Market Insights – April 1st, 2019

Essentials

In recent days, investors have focussed on the US yield curve inversion, an event that has preceded every past recession. However, this time around, the inversion can largely be explained by the negative interest rates on European and Japanese bonds. Moreover, spreads on investment-grade bonds suggest there is no risk of a recession in the medium term.

In March, China’s manufacturing PMI moved back above the 50 mark after falling for three months in a row. It climbed from 49.9 in February to 50.8 in March, beating analysts’ expectations. This uptick can be put down to the stimulus measures brought in by the government.

Oil prices continue to rally, reaching new recent highs. In addition to a very buoyant technical situation, prices have been supported by Opec’s production cuts and by bottlenecks in the USA, which have hindered the supply of shale oil downstream.

Central banks are now in extra time

Major central banks have now taken stock of the slowdown that has been affecting the world’s manufacturing sectors since trade tensions between the main economic regions escalated in 2018. On a positive note, consumer confidence is holding up well in most developed countries, buoyed by a sharp drop in unemployment and rising wages. But surprisingly, higher wages have failed to feed into consumer prices, and inflation figures are once again starting to slide worldwide. Against this backdrop, central bankers have had plenty of elbow room in early 2019: the Fed announced that there won’t be any rate hikes in 2019, the ECB plans to keep injecting  money into the banking system, and the Chinese government has stepped up its stimulus measures. These initiatives are likely to extend the macro cycle. Investors’ fears of a recession have faded, and investors are once again reaping the benefits of moderate growth combined with tepid inflation. What’s more, the USA and China seem close to reaching a trade deal. All of these developments have prompted stock markets to rally from the very oversold levels reached in late 2018. If economic activity stabilises, equities will maintain some upside potential over the coming months, partly because most sentiment indicators do not yet reflect the upbeat tone investors usually adopt towards the end of a stock-market cycle. Valuations are reasonable, especially when compared with the paltry returns offered by bonds – yields are at rock bottom and even negative on the safest government bonds. It therefore makes sense to remain overweight equities. We are bullish on the US stock market, which should be pushed up by the country’s robust output; emerging-market equities, which seem to be catching up over the long term; and eurozone stocks, which have been shunned by investors. Finally, this latest period of more accommodative monetary policies paves the way for greater stability between the world’s major currencies. For portfolios denominated in euros and Swiss francs, hedging the US dollar is still very expensive. As a result, we are reducing these hedges and instead partially hedging the yen, at a limited cost.

US equities – continuing the uptrend

Since the capitulation of  late December 2018, US equities have gained around 20%. But is this stellar performance justified? And what can we expect from US stocks when they are already riding high?

The country’s economic fundamentals go some way to explain the US market’s impressive upswing. The US economy is on a firm footing, especially when compared with other world regions. It’s true that output is slowing, but we’re a far cry from the recession that investors feared in late 2018. So 2019 looks set to be another year of solid economic expansion, with US GDP growth forecast to be near 2.5%.

Despite the sharp market rally, we haven’t detected any investor euphoria, and sentiment indicators and volatility are both relatively neutral. In addition, investor surveys show that portfolio managers are still holding a lot of cash – a sign that few investors took part in the rally earlier this year. All of these factors suggest that stock markets will continue to gain ground, albeit at a slower pace in the coming months.

As economic growth normalises, we remain bullish on companies offering greater earnings visibility, like those in the health care and consumer staples sectors.