractive for households. The Indian government wants households to stop hoarding their savings with gold parked at home.

2) Cryptocurrencies, whose first users are Asians, and Chi-nese in the lead, are an alternative to gold.

3) A few years ago, gold was a substitute to banks in China and India. Not anymore.

4) New technologies and e-commerce mean less cash in the world, a faster process in Asia.

5) South Korea will remove the coins in 2020.

The reduction of banknotes and coins in the world, especially in Asia, will translate into less physical gold buying by Asian households.


Oil, risks persist on the supply side

By the end of 2016, OPEC, in fact Saudi Arabia, and Russia had managed to come together to limit production and thus push up the prices of Brent crude that had fallen below $30 in early 2016.

It worked: Brent is $77 a barrel today. A few months ago, OPEC and Russia decided to relax this agreement for the sole purpose of preventing oil from surpassing $80, a level that could affect consumer-country demand and overall economic growth.

Today, demand remains strong, while supply remains at risk:

1) US sanctions on Iranian exports will come into force on November 4th.

2) The problems persist in Venezuela, Angola, Algeria, Iraq.

3) Over the past 4 months, there has been an end to the progress of drilling rig openings in the US due to a lack of pipelines to transport oil/gas. This situation could last until the second half of 2019.

If the world economy does not go into recession, oil prices are likely to remain high because of supply pressures.


Industrial metals follow the doldrums of EM

Since the beginning of summer, copper has lost 19%, aluminum 7%, zinc 24% and nickel 15%, the metals most correlated to overall growth. Their prices follow the Chinese economic slowdown and the flattening of the US yield curve.

Outflows from EM assets have had an impact on industrial metals. But investors fear that the real risk is a weaker Chinese economic growth, while China consumes 50% of industrial metals

This emerging crisis comes at a time when the Chinese authorities are in a process of reducing corporate debt, where the dollar is strengthening, making metals more expensive for Chinese buyers and where Donald Trump is about to increase his trade war with China. The number of futures contracts betting on a decline in copper prices are at their highest in 22 months, a sign that hedge funds and traders have a negative view on prices. In general, a positive signal for contrarians.

But prices for metals such as steel, coal or iron ore, which are not traded on the financial markets, but between customers, are at the highest, signaling that demand remains strong. The prices of industrial metals will depend on how the Chinese authorities will stimulate their economy.


  • Industrial metals


  • Precious metals
  • Energy
  • Real Estate
  • Hedge Funds




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