Searching for Growth

Markets continued to recover over the week. Risky assets moved up across the board and oil prices trended higher. Also, bond yields drifted up a bit, although their rise remains very modest compared to the rebound in risky assets seen recently. It is clear therefore that although market panic has faded substantially that low growth, lowflation and longer central bank easiness remains embedded in investor expectations.

Helped by signs of bottoming in economic data surprises, especially in the US (see graph below), have investors’ fears about a global recession come down. As a result, a gradual process of normalization in risk premia and investor sentiment and positioning seems to be unfolding currently. Many of these behavioural metrics had become very depresses in the first two months of the year, often to Euro crisis or even Lehman crisis levels. The big question now becomes how far this normalization process has further to run?

The real green shoots in the global economy are still a bit hard to find. Surprises compared to depressed expectations are turning up, but both hard and survey data themselves are not yet at levels that hint at a growth acceleration. If anything, they still indicate a steady, but soft growth backdrop. Meanwhile, (geo)-political risks continue to linger in many parts of the World with a refugee crisis and Brexit risk overshadowing Europe, election uncertainty higher than ever in the US and many EM policy challenges persisting (China and Brazil both in the headlines again recently).

More tangible signs of a DM led rebound in global growth are therefore more hope that fact at this stage. The optimistic perspective might be given a hand by the behaviour of central banks over the next two weeks when the ECB, the Fed and the BoJ will update their policy stances. Most likely at least some of them will also ease further (most likely the ECB this week already).

In combination with the growth and inflation backdrop the anticipation of further central bank easing has translated into another record low yield environment in global bond markets (see graph below).

Different from most of the post-crisis periods, the market’s interpretation of new rounds of unconventional monetary policy easing seems less certain to be positive. Negative yields have posed new puzzles for many investors and it might well be that further policy innovation needs to come from fiscal policy makers rather than central bankers to create a lasting positive effect on both the real economy and risky assets.

The low/negative yield environment provides a unique opportunity for fiscal policy makers to close the large infrastructure deficit in the majority of DM economies. By investing in education and digital/water/transport/renewable energy infrastructure both long-term growth potential and short-term cyclical momentum would be supported. At the same time, debt servicing costs would hardly rise for the governments that dare to invest in the public capital stock of their own economies. Actually, those governments that are able to fund themselves at negative yields will even see their debt-servicing costs fall as a result of investing in their own future. It’s a strange world indeed!

For our allocation stance its means that we continue to search for more tangible proof of a strengthening of the growth backdrop. Once monetary and fiscal policy makers join hands to become more forceful on this front or if evidence on the ground of a more broad-based growth rebound emerges than we will most likely move back to a clear risk-on stance.

For now, we stay in a tactical mode around a fairly balanced allocation Therefore, after the strong equity rebound over the last two weeks and technical indicators moving into over-bought territory we moved equities back from a small overweight to neutral.

Fixed Income

Bunds are a small underweight. Global economic growth is supported by DM showing resilience in face of the EM slowdown. The risk-off sentiment since the start of the year favours government bonds and has pushed Bund yields down to below 25bp. We feel that at these levels the risk/return equation is no longer favorable for an investment in German Bunds. Of course, we admit that disinflationary forces appear on the rise (oil, CNY depreciation) feeding into expectations of less FED hikes and more ECB/BoJ easing. This would prevent a strong, sustainable rise in treasury yields.

Spread products are small underweight. The global growth outlook remains on track with our base case, but short-term uncertainty has increased somewhat again. EM and corporate risks (leverage, earnings) linger. Weak commodity prices still pose a risk for US HY and EMD HC in particular. Lack of market liquidity in Spread products is another risk factor as investors flee the category so far this year.

The overweight US HY within spread products was raised to medium. With some further improvement in US macroeconomic surprise indicators we want to increase the overweight USD credit paper.

Momentum, sentiment and investor flow dynamics for US HY appear to gain traction while oil prices are in a tentative bottoming phase.

Valuation of US HY has also improved with spreads above their long term average. EUR HY is neutral. EUR HY is particularly vulnerable to investor flows. Idiosyncratic risk also is on the rise. For EUR HY, nevertheless, a dovish ECB and further easing of bank credit standards is supportive.

USD IG is small overweight. USD IG spreads are attractive versus their own history. At a time when concerns over EM dominate, USD IG also could be a beneficiary of the search for yield.

In EM, we have a neutral position. EMD HC Sovereigns are upgraded to medium overweight. With spreads above the long term average valuation of EMD HC Sovereign improved while also flows tentatively stabilize. Support from lower Treasury yields and improved liquidity is still there as FED rate hike expectations were pushed out. The underweight EM FX was closed.

Momentum and sentiment towards EM FX improved while anticipation of Chinese policy stimulus also supports the EM FX category. In contrast, the underweight EMD HC Corporates was increased to medium. Both fundamentals and market dynamics remain negative. EM earnings momentum, coverage ratio, leverage and M&A have all deteriorated for the category.

Equities

We decided to take profits on our overweight equities. The bounce since the February lows has been important driven by a reversal in the oil price, better than expected US macro data and less risk for a China hard landing occuring in the short term given further policy easing. However, in the meantime behavioural dynamics have shifted from extreme pessimism towards more neutral levels. Our market reversal indicators even indicate that the equity market has become overbought. The dovish Fed expectations, weaker USD, relative economic data, very negative positioning and a reversal in cyclical commodity prices have made us close the underweight in emerging markets and to go neutral.

Real Estate

Real estate is kept neutral. Two elements are important: the risk of a rise in bond yields and the acceleration in credit spread widening. However, underlying fundamentals remain supportive: stronger labour data, better consumer confidence, positive impact of oil prices on retail sales and rising house prices. Real estate remains the biggest beneficiary of the search for yield from institutional & private investors. Within real estate we have a small overweight European real estate. ECB QE and a strengthening labour market should offer some support and pricing is not excessive.

Commodities

We decided to upgrade commodities from a medium underweight to a small underweight. Concerns over Chinese macroeconomic data and commodity demand remain and warrant an underweight. Nevertheless, we observe signs of stabilization in Bloomberg commodity index. This is not confined to oil prices but also in metal and agriculture. We also see signs of US oil production discipline. Regarding investor positioning, both speculative long and short contracts are stretched in Brent crude futures. With signs of stabilsation above USD 30, current short positions are being covered. Finally, short term sentiment indicators for the asset class based on digital newsflow data have turned positive.

We moved WTI crude oil to small overweight as increasing signs of US oil production discipline (capex and rig cuts, annual production contraction) are seen despite expected near term weakness (against which increasing verbal intervention on coordination might cushion).

US Corn also was moved overweight as US crop yields may retrace from record high and a weaker USD and potential La Nina provide support. Zinc was also moved overweight as it is the metal with more advanced production discipline and a balanced demand cycle exposure. Gold finally was moved underweight. US FED hikes are substantially priced out and lower US real rates have supported Gold. We believe this to be at risk of reversal as also US economic surprise indicators improve since February.