The equity markets are on a roll. Following an average performance of over 2% for the previous two months, global equity markets recorded a 3% rise in November. This primarily reflects the rather overdone optimism with regard to the trade tensions in a decreasingly favourable economic context.
On the tariff war front, the two parties have made announcements concerning a “phase one” agreement, for which we still hold doubts in terms of its substance despite the prevailing enthusiasm. What is certain is that this first phase will not provide a long-term solution to the structural problems, such as intellectual property protection in China and foreign companies’ access to the Chinese market.
Another explanation is that the equity markets continue to be buoyed by a low interest rate environment that is making the bond market less attractive and pushing investors to take more positions on equities.
From a fundamental point of view, developed economies continue to send out mixed signals. Firstly, economic growth has held up well so far. In the United States, annualised third-quarter growth was initially estimated at 1,9% before being revised upwards to 2,1%. As has been the case over the year, consumer spending was once again the main driver of the economy. However, the more cyclical components of the economy, such as private investment and exports, continue to hamper growth.
In Europe, although growth is not as strong, it is still there. From the previous quarter, the eurozone’s economy grew at 0,2%, i.e. 1,2% year-on-year.
For the coming month, caution is key. The lead indicators, notably the PMIs, do not allow us to be more optimistic as they point to a general stagnation of economic activity. According to these indicators, manufacturing activity is unlikely to pick up in the near future in developed countries, while a slight recovery is expected in emerging countries. We note a year-over-year drop of more than 2% in company earnings, which reflects the economic slowdown that we had expected for this year.
For the time being, neither industrial production data nor the latest international trade figures have shown any substantial improvement.
In sum, the economic outlook announced by the OECD for the next three years notably indicates global growth of around 3%, with 2,9% for 2019 (the lowest growth rate in 10 years). The political risks are real, with popular movements springing up on all continents, from Latin America to Hong Kong and the Middle East. They of course come on top of the trade tensions already mentioned. 2020 is set to see a lacklustre global economy in a political and social climate still under pressure. This is why we maintain our cautious allocation that underweights equity markets in order to protect the portfolio from the potential effects on the markets of the above-mentioned risks.
The stock markets have continued to rally: for the period from 31 October to 29 November, the performances calculated in euros of the different indices are all in positive territory: +4,05% for the MSCI World index, +2,72% for the MSCI Europe, +4,92% for the MSCI North America index and +1,05% for the MSCI Emerging Markets. In this context, the US markets stood out, with the S&P 500 hitting a new record.
This enthusiasm was sparked by the progress made in the China-US negotiations: the two countries are said to be on the verge of signing a “phase one” trade agreement in a somewhat delicate context, as Donald Trump added his signature to the law in support of the Hong Kong protesters. This law provides for annual reviews of Hong Kong’s special status as a trade partner, as well as sanctions against authorities who violate human rights or menace the city’s autonomy. China has threatened to take retaliatory measures.
Our view of the equity markets remains negative as the current economic slowdown is weighing on companies’ earnings growth. Indeed, earnings showed a 2,2% decline year-over-year at the end of the third quarter. In this respect, economic sentiment indicators still do not point to a recovery of investment that could provide sustainable support to growth.
The current environment prompts us to keep more exposure to the US market at the expense of Europe. We thereby benefit from stocks that experience secular growth, which are more abundant in the US than in Europe. We also note that the US dollar, with its safe-haven status, offers additional protection in the event of a market downturn.
Regarding sector recommendations, we maintain our negative view of the Materials, Energy and Semiconductors sectors, which represent the most cyclical part of the IT sector. Conversely, we still favour the Communications Services and Real Estate sectors. We also have a favourable view of the Healthcare sector. Its valuation is attractive, its profile defensive, and the sector is undergoing renewed M&A activity, which should push valuations up, while continuous investment in research and development will bear fruit in the coming years.
Sovereign yields and bonds
The risk-on trend that began in September is continuing, but has weakened. Sovereign bond rates, reputed for their quality, have lost ground to equities. Investors appear to have preferred to focus on the recent surge in optimism due to a possible solution to the China-US trade conflict, rather than lend more weight to the troubling fundamentals in their investment choice. In Europe, growth forecasts are hardly encouraging, and inflation forecasts are not promising either.
In the United States, interest rates have risen as well. While yields are much more attractive than in Europe, we believe that the level of the US 10-year rate is still relatively low, as the US Federal Reserve is likely to allow inflation to run over its 2% target for a while. However, demand from non-US investors could push rates down further.
We thus recommend remaining cautious and propose a neutral positioning with regard to the bond market.
Given the downward trend and historically low rates in Europe, investing in a money market instrument denominated in euros is not an attractive option for investors.
Last month, the European credit market saw a timid rise in risk premiums, recording a slightly negative performance. For the credit market, an environment of monetary easing tends to push investors seeking returns towards less liquid assets of mediocre quality.
Overall, the central banks are supporting the credit market. US corporate bonds are supported by favourable technical factors, but not to the same extent as the European investment grade credit market. The latter is benefiting from the launch of a new round of asset purchases as well as the negative rates prevailing in Europe. However, the support of the monetary policy guarantors comes in an economic environment in which indicators are pointing to a slowdown in activity. In this context, the fragility is compounded, suggesting that the viability of debt, a solid balance sheet, and liquidity risk are factors to be emphasised.
The central banks are providing their contribution and demand is sustainable, but our economic concerns nevertheless lead us to remain vigilant with regard to the asset class and focus on defensive and quality companies. Furthermore, we are interested in private debt eligible for purchase by the European Central Bank. The demand that it generates and its “buy & hold” nature buoy performance and result in lower volatility.
While European economic data does not show any real improvement, the US economy, despite the mixed signals, remains in a better place than Europe's. For example, job creation in Germany recorded a decline (-16 000) instead of the expected growth. Likewise, retail sales collapsed, in an environment in which consumers represent the final bastion of the economy.
As we already mentioned, although growth is slowing everywhere, the US economy is enjoying a stronger pace of growth than in Europe. Given the economic divergence and interest rate differential in favour of the dollar, we maintain our upper limit of 1,15.
In 2019, the central banks appear to have done what was necessary to support economic activity. In this context, with the prospect of an interest rate increase ruled out in the upcoming months, we do not expect any more rate cuts either in the US before the end of Q1, if the economy continues to deteriorate.
The euro/dollar path will also remain greatly dependent on political developments, notably the trade wars and Brexit. If the economic and political environment were to deteriorate, this would trigger a flight to safety and a possible appreciation of the dollar.
In November, the price of gold dropped, ending the month at around $1460 per ounce. While this price seems low, it is nevertheless well above recent historical averages: in 2019, it traded at $1380 and in 2018 at $1269. We believe that the low level of the past few months results simply from a natural correction following a very rapid appreciation in its price. This said, the underlying trend remains intact: it is supported by low rates, rather expensive equity markets and particularly high demand from central banks. As an asset that does not generate a return, gold had an opportunity cost in relation to equities and bonds. In this environment of low or even negative rates, this opportunity cost is minimised, which increases the metal’s appeal.
The current level of prices enables gold mining companies to post high profitability, as most of them bear extraction costs of around $950 per ounce. This is why we favour exposure to the change in the price of gold via mining companies. Moreover, the increase in M&A within the industry seems to confirm this momentum.
We believe that the price of gold could remain within the range of $1470-1530, and our view is even more positive in the medium term, especially if stock markets were to undergo episodes of turbulence.
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