PLEION SA - Gestion De Fortune

WEEKLY – Investment Adviser – 8 August

PERFORMANCES 2019

Equities Bonds
MSCI World +12.2% CHF Corp +4.0%
S&P 500 +5.0% US Govt +7.4%
Stoxx 600 +10.2% US Corp +12.2%
Nikkeï +2.9% US HY +9.4%
SPI +19.8% EUR Gvt +8.7%
China +21.9% EUR Corp +7.2%
Emerging +0.7% EUR HY +6.9%
Currencies Commodities
USD index +1.5% Gold +16.8%
EURUSD -2.4% Silver +9.8%
EURCHF -3.1% Brent +5.9%
USDCHF -0.6% CRB index -0.3%
USDJPY -3.3%
EM FX +1.6%

Volatility is back

Equities. An underweighting justified by uncertainties and not by the risk of recession

To support the economy, the Fed cut its key rate on July 31st. A few hours later, probably frustrated that the Fed did not cut it by at least 50 basis points, Donald Trump announced, in full trade negotiations with China, tariffs increase on Chinese goods for September 1st. The financial markets did not understand this new measure, except its electoral base. If the US economy goes into recession, it will be the Fed fault. Donald Trump starts his election campaign, if he had never left it, and the next 14 months will be (very) aggressive, partly to warp the debate among the Democrats.

In this summer period, with low volumes, the market has corrected by 7% in 5 days since its highs to come back to their 200-day moving averages. They seem to hold for now. Market volatility (VIX and V2X) has strongly rebounded. In this environment, gold, mining companies and hedging strategies (put options) performed well. Diversification remains essential in portfolio management. We have increased our gold exposure into our balanced portfolios to 6% from 4% and favored Swiss equities (2% of Nestlé and 4% of Novartis) as well as Japanese equities (10% of Nikkei in Yen) to be exposed to the Yen and the CHF in our tactical baskets. The liquidity has been increased to 20% from 15%.

The US Administration has just signed an agreement with Europe on US beef exports while US farmers suffer from the trade war with China. Donald Trump announces this agreement as a great victory, while the European consumer does not want US meat with hormones and cleaned with ammonia. He maintains his pressure on the German car industry, and it is more than likely that he will impose an import tax of 25%. French wine is also in a high-risk situation. It is still surprising, for the moment, to see so little international response / opposition to US outright protectionism.

The decelerating global economy does not need this. Results of the second quarter show that companies are rather resilient. Factset reviews its earnings growth estimate for the S&P 500 from -2.7% to -1%; the increase in revenues is expected at +4.1%. Refinitiv estimates an increase in profits of 2.7% and 3.4% excluding the energy sector, and 4.5% for revenues. In Europe, Refinitiv estimates a Stoxx 600 profits rise of 0.6% in the 2nd quarter and 2.7% for revenues. The bad news is that for the 3rd quarter, the two analysis and forecasts institutes predict a decline in profits of -1% for the first and -0.7% for the second, while at the beginning of the year they were anticipating a strong rebound in profits in the 2nd semester.

This week, 60 companies will release their results including Disney, US Hotels, CVS Health, Viacom, News Corp., Activision Blizzard.

In this environment, the underperformance of emerging equities will continue: investors’ cautiousness with the growing uncertainty about the global growth and trade, the unexpected strength of the US dollar and the probable decline of the emerging companies profits in 2019. De-globalization is a negative process for emerging economies.

  • The campaign for the US presidency will escalate Donald Trump’s aggressiveness
  • Volatility on equities should rise

Asia has been a haven of prosperity…

The region learned the lessons of the 1998 crisis, which seems far behind now. Incestuous monetary links – say pegs – with the USD and extreme reliance on foreign debt have notably receded. Since then, the region has actually experienced peace, supportive demography, growing economies, measured inflation and solid links – alliances – with the Western world. It is no accident that it has become the recipient of huge foreign investments. Thanks to globalization, Asia is now the undisputed leading location for supply chains of most world’s consumer goods.

As a logical consequence, Asia has been investors’ Darling over last decades. It definitely thrived, compared to other emerging markets’ regions, be it Latin America or Eastern Europe.
Perspectives of rampant ¨de-globalization¨ are shaking the foundations of Asian prosperity

…But unadulterated US mercantilism represents a concrete threat

Trump Administration is attempting to reverse its trade deficit (with Asia) and restore US competitiveness. Tariffs is one obvious means of action. The outright weaponization of the USD (and of predominant American financial and payment systems) is another one, just like the forced re-negotiation of military aid / protection. Recurrent attacks against Chinese technology champions (ZTE, Huawei, etc.) are of the same vein.

The next – unusual and corrosive – step might be a USD devaluation. US Administration is indeed reportedly contemplating forex interventions to engineer a 10% fall of the greenback vs. key currencies. Such a strategy has never been unilaterally implemented by the US. Indeed, all the former currency adjustment phases including the USD (Louvre, Plaza, Shanghai) have been multilateral.

US is officially attempting to unbundle Asian supply chains of production. If successful, such a process would definitely imperil Asian prosperity
Watch for US currency interventions, that would seriously disturb sleeping currency markets

 

An insane intra-regional contagion

Interestingly, US targets do not include only adverse countries, but also allies. South-Korea and Japan have been under pressure. Both have been forced to revisit bilateral trade agreements, at the obvious advantage of Washington. Seoul obeyed, while Tokyo has smartly kicked the can down the road yet…

North-Korea has not denuclearized, quite the opposite. South-Korea and Japan are the two most concerned neighboring countries, with quite unreconcilable objectives: merging / containing Kim vs. demilitarizing / confronting Pyongyang. This strategic dissension emerged lately when Tokyo decided to unilaterally stop exports from ¨sensitive¨ chemical products to South-Korea for an unspecified period…

Hong Kong is on fire. Beijing is contemplating to maintain order by force, which would be a dangerous precedent. Mainland China has become less dependent of HK as a financial gateway. It is concerned that endless demonstrations may ultimately spread and fuel a leadership challenge mainland. China is also militarizing islands in the South China Sea to intimidate other countries and force them abandoning their claims. Taiwan’s future is far from clear. Unifying Taiwan with mainland remains the ¨Chinese Dream¨ of Xi.

Japan is on the verge of changing its constitution. The idea is to re-militarize the country and namely to develop its nuclear capacity. For now, despite his large victory at recent elections, Abe has not the necessary 2/3 majority to proceed for it. But intense negotiations with a small party are underway. No doubt that a nuclear Japan would infuriate China and South Korea…

Asian Golden Age is under threat. It is easy to imagine that Asian future could be worse than that of the last two/ three decades
China rise is deeply shaking the development models of Asia. Fortunately, China hates precipitation and short-term tactics

  • China holds most of the keys that may trigger major strategic changes / developments in the region
  • But Japan also deserves particular attention, because of its actual – unusual – strategic weakness
  • We are probably experiencing the last moments of (too) low currency volatility
  • Asian assets are due for further consolidation / underperformance

 

Fixed income. The Fed is not to blame

As expected, the Fed cut for the first time in a decade its Fed funds rates by 25 bps to 2.00-2.25% by 8 pros and 2 cons. A bit surprisingly, the Fed decided to end its balance sheet shrinking immediately, i.e . a couple of months earlier than scheduled, but the decision is not a game changer. The Fed highlighted 3 reasons for easing (1) higher trade uncertainties, (2) a slower global growth and (3) a low inflation. However, a big difference shall be done. It is the first time the Fed cuts its policy rates in a so easy environment. Financial conditions and real yields have never been so low at the time of the first rate cut.

The Fed was trying to balance between delivering a dovish message and not promising more than it wants to deliver at a later stage. In line with our expectations, the Fed repeated that it will act as appropriate to sustain the expansion. This easing bias suggests that more cuts are likely. However, FOMC members will not pre-commit to more cuts. This was more on the hawkish side. Powell did
not rule out more cuts. He did not qualify it as the beginning of a long easing cycle but rather a mid-cycle adjustment or an insurance cut. Fed will be data and trade talks dependent. Given the Fed’s data dependency and focus on trade talks, it has become more difficult to predict monetary policy.

He later clarified that it just means that the FOMC does not expect a long cutting cycle like in a recession. It does not mean this was a one-off rate cut.

This cutting cycle might be more comparable to the 1995 and the 1998 easing periods, when the Fed cut rates 3 times to prolong the expansion period.

The global manufacturing cycle had a weak start to Q3, giving global central banks the perfect excuse to ease monetary conditions. July PMIs dropped by more than expected in Europe and the US. The unemployment rate remained near historical lows and the underemployment rate declined to its lowest level since 2000.

June spending data suggest the consumer remains on solid footing, and a pop in the consumer confidence index for July suggests spending should remain elevated.

Despite the US expansion now being the longest on record, the solid Q2 GDP growth and the low unemployment rate, the benefits of easing the monetary policy are now greater than the costs of not doing it.

Even more when the inflation remains on the low side and the uncertainty surrounding the macro outlook has increased. Trumps 10% tariff on further $300bn worth of Chinese goods could be the trigger. We still look for more rate cut this year.

  • More Fed Funds cuts depend on data and trade talks

 

Fixed income. European long-end yields could stabilize

It may be worthwhile highlighting that European long bond yields could be about to stabilize a little once the ECB announces a new round of asset purchases in September. Why? Because investors have already well front run the ECB QE program impact.

  • The record low long European yields should support low US treasury yields

 

 

Disclaimer

This document is solely for your information and under no circumstances is it to be used or considered as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. All information and opinions contained herein has been compiled from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to their accuracy or completeness. The analysis contained herein is based on numerous assumptions and different assumptions could result in materially different results. Past performance of an investment is no guarantee for its future performance. This document is provided solely for the information of professional investors who are expected to make their own investment decisions without undue reliance on its contents. This document may not be reproduced, distributed or published without prior authority of PLEION SA.