Global growth is likely to return to form

Despite the current weakness in economic figures, particularly in Europe, and a near-inversion of the US yield curve, global growth is likely to return to form in the second half of 2019. Growth in credit, a key factor in Chinese economic growth, is no longer slowing and should help restart global trade in the second half of the year. Europe will be driven by this trend, and by the recent significant easing in financial conditions.

Growth in the US is resilient, driven by solid consumer spending, an upturn in the housing market and recent gains in productivity that have outstripped growth in nominal wages. Inflationary pressures have vanished, and there is little risk of recession for 2019. However, political risks have not faded (Brexit being the first among them) and could undermine the economic upturn. But there again, notable progress has been made, and an agreement on customs duties seems near between China and the United States.

Microeconomic environment

Equities: As soon as global growth begins to recover, probably by mid-year, we plan to reduce our exposure to US equities and rotate more aggressively into international equities – Europe and emerging markets in particular. From a sector viewpoint, it is time to take profits on defensive sectors, particularly foods and beverages, whose valuations have hit stratospheric levels, and switch into more cyclical stocks.

Financials will return to form, once yields have turned up and growth has accelerated. Let’s wait patiently for this signal, which may come from more dovish ECB measures on excess reserves, even if the positive impact would show up more in Germany or France than in Italy. We still like emerging equity markets for their relative valuations, governance, and EPS growth differential.

Government bonds: We are sticking to our underweighting of government bonds for the next nine months. While investors have priced in the end of monetary policy normalisation, they are still too complacent with regard to possible US inflationary pressures. Moreover, when expressed in dollars, yields are currently higher in Germany and Japan than in the US.

Corporate bonds: We remain bullish for the medium term, as an eviction effect should guarantee a stabilisation or compression in spreads.In the second half of the year, gains will probably be driven more by the carry trade than capital gains.

Currencies: The euro is likely to be driven up vs. the dollar by the relative improvement in global economic activity. Leaving aside the possibility of a convergence towards its estimated $1.30 purchasing power parity, a return to $1.15/1.20 is certainly possible.

Basic materials: Prices of basic materials will be boosted in the second half of 2019 by the weakening in the dollar and firming up in global growth. Copper and oil are likely to benefit. Oil prices are likely to continue moving up, as the skewing of supply and demand (due to Venezuela, Iran and other issues) cannot be resorbed quickly, despite the steep rise in US shale output.

Allocation: We are sticking to our neutral stance on equities for as long as the Brexit cloud hangs over us. Valuations have returned to their historical standards and stocks are no longer trading at meaningful discounts. That being said, we are not “de-risking” our portfolios, as market gains have been driven little by inflows, particularly in equities, and repositioning after a Sino-US trade agreement or a favourable Brexit outcome could produce one last upward surge… that should not be missed. After that, risky assets are likely to enter a quieter period.

So, stay tuned.