The political risks have receded somewhat...
February was relatively calm, enabling the rebound observed in January to continue, with the equity markets on the rise, government bond yields slightly higher and the credit markets showing a marked improvement.
In the United States, Q4 GDP growth surprised to the upside at 2.6% qoq, despite the sharpest drop in retail sales in a decade (-1.2% in December). The indicators are now pointing to a modest recovery in Q1, on the back of robust industrial output numbers and a rise in the services PMI.
Figures also edged up in the eurozone, with the services and composite PMIs at 52.8 and 51.9 respectively. Are we starting to see the reversal of the downtrend in place over the last year? It is too soon to draw any conclusions, but it looks like the European economy has moved beyond the bottom of the cycle, thanks in part to the range of budget stimuli implemented in the different countries.
China’s economic data has not seen a rebound, but nor has it deteriorated. The various stimulus plans announced by the Chinese government are starting to bear fruit (rise in new loans), but the full effects should take a little while to emerge.
Reassured by the slightly rosier macroeconomic picture, the markets also welcomed the progress made on some of the current political issues.
For example, President Trump has announced that he would delay the proposed tariff hike, but without giving any more information on the postponement. Significant efforts “appear” to have been made on technology transfer and intellectual property protection. Is this real or fake news? The markets have decided that the progress is real, and are now expecting a positive outcome to the negotiations, with the various tariffs imposed being lifted. The situation in the UK also became slightly clearer with Theresa May’s announcement of a vote on her deal on 12 March, to be followed - if this fails to get through the UK parliament - by a second vote on “no deal” on 13 March. If this also fails, it will be followed by a third vote on extending Article 50. As there is very little chance of the May deal or “no deal” being approved, an extension to Article 50 seems to be the most likely option. The extension would, however, have to be for a fairly limited period.
Lastly, and although this is currently having less of an impact on the financial markets, the political situation in Italy seems to be turning in favour of the League, after the results of elections in Sardinia which saw the Five Star Movement lose a lot of ground. This victory for the right followed a similar reversal for 5SM two weeks ago in Abruzzo. The League now seems to be well placed to form a government, if the current administration falls in the coming months. This would very likely be good news for Italian assets.
In this environment, we are maintaining our preference for the emerging markets, although we have taken profits on Chinese assets as these have done extremely well since the start of the year. We also continue to be positive on Spain and Portugal, and on subordinated financials. European inflation expectations also seem to still be too low in our view, given the recent oil price movements.
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