AXA IM's macroeconomics and asset allocation convictions for April 2019
The story of the ever continuing idiosyncratic Brexit drama, and the Goldilocks rally
Laurent Clavel and Serge Pizem discuss their macroeconomic and asset allocation convictions for April.
According to Laurent Clavel, Head of Research at AXA Investment Managers: “From the European Central Bank’s tiny steps to the US Federal Reserve’s balance sheet policy, the liquidity tide is high”.
- In March, both the European Central Bank and the US Federal Reserve leant on the dovish side: the “central bank put” is well in place
- The macroeconomic news flow has been rather soft in China and Japan, mixed in the Eurozone and the US with external weakness but domestic resilience
- The strong performance of risky assets so far this year may be pricing a lot of good news, from a US-China trade truce, a delayed/soft Brexit, and a sequential rebound in global growth
“With the Governing Council pledging to leave the deposit rate at its current level (-0.4%) until at least the end of 2019 at the March European Central Bank (ECB) meeting, our view last month that the global cyclical downturn would eventually prevent any interest rates normalization was confirmed. We think, a partial normalisation is still possible in 2020 though. As for the Fed, even though they have been adamant about not seeing reserve scarcity, we believe the rising pressure evident in short-term interest rate markets has contributed to the decision to stop reducing the Fed’s asset holdings.
“Put together, this dovish shift of developed central banks has contributed to the easing of financial conditions, lowering interest rates and boosting risky assets. In our baseline scenario (50% probability), we expect the “global economic policy put” (monetary accommodation, but also the Chinese and European fiscal stimuli) to prove enough of a support. Market prices and the consensus forecast have however largely subscribed to this view and may have already discounted a lot of good news in their year-to-date adjustments.
“In China, the total stimulus could amount to 2.1% of GDP in 2019. The People’s Bank of China (PBoC) has stepped up its monetary easing but the transmission to the real economy seems to have been stifled until recently, with many small and medium enterprises (SMEs) still struggling to source the necessary financing to support business expansion. Activity data has remained weak (so far) with exports declining, while retail sales and investment components continue to decelerate. More worrying are the first signs of cracks in the labour and housing markets.
“In this context, Eurozone business surveys offer a striking divergence between external weakness and domestic resilience. The macro news flow has been more disappointing in Japan (from surveys to industrial production, exports and consumption) while short-term signals have been mixed in the US. Manufacturing indices have retraced, whereas the housing sector and consumer confidence have recovered from year-end lows on most metrics.
“Beyond these global dynamics, the UK continues its idiosyncratic Brexit drama. While May doggedly pursues the approval of this deal, the risks of leaving without a deal seemingly just shift in time. We expect the EU to accept another extension – beyond 12 April, avoiding a brutal exit but prolonging the Brexit uncertainty, which continues to depress UK activity and rates.”
Click here to read our macro-economic views of the month.
Serge Pizem, Global Head of Multi-Asset Investments at AXA IM exposes his asset allocation views for the month to come: “The main question we are raising as an investor is the following: How long can the ‘Goldilocks’ rally last? While both risky and ‘safer’ assets are posting positive returns, the global equity indices continue to make new year-to-date highs while volatility is falling across asset classes. After such a strong year to date rally, we reduced our equity allocation in March and maintain our modest risk appetite with neutral tactical asset allocation but with a positive focus on emerging markets. As central banks all turned dovish we also believe it is a good time to increase our existing carry strategies by buying emerging markets debt, high yield, Eurozone peripheral debt.
- We remain overweight on emerging markets assets, both debt and equities
- We remain our position on Euro core government bonds to neutral
- We remain underweight on EMU equities and use it as a source of financing our longs
“The usual suspects behind this 'Goldilocks' rally are well known. Amid slow growth and weak inflation, developed markets (DM) central banks remained resolutely dovish. The by-product of this policy stance, i.e. lower volatility and lower real rates, is supportive for risky assets.
“While the length of the current equity rally is still within the typical range, historically less than 20% of rallies last longer than 3.5 months. This apparent asymmetry is reinforced by the swift repositioning of investors who started to turn much more bullish. Inflows surged for US equity funds, with 25bn USD inflows in US equity ETFs alone. There have been only a few episodes in the past when US equities experienced inflows at such a strong pace and in most cases these constituted a contrarian signal. Similarly, systematic funds such as CTA or volatility target strategies also increased their equity exposure while Hedge Funds gross risk is back to levels last seen pre-Q4 last year.
“This rally is occurring in a context where macroeconomic data have not yet shown convincing signs of rebound. As mentioned by Laurent, China's economic activity has continued to soften even if we can find the first signs of stabilization, and in the US indicators are pointing to slower growth of household spending and business fixed investment. This reinforces our view that markets are getting ahead of themselves.
“Therefore, we continue to believe that without a pick-up in global growth, which remains relatively weak, there are growing risks for equities as valuations and positioning are likely to limit returns. We maintain our prudent thus tactically neutral equity allocation. We believe it is a good time to increase our existing carry strategies by buying emerging markets debt, high yield, Eurozone peripheral debt as central banks all turned dovish.”
Click here to know more on our asset allocation views for the month.