Market Insights – January 21st, 2019

Our experts share with you their views about markets, every week.

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New Year concept - ‘2019’ formed on background of beach sand. With blurred vintage styled background.

Essentials

Confidence in lower-quality bonds has returned. Over the last two weeks, risk premiums on US high yield and emerging-market debt have dropped sharply, reversing some of the losses recorded at the end of last year.
Earnings expectations are so low that we think there will be some pleasant surprises from US corporates when they publish their results. Bank stocks, for instance, reacted very well when their earnings figures were released. The con-sensus forecast is for a 12% rise in earnings in the fourth quarter.
In December, China’s industrial out-put was up 5.7% year on year, beating the analysts’ forecast of 5.3%. And retail sales stopped slowing, gaining 0.1% on November. This could mean that the stimulus measures adopted in recent months are starting to have an impact.

A brighter year ahead

We think that the fears of a recession are overblown, especially since the slump in oil prices is likely to extend the macro cycle. Lower oil prices will cut energy costs for consumers and companies, thereby increasing their purchasing power, staving off the risk of a rise in inflation and discouraging central banks from tightening monetary policy. A soft landing looks to be the most likely scenario for the global economy in 2019, but this will depend on the resilience of its two driving forces – the USA and China. The US economy remains robust, with consumer spending buoyed by low un-employment and rising wages. But China is more of a question mark. The monetary and fiscal
stimulus measures brought in by the authorities have not yet been enough to offset the effects of the trade tensions with the USA. Talks are now under way, so an agreement between the world’s two superpowers does seem more likely. This would allow the Chinese economy to stabilise in the spring. Europe, which lacks political leadership, would also benefit indirectly from an easing of ten-sions. After the December panic, there’s a good chance that equities will rally in 2019. Although it’s rare at this point in the cycle, valuations are once again attractive. This is especially true when compared with other conventional asset classes. Bond markets, for instance, offer very little upside, with the exception of US corporates and emerging-market debt – two higher-risk segments that fared poorly in 2018.
Equities are likely to outperform, which has prompted us to increase our allocation. For balanced portfolios, we are upping our equity exposure by 2%. We are increasing the USA, which offers greater visibility in terms of economic growth and corporate earnings, and Asian markets. Emerging-market assets and currencies should make a comeback if the Fed postpones its monetary-policy tightening. But the greenback should hold up well against other strong curren-cies. For portfolios denominated in Swiss francs, hedging dollar risk is now very expensive. We are therefore increasing our exposure to Swiss-franc-denominated investment vehicles by diversifying into real-estate funds, which have seen their average agio drop off sharply recently.

Brexit: so bad it’s good?

It was a tough week for UK Prime Minister Theresa May. Parliament overwhelmingly rejected her Brexit deal, and then her government narrowly survived a no-confidence vote tabled by the opposition. She may be weakened, but the PM is now trying to get the job done and find a compromise. This time around, however, Parliament will get to have its say on the options available. Given the lack of consensus between Remainers and Brex-iteers, this could be an arduous task.
Yet recent events seem to have been largely priced in by the financial markets. And these developments may even sug-gest that the UK is heading for a delayed or a soft Brexit. Whatever the outcome, it will be a long and complicated road, and uncertainty will continue to reign. We still think the most likely outcome is an orderly exit from the EU, but we can’t rule out the possibility of a hard Brexit. For risk-management purposes, we have there-fore decided to partially hedge our exposure to the pound . However, if the Brexit outcome is favourable, the pound and the UK stock market should rally. Sentiment is very low, if recent record fund outflows and the UK market’s extreme under-weighting in portfolios are anything to go by. What’s more, UK equities are trading at a 30% discount relative to global equi-ties, which increases their appeal. To sum up, once the uncertainty has faded, there will no doubt be some attractive entry points on both the pound and the UK stock market.

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