Our 10 strongest investment convictions

Key Asset Allocation Views

Half way through 2019, we have updated our December outlook with ten investment convictions for the remaining six months of this year.

Two factors drove markets over the first half of 2019. Firstly, at the macro level, the Federal Reserve signalled that it would put rate hikes on hold, then dropped a promise to be “patient” and in June indicated it’s open to cutting rates. That prompted markets to recover their late 2018 losses on a rising streak that ran through April. Other central banks have followed suit, including the European Central Bank, which has killed off any expectations for a rate hike before mid-2020. In China, the People’s Bank of China has signalled that it is ready to boost growth.

Secondly, markets fell back in May as President Trump increased tariffs on Chinese imports and threatened duties on Mexican goods, before hitting all-time highs in June and early July with signals that the US and China are seeking to calm tensions.

As we look ahead to the rest of the year, the trade environment remains the biggest uncertainty. Whilst much of the impact from the current level of tariffs is priced in, an escalation most definitely is not. The lengthy trade dispute has disrupted supply chains and undermined business confidence and growth. That situation was further complicated last month with rising US/Iran tensions.

In the circumstances, we believe that investors need a balanced risk exposure in their portfolios, with hedges in the form of gold and the Japanese yen, to soften any new volatility episode and threats to the economic recovery. Central banks’ actions can definitely support valuations and sentiment in the short-term and in a context where earnings are highly dependent on the trade outlook, we feel comfortable with our balanced risk exposure.

1. Watch volatility

While coordinated central bank easing tends to reduce volatility, we are in the late phases of the economic cycle and trade tensions are clouding the outlook. For this reason, we prefer to maintain a defensive stance and a number of hedges, as the probability of an economic accident remains high.

2. Hold adequate liquidity and cash

We maintain our exposure to liquid assets to respond to volatility spikes and take advantage of opportunities as they appear. In an environment in which we do not expect interest rates to rise, we have cut exposure to cash in favour of carry strategies, which offer sound risk-reward profiles.

3. Prefer fixed income to equities

We still expect mid-single digit earnings growth in 2019, close to the long-term average, but we continue to watch for signs of the impact of trade uncertainty on companies’ capital expenditure and growth plans. We favour liquid fixed income, such as emerging market debt in local currencies (see below), which also offer high market beta and carry opportunities. Without additional support from declining bond yields (and the current market pricing for Fed cuts is already relatively aggressive in our view), equity prices have limited upside from now on and will primarily be driven by earnings dynamics and the outlook on global trade (see chart 1).

4. Equity gains depend on tech, be patient on banks

Equity margins are probably close to their peak and any market earnings consensus is becoming far more volatile and dependent on the global trade outlook. As we move into the second half of the year, more than ever, companies will be punished for anything less than pristine balance sheets. While banks in the US and Europe have lagged the wider market and valuations remain cheap, as interest rates stabilise we expect to see some performance catch up. Technology stocks in general and semi-conductor names in particular have been buffeted by the global trade uncertainties. For this reason, the tech sector remains a much less crowded trade than in 2018. If the wider stock markets are to make further new highs this year, there will have to be progress in the US/China trade dispute, and given the weight of the sector, in tech names generally.

5. Emerging currencies & debt will outperform EM equities

With this uncertainty in mind, and the low rate environment as well as the change in Fed stance making interest rate cuts feasible, we expect emerging currencies and debt in local currencies to outperform emerging equities. Today, we are neutral on emerging market assets, with a preference for local debt, which provides carry opportunities and liquidity compared with equities that remain highly sensitive to the news flow around global trade.

6. Gold as a haven

Gold reached a six-year high in late June, anticipating Fed easing, a weaker USD and reflecting US-China and then US-Iran tensions. We think the case for holding gold in a multi-asset portfolio remains valid today as investors continue to search for yield, and we see limited downside risk as gold offers an effective hedge from market turmoil. A lack of alternatives for diversifying a portfolio is also driving financial demand as non-USD government bond yields are now trading in negative territory.

7. Accelerating USD weakness

In December, we argued that 2019 would see broad-based dollar depreciation. This has played out, though more modestly than we expected. We see USD depreciation gaining traction in the second half, largely due to the Fed’s easing and slowing US growth as fiscal impulses fade and the twin deficit problem becomes more evident. US-Rest-of-World rate differentials have already compressed, suggesting the USD is about 5% overvalued. Assuming further rate compression, we see the USD converging closer to levels more consistent with yield spreads. That said we do not expect a TW USD depreciation to exceed 2.0% against the G10 bloc, as the dollar’s yield advantage – though eroded – offers some cushion. 

8. Further JPY gains

At the beginning of the year we favoured buying the JPY against the EUR and the USD as a hedge in periods of rising volatility and because the yen was undervalued. During the first half of the year, USDJPY depreciated 1.6% and EURJPY lost 2.5%. As the second half of the year begins, we continue to favour JPY long exposure against the USD, CHF and GBP in their respective portfolios. We expect the yen to remain the best currency hedge against volatile risk appetite as the Swiss franc has lost much of its haven status with deeply negative rates. The yen typically outperforms in a very mature US business cycle, and although Fed easing plus fears around Brexit have reduced some of the currency’s undervaluation, they still provide an additional tailwind for the Japanese currency.

9. EM FX on the back of carry strategies

In December, we were GBP bullish on the assumption that the UK would approve an EU withdrawal agreement. In its absence, sterling ended 0.5% lower against USD. The next few months are likely to see more volatility and significant pressure on sterling and we believe emerging market currencies may offer more interesting performance. A combination of major central banks’ easing and no signs of a global recession will significantly boost carry trades. Current US yields imply significant upside for EM local debt and EM currencies (see chart 2) and, with more attractive valuations at this stage of the cycle, we expect them to sustain recent gains and to see more flows to EM debt securities.

10. Real estate’s role

We believe that listed real estate may play a useful role in multi-asset CHF or EUR portfolios. Valuations look reasonable in this low-yield environment and dividend yields are largely higher than available on corporate bonds. As we expect the European Central Bank and the Swiss National Bank to remain dovish through 2020, and economic activity in Europe remains sound, we believe that the investment case for European real estate is compelling. By its nature, real estate correlates to economic activity although it is worth mentioning that this correlation has diminished in low-yield environments and/or mild recessions, such as in 2001.