Reduced visibility for financial markets
19 April 2018
Since the beginning of the year, a number of factors have obscured visibility on financial markets.
To kick things off, US President Donald Trump announced tariffs on imports of steel and aluminum of 25% and 10% respectively. This measure is much like that which was implemented in 2002, with the difference that this time most countries were subsequently given exemptions. In the end, less than 30% of these US imports will be subject to tax increases, mainly from China and Russia. Since steel and aluminum represent only 2% of US imports, the impact will be marginal at worst.
The US president then announced a 25% tariff on USD 50 billion of Chinese imports, to which the Chinese countered with similar measures on US imports. It should be noted that these announcements are only baselines, open to negotiations which should last about two months.
How do we interpret this resurgence of protectionism?
These negotiations are, in our view, mainly political, given mid-term US elections in November. As it stands, these measures are not expected to have a significant impact on global growth: they represent USD 12.5 billion in effective taxes, or about 0.1% of Chinese and US GDP respectively.
Even if markets remain volatile over the coming weeks, global growth remains well oriented, despite current geopolitical tensions (i.e. Syria, Russia, etc.).
However, factors such as the risk of a trade war between the US and China, plus inflationary fears in the United States, have supported the decline in sovereign debt yields, hindering in the short-term our scenario of harmonization of interest rates of core countries and their economic fundamentals.
After years of almost uninterrupted growth, US technology stocks have been under pressure for several weeks. The issues are multiple and generally specific to the relevant companies (Amazon, Facebook, Tesla, etc.). Several questions arise:
Are technology stocks expensive? At first glance, they are undoubtedly expensive with P/E ratios around 25-30x, but these valuations can be explained by very high growth rates. We are not at all in a situation similar to the 1999-2000 period, as many companies have become extremely profitable.
Are some companies at risk? We must distinguish the established, profitable business models (Amazon, Google, etc.) from those which are not yet (Tesla, Netflix, etc.) and whose market capitalizations leave only little margin for error.
Overall, the US technology sector does not seem overvalued but some companies may show continued weakness in the coming months. On this basis, should we question the upward trend of stock market indices? We think not.
Leveling off of economic growth
The pace of growth in the Eurozone and in the United States clearly saw a phase of acceleration in the last months of 2017. However, confidence surveys, especially those carried out with companies, and Q1 2018 statistics (retail sales, industrial production) were mixed in the United States and below expectations in the Eurozone after the peaks reached at the end of 2017. The latest inflation figures published in these two regions came out as expected, with the exception of core inflation in the Eurozone, which disappointed slightly, at a level of 1% year-on-year.
We do not believe there is any cause for concern: we remain in line with the 2.4% growth consensus in the Eurozone for 2018 and slightly below consensus expectations for US growth, which stand at 2.8%. Our conviction remains unchanged: US inflation numbers could exceed consensus expectations in the coming months.
The UK economy continues to hold up well in light of Brexit: only foreign trade has been penalized. As in Japan, growth in these two countries is expected to reach an annual rate of 1.4% to 1.5%.
Expansionary monetary policies of the BoJ and the ECB
Powell's first committee as Chairman of the US Federal Reserve was as we expected: 25bp rate hike and raising Fed Funds rate projections through 2020, in response to the improving economic outlook. Any future adjustment to monetary policy will depend on economic data, particularly future inflation figures.
The renewal of two governors at the BoJ has clearly strengthened the “dovish” tone in recent weeks.
Lastly, the ECB's latest economic forecasts are now aligned with the 2018 consensus, but inflation has been revised downward in 2019, confirming that the ECB is not taking any risk on its inflation scenario. It has abandoned the idea of any further increase in its purchasing programme, a move that we expected.
Emerging debt markets
Our economic scenario for emerging countries is playing out. Growth prospects for 2018 will build on the solid results of 2017: 4.8% growth in the EM universe.
The recovery observed in Latin America over the past two years continues mainly in Argentina, Brazil and Colombia, and is expected to contribute to growth, which should be close to 3% this year in South America.
In emerging Europe as well as in Asia, activity benefited from the good recovery in world trade and the still expansionary monetary policies (in Europe and Japan). This recovery, ongoing for two years now, is taking place under conditions rarely seen in emerging countries. The level of debt is very contained in both absolute terms (below 50% of GDP) and in relative terms compared to developed countries. External accounts are on average positive and reserve levels are at their highest (USD 2,500 billion excl. China). Inflation, averaging 3.3% in 2017 in emerging countries, has never been so low and central banks could, if needed, further ease their monetary conditions.
Despite the very positive outlook for emerging bond markets, the questioning of trade agreements such as the North American Free Trade Agreement (NAFTA), fears of a trade war via protectionist measures/threats from the United States, as well as faster FED normalization expectations have together contributed to weakening the initial outlook since mid-February.
The normalization of US monetary policy should continue at a pace in line with market expectations, without causing a shock to emerging markets.
Absolute return Fixed Income Strategy
Our main convictions remain unchanged, including the rise in real European rates, US short-term rates and US inflation breakeven points on long-term maturities. Finally, our view remains positive on convertible bonds and banks’ subordinated debt in the Eurozone.
Absolute Return Emerging Market Debt Strategy
Today, we believe that the recent upsurge in volatility has been priced into the market. It is not likely to change our central scenario. We therefore maintain a positive outlook on risk premiums and on emerging market bonds in local currency.
Absolute Return Multi-Asset Stratgey
For all of these reasons, and in keeping with our contrarian approach to portfolio management, we maintain a positive outlook on risk-bearing assets in general and on equities in particular.
Source: La Française, data as at 31 March 2018, information current as at 9 April 2018. For professional investors only. The information and material provided herein do not in any case represent advice, offer, solicitation or recommendation to invest in specific investments. All information and data included in this document is considered as accurate at the date of its preparation considering the economic, financial and stock-exchange related context at that date and reflect the perspectives of Group La Française on the markets and their evolution. It is subject to change and does not represent or create contractual obligations. It should be noted that past performance does not necessarily determine future performance which may vary over time. These opinions may differ from those of other investment professionals. Issued by La Française AM Finance Services, home office 128, boulevard Raspail, 75006 Paris, France, regulated by the “Autorité de Contrôle Prudentiel” as investment services provider under the number 18673 X, affiliate of La Française.