Investment Strategy - January 2020

According to Gilles Moëc, Chief Economist at AXA IM: “Markets clearly want to believe in a robust recovery, and to some extent we agree the skies have cleared. Still, we would love to see actual data match this rebound in sentiment. We continue to think it is not going to be easy for global growth to exceed potential this year, even if some signs of improvement are appearing. China – as often – will be pivotal.”

The world economy is breathing better but it is still not ready for a sprint.

In China, dealing with the financial imbalances and a reacceleration of the reforms – although obviously a positive in the medium run – will cap the re-acceleration this year.

In the developed world, consumption is doing well but we remain concerned by the poor investment dynamics.

“Global dataflow has not changed much over the last few months. In most regions manufacturing continues to struggle – even if it has probably stopped deteriorating – while services remain resilient, supported by a robust labour market."

“The dominant view is that the good news on trade war, coupled with the lagged effect of the monetary stimulus provided last year, will quickly trigger a turnaround of global trade and thus of manufacturing activity. The very latest data from China is encouraging from this point of view. GDP growth has stabilised at 6% in Q3 and Q4, and manufacturing surveys have rebounded in the last two months. In the medium run this is good news for the world economy – slower but higher quality growth in second largest market of the world would be a net positive – but the transition may be a bit painful."

“In the US, there is no reason to stop trusting in the consumer’s capacity to keep economic growth decent. In the UK, the Bank of England (BoE) seems to take the recent signs of slowdown seriously and we now expect the Monetary Policy Committee (MPC) to opt for a pre-emptive rate cut at the end of the month. In the Euro area, Germany remains the point of focus. Those who like their glass half-full will focus on second derivatives and the fact that manufacturing is contracting at a slower pace in mid-2019, but if global investment remains constrained, re-accelerating fast will be difficult."

“The world economy is breathing better, but it is not yet ready for a sprint. But markets have sprinted out of the blocks so far new year.in the Short-term performance has been led by the most cyclical assets – Japanese, US and emerging market equities – reflecting the renewed confidence in the global cycle. These have been closely followed by higher yielding debt assets in terms of total return performance, continuing the trend that began back in October. It is very much a risk-on start to 2020 driven by the expectation of some cyclical growth pick-up and that this will be reflected in a resumption of corporate earnings growth. The fact that the hurdle for central banks to raise interest rates is so high at this juncture means that rate risks are not on the investment horizon.

Valuations, however, are to be watched. The renewed growth in developed market central bank balance sheets has its counterpart in liquidity and broad money growth. With risk-free rates at or close to zero, it is unsurprising that the liquidity environment has propelled asset valuations to post-financial crisis highs. All developed equity markets re-rated during 2019 as recession fears got pushed back. However, this was not reflected in stronger earnings expectations. If confidence in earnings does not recover, current equity valuations may come under pressure.”

Serge Pizem, Head of Multi-Asset at AXA IM, outlines his asset allocation views for February: “As we argued at the end of 2019, positive market developments continue to release some pressures that should allow global growth to navigate a soft landing in 2020. In October we added more risk in our portfolios and looking into 2020 we believe that the positive drivers will continue, at least for the first half of the year. As things continue to go in the right direction, we consequently decided at the end of last year to tactically upgrade our equity exposure to overweight – a position we continue to hold.”

We continue to overweight equities as positive developments with central bank easing, the Trade War and Brexit release some pressures and should allow global growth to navigate a soft landing in 2020.

With macro data suggesting the manufacturing cycle has bottomed out, we maintain a cyclical tilt in our equity exposure.

We remain positive on Euro High Yield as a dovish US Fed, European Central Bank and Bank of Japan are supportive of carry positions.

We remain constructive on Eurozone and US inflation breakevens, as market pricing remains too pessimistic.

“Market sentiment is currently resolutely optimistic. True, there remains several areas of concern but the path of least resistance is currently up for risk assets. Indeed, it was striking to see that on the night when Iran launched ballistic missiles on a US base in Iraq, S&P 500 futures briefly dropped 2% but to quickly recover and finish the day up while implied volatility barely moved. In normal times it should have triggered a more vigorous market reaction. So why are markets so resilient?"

“The positives are simply more powerful in our view, at least for now. Monetary stimulus is still increasing and financial conditions are still easing as central banks continue to cut rates across the board, Mexico and South Africa being the most recent. As a result, global short rates continue to fall, down 50bps from a year ago. Monetary stimulus is driving up asset prices, particularly stock prices and the housing sector. For instance, US December housing stats released last week were incredibly strong, surpassing all economists’ expectations and their highest level since December 2006. Ironically, the increase in asset prices could be self-fulfilling as the resulting rise in consumer net worth is likely to support consumption and then GDP growth in 2020."

“All this in a context where global trade could be already accelerating. The IMF, in its most recent report released earlier this week, expects global trade growth to be 2.9% this year after 1% last year, boosted by the trade truce between the US and China. Anecdotally, China December trade data surprised significantly to the upside as exports jumped by 7.6% year-on-year, and import growth accelerated sharply to 16.3% YoY. Trade data from Korea confirms this improvement. History tells us that the S&P is likely to continue to increase until a recession is in the distance. We are simply not yet there.”  There is new source of stress however with the speed of spread of the coronavirus in China.  We need to follow closely its evolution as China has taken drastic measures to fight it.  In a context of a slow improvement in the global economy this threat has the potential to change the outlook."