Multi-Asset Investments views – February 2020 – The market is climbing a wall of worry
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Our key convictions :
- We continue to overweight equities as positive developments (Central banks easing, Phase 1 Trade Deal signature, Brexit ) release some pressure and should allow global growth to navigate a soft landing in 2020
- We maintain a cyclical tilt in our equity exposure as macro data suggests the manufacturing cycle has bottomed out
- We remain positive on Euro High Yield as a dovish Fed, ECB and BOJ are supportive of carry positions
- We remain constructive on Eurozone and US inflation breakevens as market pricing remains too pessimistic
- Overweight equities
- Cyclical tilt in our equity exposure (including call option on banks)
- Positive Euro High Yield
- Positive US and Eurozone inflation breakeven
- Long equity call options delta hedged to protect the portfolios where possible
Market sentiment is currently resolutely optimistic. True, there remains several areas of concern; not least the US election and impeachment, trade worries, weak capex, heavy corporate debt and geopolitical risks, 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. This is all the more surprising given that President Trump had promised a few days before a quick retaliation on more than 50 targets in case of an attack from Iran and that US equity futures long positioning is near record highs now, pointing to very stretched speculative positioning. Short term, this positioning could be 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 (cf. chart below) 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 starts 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% YoY, 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.