Multi-asset investments views - It’s time to go neutral

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After a strong start to the year, US equities are now up 10% year-to-date. This risk-on rally contrasts with a recent tide of negative macro data. Such a disconnect is understandable when risk premia are very high, as was the case last December. However, the dynamic becomes progressively less sustainable at ever higher levels on stocks, tighter spreads and lower volatility, making the risk-reward less attractive. In this context, we think it’s time to go neutral on both bonds and equities.

In our view a stabilization of the macro data, together with a US/China trade deal, is a necessary condition for a sustained rally. Precisely, we need macro indicators to turn which is not what our macro signals are currently showing. Global growth continues to slow, led by the weakness in China. The quarterly growth profile, which shows a persistent weakening trend is indicative of the multiple headwinds that the Chinese economy is confronting. Growth continues to disappoint across Europe which has led us to revise our forecast for the Eurozone to 1% for 2019, i.e. below potential. In the short term, GDP trackers point to another weak print in Q1. We expect Italy’s recession to continue in Q1 and look for subdued growth in both Germany and France. In the US, incoming data have been mixed, as shown by the extremely disappointing December retail sales report, and first quarter growth is likely to be relatively soft due to a variety of factors — the government shutdown and uncertainty about trade policy, among others.

The crosscurrents from slowing global growth are in this context unlikely to dissipate in the short term - even if we expect a stabilization and then a rebound later this year - while risk premia and valuations have realigned with fundamentals in most markets (cf. chart below) such that most of the easy money has been probably made for this year in risky assets. Therefore, we downgrade our equity views over the next 3 months to neutral.

Similarly, we have decided to neutralize our short duration bias on euro core government bonds despite lower bond yields. In a period of cyclical weakness and political tensions (e.g. Brexit, Italy) it is unlikely to see a substantial repricing higher of real yields, particularly with the ECB likely to undertake further liquidity provisioning (TLTROs). At the same time, short rate expectations could reprice even lower as the deterioration in the macro backdrop should push the ECB to defer rate hikes. We have also downgraded and delayed our expectations for further Fed tightening and we now anticipate that the Fed will raise rates only once later this year. Inflation breakeven could also continue to slip as headline inflation converges toward core inflation, i.e. around 1.1%, due to strong negative base effects on commodity prices. All in all, the upside on bond yields seems limited over the next 3 months while the carry and roll down effects makes shorting bonds costly.

 

Valuations are back toward their long term average

Source: Datastream, AXA IM

Our key convictions :

• Positive on emerging markets assets, both debt and equities as a more dovish Fed, a peaking US dollar and cheaper valuations are supportive
• We have upgraded Euro core government bonds to neutral as a lower growth and falling inflation should cap bond yields
• We remain negative on EMU equities as the region is leading in the economic slowdown

 

Our positioning: 

• Positive EM equities vs negative EMU equities
• Positive GBP versus EUR and positive NOK versus AUD and CHF
• Long equity call options delta hedged to protect the portfolios