monthly house views - société générale€¦ · monthly house views february 2019 a rousing...

MONTHLY HOUSE VIEWS

February 2019

A rousing start to the year A sharp market rally in January from oversold levels

Risky assets rebounded sharply in January from oversold levels at the end of 2018, which resulted from tighter financial

conditions, weaker macro data and rising political uncertainty. Recession risks were, however, overblown; there was also

considerable relief due to the Federal Reserve’s more dovish tone. Nonetheless, political risks still abound – Brexit is just one a

few European bones of contention. Moreover, downside momentum for earnings and growth is cause for concern.

Macro risks remain skewed to the downside but a recession is not on the cards

Global economic growth will likely decelerate further in 2019. US fiscal stimulus is waning, and higher US interest rates will filter through. The trade war will continue to weigh on exports and business sentiment, though any US-China deal would boost sentiment. In China, economic activity has been hit by the trade war and further policy relaxation is still necessary to stabilize growth. In the euro area, the end of European Central Bank (ECB) quantitative easing, limited room for fiscal expansion and faltering overseas demand will dampen activity this year. On top of this, a non-deal Brexit scenario would likely disrupt both the economy and the markets. In brief, macro risks remain skewed to the downside but a recession is not on the cards. Indeed, decelerating economic backdrops can last for years, and have historically proved fruitful for risk taking.

Bottom line

At present, the global macroeconomic environment remains in slowdown mode, but that is still supportive of risk assets and corporate profits. Moreover, equity valuations are largely fair and sentiment remains skittish, a positive from our contrarian perspective. Momentum, however, is in a downtrend – a cautionary factor – despite the January rebound. This keeps our overall risk at neutral.

In accordance with the applicable regulation, we inform the reader that this material is qualified as a marketing document.

CA043/FEB/2019

Monthly House Views | February 2019

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OUR ASSET ALLOCATION

The table below presents an overview of the KH Investment Committee views.

Positioning *Duration (Measure of the sensitivity of the price of a bond to change in interest rates)

UW Underweight Short

N Neutral Benchmark

OW Overweight Long

UW N OW delta UW N OW delta

GLOBAL EQUITY - -

United States - -

Eurozone

United Kingdom +

Japan -

Emerging +

GLOBAL RATES +

U.S. Treasuries +

U.S. Breakeven

Bunds

EMU Breakeven +

Gilts

Gilts Breakeven

JGBs +

EM Govies ($) + +

U.S. IG - -

U.S. HY +

EMU IG -

EMU HY -

UK IG -

UK HY -

EURUSD - +

USDJPY -

GBPUSD +

USDCHF -

EM FX (vs. USD)

Brent + +

Copper

Gold

ALT. STRATEGIES

L/S Equity -

Event-Driven

FI Arbitrage

Global Macro

CTAs

FIX

ED

INC

OM

EA

LT

ER

NA

TIV

E

12-Month

CO

MD

TY

EQ

UIT

Y

MARKET VIEWS 3-Month

CO

RP

OR

AT

ES

OV

ER

EIG

N

FX

UW N OW delta UW N OW delta

GLOBAL EQUITY - -

United States - -

Eurozone

United Kingdom +

Japan -

Emerging +

GLOBAL RATES +

U.S. Treasuries +

U.S. Breakeven

Bunds

EMU Breakeven +

Gilts

Gilts Breakeven

JGBs +

EM Govies ($) + +

U.S. IG - -

U.S. HY +

EMU IG -

EMU HY -

UK IG -

UK HY -

EURUSD - +

USDJPY -

GBPUSD +

USDCHF -

EM FX (vs. USD)

Brent + +

Copper

Gold

ALT. STRATEGIES

L/S Equity -

Event-Driven

FI Arbitrage

Global Macro

CTAs

FIX

ED

INC

OM

EA

LT

ER

NA

TIV

E

12-Month

CO

MD

TY

EQ

UIT

Y

MARKET VIEWS 3-Month

CO

RP

OR

AT

ES

OV

ER

EIG

N

FX


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FIXED INCOME

Yield rise will be capped

We have lowered our long-term yield targets for US and German bonds. We maintain an Underweight position and a short duration stance as we see more value on the short end of the US curve and deem Bunds still far too expensive. We still prefer credit over bonds but suggest being selective. We prefer High-Yield (HY) bonds over Investment Grade (IG) bonds as seek carry in both the US and the euro area. In the UK, we remain neutral on gilts and credit amidst the Brexit-related uncertainty.

Maintain a short duration

Despite the recent oil price rebound, US inflation is set to stay muted as oil price base effects will weigh on headline inflation until late 2019. Any upside risk seems contained. In late January, the US Federal Reserve (the Fed) softened its tone in terms of future rate hikes stating it would be more patient in terms of future hikes and would slow the balance sheet run-down. Against this backdrop, we have cut our US Treasury 10-year yields from 3.4% to 3.0%. In the US, we still prefer short-dated bonds offering almost similar yield but with much less interest rate risk given the flat yield curve. Should further long-term yields pick up, we would turn more constructive on long-dated Treasuries. But for now, we maintain an Underweight position and a short duration stance as see more value on the short end of the US curve.

Regarding EMU bonds, recent market stress has suppressed core yields. The Bund 10-year’s yield is back below 0.2%, the lowest point since late 2016. As we foresee slower growth and lower inflation in the region, we have also revised down our Bund yield target to 0.4% by year-end versus 0.8%. At the current level, yield is unattractive and valuation overly sensitive to rate moves. However, we still see value in peripheral bonds.

In the UK, MPs finally voted for a renegotiation of the withdrawal agreement with the EU. We remain constructive on sovereign gilts given the existing risk of a no-deal Brexit, though we see this probability as low. Receding inflation and sliding growth momentum should keep the Central Bank (Bank of England) on hold, supporting gilt valuation.

Remain selective across the credit space

In the US, credit spreads could widen in 2019 after the early 2019 pull back. Any Fed rate hikes could tighten financial conditions and weigh on growth in the second half. However, such a widening should be contained by stable oil prices, low default rates (well below historical averages) and stable corporate bond issuance. We still prefer HY to IG given their compelling carry and cushion if long-term yields pick up.

In the eurozone, slower growth and lingering political uncertainty might drive spreads wider in 2019, though positive drivers could mitigate this risk. Bank lending to non-financial corporates is gaining traction and there is no sign of tightening financial conditions (besides Italy). Like in the US, default rates should decrease in early 2019 and remain well below historical averages. The chase for yield will encourage investors to prefer corporate bonds to sovereigns. We prefer HY to IG given its higher carry but are very selective.

In the UK, the bounce in oil prices has helped spreads to narrow HY spreads. However, Brexit risk should continue to weigh on corporate credit in the short run, keeping spreads relatively high and volatile. Despite the attractive carry, we prefer to remain neutral on UK credit until the Brexit outcome is clearer.

US and EMU yield gap should persist Oil should continue to underpin HY yields

Sources: SPGB, Macrobond, ECB, Eurostat, BEA, data as of 30/01/2019 Sources: SPGB, Macrobond, Bloomberg, data as of 30/01/2019

Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.


4 |

EQUITIES

Fed’s dovish stance eclipses weakening profits outlook

Global equities rebounded in January as the mood improved. Investor sentiment was boosted by the Feds dovish stance, stimulus measures in China and the US-China truce. These positive developments seem to have eclipsed the global synchronised slowdown, rapid overall deceleration in profits growth and high political risks. Downside risks seem higher in Europe, while emerging markets seem to have pulled through.

Eurozone: some risks of disappointment

Eurozone equities rallied in January despite weak economic data and Draghi’s (President of the ECB) acknowledgment of higher downside risks. Investor sentiment may have improved with hopes of a US-China trade agreement. However, trade frictions are not over yet, and the US may still impose auto tariffs, which would badly hit Europe. Political uncertainties are high with the looming Brexit deadline and rising populism ahead of European elections this Spring.

IBES analysts’ consensus expects solid sales growth and margins expansion this year, and greater earnings-per-share growth from 4.1% in 2018 to 8.9% in 2019. This assumption may prove too optimistic given the global slowdown, weakening eurozone growth and narrow room for policy manoeuvre – any fiscal stimulus will be contained, and the ECB is stuck with low rates for long, i.e. a negative for the banking sector. Profits warnings and further cuts in Earnings Per Share (EPS) forecasts in the coming months could be a likely source of investor disappointment.

Uncertainties regarding Brexit remain high

UK equities remain volatile as the Brexit outcome remains highly uncertain. If a deal is reached, a stronger sterling would be expected to penalise large multinationals (FTSE 100) which generate around 70% of their revenues abroad. However, the opposite may well occur through just sheer relief. More fundamentally, a high dividend yield and attractive valuations remain strong draws for a market mired by significant pessimism.

Emerging equities: the worst may be behind us

The Chinese deceleration is spreading as the trade war starts to bite. Negative sentiment will prevail in the short term. However, markets will probably factor in the intensifying stimulus measures taken. Also, financial conditions are easing thanks to a more dovish Fed and a dollar peak. Most emerging central banks are turning less restrictive, currencies have stabilised, and capital inflows are recovering. With equities already factoring in increased pressure on global exports and a Chinese Gross Domestic Product (GDP) decelerating toward 6%, valuations look compelling.

US: the Fed is in the driver seat

The Fed’s more dovish stance, trade truce and end of the shutdown seem to have eclipsed the sharp deceleration in profits. Given slower sales and the dampening of the tax boost, earnings estimates have been slashed and are expected to grow only modestly in 2019. There should also be some major challenges in the US, such as regulatory risks in the internet sector, a tech war and high corporate leverage.

Japan: penalised by the global slowdown and the yen

Structural reforms, higher firms’ profitability and attractive valuations are appealing. Specific government measures ahead of the VAT hike should support growth. However, in the short term the global slowdown and trade tensions should penalise this cyclical market.

Slower global growth weighs on EMU equities Dollar peaking will help Emerging markets

Sources: SGPB, Macrobond, data as of 31/01/2019 Sources: SGPB, Macrobond, data as of 31/01/2019



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CURRENCIES AND ALTERNATIVES

USD is likely reaching a peak

The US dollar appears near a peak, putting some pressure on assets denominated in dollar. We see limited directionality for G3 currencies. The oil price recovery is not over yet as OPEC+ has started tackling the excess supply. The gold rally is running out of steam and could lack fundamental drivers. Hedge funds are attractive relative to traditional assets, but caution is required on strategies with a long equity market bias.

Currencies: USD is about to peak

The US re-convergence with the rest of the world begins

We expect the dollar to peak. The US economic and monetary convergence with the rest of the world is weighing on key dollar supports. The trade war de-escalation and a clearer picture in Europe in late 2019 could also erode the dollar’s safe-haven status. Moreover, we expect flows in the US to moderate as repatriations of foreign earnings stall and non-dollar settlement initiatives intensify. The long-term drag from twin deficits could also start to weigh. In the short term, a stretched long dollar position would cap the dollar.

Less directionality in store for G3 currencies

EURUSD could remain under pressure as EMU economies continue to decelerate along with subdued inflation. Multiple uncertainties and a dovish ECB would constrain the euro in the first half of 2019. Yet, a peaking dollar would limit the downside.

The Bank of Japan could remain on hold, but its dovish stance is fully priced in. The Federal Reserve should shortly end its rate hike cycle and balance-sheet normalisation should lead to further USDJPY downside.

The spectre of a no-deal Brexit – or the prospect of a deal – should keep GBPUSD volatile, and outcomes for the currency pair are somewhat binary at present. Still, Sterling remains cheap versus the US dollar, and an appreciation on some sort of “soft-Brexit” is the base case.

Cyclical commodities offer better prospects

The recovery in oil prices is not over yet

Oil fundamentals are overall weak: markets remain over-supplied and demand is vulnerable to the macro momentum. However, OPEC+ is starting to tackle excess supply and US producers are moderating output, and signs of glut in US oil infrastructure are resurfacing. While the rally is gradually phasing out, lingering supply risks and a moderate market imbalance in 2019 still support our $65/barrel target.

Gold likely to range trade

Rising rates and inflation do not call for a compelling upside for gold. Nonetheless, the perennial safe-haven attraction remains strong, and was clear to see over the fourth quarter. Moreover, Gold’s fundamentals recently improved, supported by lower output, weak macro momentum and the repricing of tail risks.

Copper will be attractive later in 2019

Geopolitical risks for producers, low inventories, and Chinese demand in copper intensive segments are supportive. Prices could also benefit from Chinese infrastructure spending. In this context, the supply and demand balance could remain under pressure. We stay neutral but could seek opportunities in the coming months.

Hedge funds: Overweight, but selectivity is key

Prefer Merger and Fixed-Income Arbitrage to L/S Equity

Hedge funds can help navigating unstable market conditions, but selectivity is key. In effect, some strategies suffered severe drawdowns in 2018 Long/Short (L/S) Equity, Special Situations, Commodity Trading Advisors (CTAs), while others were fairly resilient (Merger Arbitrage, Fixed Income Arbitrage, Global Macro). We still prefer strategies that have been able to navigate bear markets in the past, such as Merger Arbitrage. Fixed-Income Arbitrage has also proved resilient during higher equity volatility, though is sensitive to liquidity conditions, which remain supportive at present. Finally, we are defensive on L/S Equity strategies with a long market bias.

Oil excess supply expected to ease

Sources: SGPB, Macrobond, data as of 31/01/2019



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IMPORTANT INFORMATION – PLEASE READ

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This document is intended to report solely on the services, products, investment strategies and opportunities provided by or identified

by the Kleinwort Hambros group (“Kleinwort Hambros Group”). The services, products, investment strategies and opportunities

described herein may not be suitable for all clients. Potential clients should consult their financial adviser to assess the suitability of any

proposed transaction before taking any action.

FINANCIAL PROMOTION

This document is a financial promotion.

LIMITATION

Information herein is believed to be reliable but the SGPB does not warrant its completeness or accuracy and it should not be relied on

or acted upon without further verification. SGPB disclaims any responsibility to update or make any revisions to this document.

Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. As such, SGPB,

Societe Generale and its other subsidiaries shall not be held liable for any consequences, financial or otherwise, following any action

taken or not taken in relation to this document and its contents.

PAST PERFORMANCE

Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations and

the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you

may not get back the amount you invest. Changes in inflation, interest rates and the rate of exchange may have an adverse effect on

the value, price and income of investments.

MARKETING

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