Brexit developments also moved in the right direction, as Boris Johnson negotiated a Withdrawal Agreement with the EU, and Parliament voted for it “in principle.” Parliament then rejected an accelerated timeline but Labour has finally agreed to early elections where Johnson could win the majority to pass his deal without amendments or a second referendum attached. Uncertainty persists, but we may finally see the end of the saga before the new deadline of January 31, 2020.
Reading the economic data
Economic data releases remain mixed, with misses in Europe in particular, but we believe that growth appears to be stabilizing. Manufacturing surveys in the US appear to be rebounding, consumption remains solid and housing is pointing up. Chinese Q3 GDP came in just below expectations, but recent releases have rebounded as well, suggesting growth will stabilize around 6%, in part thanks to ongoing targeted stimulus. Germany is likely in a technical recession, and we may not have seen the bottom yet. Unfortunately, fiscal easing might be slow to materialize, even though we believe it is needed as the ECB alone will not be able to spur growth.
Equity markets reached new record highs in the US, and should continue to do well as geopolitical clouds clear and uncertainty gradually fades. While accommodative central banks will remain a support, we believe that decent earnings from the Q3 season – which we are seeing so far – will also be needed to bring fundamental support to the rally. With a trade truce and better news on Brexit, some optimism that we are reaching the bottom in German growth could lead European assets to bounce in the coming months.
Sovereign yields continue to drift higher on improved investor sentiment, a trend we expect to continue into year-end if geopolitical tensions ease. However, with ongoing growth concerns, low inflation and central bank easing, a sharp back-up remains relatively unlikely. Credit spreads have benefited as well, and we maintain our preference for corporates over sovereigns. As we move along in the cycle, we favor investment grade over high yield debt. We still see attractive opportunities in emerging market credit.
Recent improvements in the US-China trade dispute have continued to support equity markets, as have expectations for another interest rate cut by the Federal Reserve. Economic data releases have showed ongoing weakness in some areas, notably Europe, but also potential for stabilization in the US and in China, easing fears of an imminent recession.
The Q3 earnings season kicked off with slashed expectations, and also a very high mark to beat given last year’s stellar Q3 results. So far, earnings have beaten expectations, with results pointing to flat growth on a year-on-year basis. In our view, this is already an encouraging development given fears of an earnings ‘recession’. Nonetheless, we look to forward guidance for signs of improvement into 2020, helped by potentially reduced uncertainty, and continue to believe that decent earnings will be needed to support the recent rally.
We maintain our constructive positioning, acknowledging that higher volatility is to be expected. We continue to favor developed markets over emerging markets, though the latter could do well if trade improvements last. We believe that European assets could benefit from an improved outlook on global trade and demand, implying a possible bottom in German growth in the coming months and better Brexit news. Somewhat higher yields should also help the more Value sectors in European indices, such as financials.
Sovereign yields are likely to continue their upward move, as better trade news is helping to alleviate growth fears and unwind some of August’s extreme yield moves. Nonetheless, given still weak growth, low inflation and ongoing central bank support, we do not expect an overly sharp move. Indeed, this has been accompanied by better investor sentiment and rising equity markets.
We maintain our preference for credit over sovereign debt, as sovereigns remain richly valued despite the recent move. US 10-year yields still sit around 1.83% as of October 29, while 10-year German Bunds remain in negative territory, around -0.34%. Credit spreads have also benefited from the recent improvement in risk appetite, tightening as sovereign yields have retreated. We believe that investment grade should hold in better than high yield given we are still advanced in the cycle and growth concerns are unlikely to vanish in the short term, but we see no systemic risk on lower ratings for now.
Emerging market debt should continue to do well given improved trade prospects and a weaker USD, despite some idiosyncratic events. We maintain a preference for hard currency corporates that offer attractive carry with low volatility.
Improved risk appetite, renewed expansion of the Fed’s balance sheet and lower interest rate differentials have weighed on USD, a trend which is likely to continue, to some extent, in the coming months. The euro has benefited from improved trade developments and encouraging prospects on Brexit. Better growth expectations could also lift the euro (EUR), though this may take some time as data is still disappointing. Pound sterling (GBP) has benefited from the receding of no-deal Brexit fears, and an agreement would see it move higher still. Emerging market currencies should benefit from recent trade developments and a weaker USD, but idiosyncratic risks remain.
Oil prices have advanced on better growth expectations and reduced trade worries. Recent Middle East developments are likely to suggest a somewhat higher risk premium as well. That being said, medium-term supply is expected to remain ample thanks to shale production, capping prices.
Gold retreated as safe haven demand softened, and we believe we may have seen the top for now. Nonetheless, growth concerns and low rates and inflation should maintain some underlying support.
We continue to see a place for alternatives in portfolios, as we look for de-correlating and diversifying strategies to complement traditional asset classes, particularly with liquid alternatives. We believe that real assets can also help provide income in a low yielding world.
Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.
Commodity-related investments, including derivatives, may be affected by a number of factors including commodity prices, world events, import controls, and economic conditions and therefore may involve substantial risk of loss.
Currency exchange rates between the US dollar and foreign currencies may cause the value of the investments to decline.
Alternative investments involve unique risks that may be different from those associated with traditional investments, including illiquidity and the potential for amplified losses or gains. Investors should fully understand the risks associated with any investment prior to investing.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed may change based on market and other conditions.
All investing involves risk, including the risk of loss. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.