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How Investors Should Assess the ECB’s Next Move
In the five years since the ECB went “unconventional”, there has been one stand-out winner among eurozone equity markets: France (see chart below). The other majors have all underperformed. France - and the Netherlands - have been the main beneficiaries of the secular outperformance of ‘growth’ and ‘quality’ over ‘value’. The challenge for investors will be to decide whether after today the ECB is “ahead of” or “behind” the curve. If they come away disappointed, resigned to waiting for the Fed to deliver a meaningful policy shift, then the trends of the past 5 years will probably run on a bit longer. However, if Draghi surprises positively enough to sustain a bear steepener of yield curves, then this could be the start of something of a game-changer.
To Assess the ECB Requires an Assessment of Eurozone Real Economy
The eurozone looks close to an industrial recession; indeed, Germany is probably already there. ASR’s Turning Point Indicator suggests that the slowdown could broaden and intensify. But the picture is by no means clearcut: France and Italy have been relatively unaffected so far; consumer confidence remains resilient; and real narrow money growth has been strong. Inside this report we review the mixed evidence.
It’ll Need to be a Big Bazooka
We still see downside risks to the eurozone real economy; for us that raises the bar for what policymakers need to do next. Until we get clear evidence of a policy stimulus big enough to deliver an upturn in world trade growth and a sustained positive shift in yield curves, we will stick with our quality / growth bias.
• Parliament is likely to pass anti-‘No Deal’ legislation in September
• This may result in temporary relief for sterling but that relief may be short-lived
• Three things could see no deal risk return: Refusal of Royal Assent for the bill; Judicial review; An election
• An election remains highly likely and could bring with it the risk of a second referendum and a Corbyn government
• UK Political uncertainty is likely to remain elevated for the foreseeable future
• The prospect of US recession in 2020 is likely to result in a bear market
• We are ‘Maximum Underweight’ on Equities along with High Yield Credit
• Fed Funds at 0.25% will see 10yr US Treasury yields fall towards 1%-1.25%
KEY THEME: Recession will Challenge the Excesses Implicit in the New Normal
1. Excess reliance on Monetary Policy to sustain the ‘muted’ cycle
2. Excessively Low Rates creating an excess reliance on debt financing
3. Excess use of US Dollar Debt placing global growth at risk from US policy
4. Excessively ‘Tuned’ Business Models, built on Globalized capital & trade
5. Excess Profit Shares assumed to persist even through the recession
EQUITIES: Recession will see Global Equities head towards a bear market as earnings fall -5% to -15% and PEs contract, making us maximum underweight.
BONDS: UST 30-year yields have led the curve. As Fed easing accelerates, the UST rally will pivot to the front end, even as 10-year yields fall to 1%-1.25%.
CREDIT: With US recession now on the horizon, expect High Yield spreads to widen to 700bp+. A drop in WTI oil prices below $$$$50pb would provide extra fuel.
COMMODITIES: The US recession will challenge activity-exposed Commodities. Brent could test $$$$50p/b and we favour Precious over Industrial Metals.
REAL ASSETS: Low rates tend to support real assets. We prefer Real Estate to Infrastructure, with Hedge Funds providing additional downside protection.
US DOLLAR: There is more room for the dollar to appreciate against emerging and commodity currencies. For a broad-based dollar decline, clear signs of recovery in World ex US growth may be required, which seems unlikely before mid-2020.
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