Multi-Asset Investments views - June 2019 - Trade war remains front and center

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Trade wars remain front and center. As a result, developed markets (DM) have adjusted slightly lower recently but remain within firing range of their recent highs. Government bond yields have repriced lower with German Bund yields back in negative territory. Therefore, DM equities have a lot less priced in for a downdraft in global trade, that could have negative spillover effects on global growth, than government bonds. Part of this divergence is due to investors’ expectations that the Fed could be forced to exercise their put if an equity market correction were to lead to a tightening of financial conditions. This has helped to cushion any adverse market move and generates a “buy the dip” behavior from investors. On balance, our view is that risks have increased leading us to adopt a more cautious stance in our portfolios.

First and foremost, trade negotiations between China and the US are taking a turn for the worse with bilateral relations deteriorating quickly following the US decision to hike tariffs on USD200bn of Chinese exports to 25% from 10% and the announcement of retaliation by China shortly afterwards. The tone from both sides seems to have toughened. On the US side, with the equity market close to all-time highs and the strong Q1 GDP print, there is no urgency for the president to quickly conclude the trade deal, while Chinese official media suggest that Chinese authorities will not continue negotiating until the US shifts its current position. In this context, we do not expect China to give in soon and the probability that both sides don’t reach a deal before the G20 summit on June 28 and 29 is clearly rising. Moreover, there are more and more signs that the trade war is gradually morphing into an all-in, full-spectrum economic war, as shown by the recent addition of Huawei, China’s largest technology company, to the “Entity List” in the US which bars it from accessing key US origin technology, putting the company at risk.

Second, the “Fed put” is likely to be lower than just the moderate selling witnessed so far. The May FOMC meeting was not supportive of the market narrative that the FOMC is moving inevitably toward near-term “insurance” cuts. Moreover, Chair Powell repeatedly characterized recently lower core PCE inflation as "transient".

Third, we are still waiting for clear signs that global growth has bottomed out. April activity data in China came out weaker than expected, with investment, industrial and retail sales all slowing, the latter to the slowest pace since 2004. These mixed numbers arise while the 25% tariffs have not even started to bite. In Europe, despite better growth numbers in the first quarter, the underlying momentum remains weak and the Germany’s manufacturing crisis persists. Lastly, the US economy is likely to slow rather than accelerate to the upside from here.

In this context, we have decided to reduce our equity exposure by downgrading our position on emerging equities to neutral while keeping our negative stance on EMU equities. We maintain a neutral stance on duration.

 

DM equities have a lot less priced in for a downdraft in global trade than bonds

Source: Bloomberg, AXA IM Multi Asset Investments

 

Our key convictions :

  • We are prudent on developed equities given that risks have increased as trade negotiations between China and the US are taking a turn for the worse
  • We remain positive on emerging debt and US High Yield as a more dovish Fed is supportive for carry positions
  • We maintain Euro core government bonds at neutral as lower growth and falling inflation should cap bond yields

Our positioning:

  • Underweight EMU equities
  • Positive EM debt and US High Yield
  • Positive GBP versus EUR and positive NOK versus AUD and CHF
  • Long equity call options delta hedged to protect the portfolios where possible

 

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