Market overview

Lyxor Cross Asset Research Q4 2019: Cut Risk Into Year-End

A tug-of-war between macro and liquidity
Markets are again flirting near historical highs. The trade war escalation continues to weigh on market sentiment while the rates pullback is underpinning risky assets’ valuations. Macro readings point to a growth deceleration as manufacturing has entered recession territory and services are edging down. The manufacturing slump should worsen in the short run, with growth bottoming out only in early 2020. Corporate profit expectations are likely to be revised down as growth sputters and tariffs hit margins. The Federal Reserve (the “Fed”) may be reluctant to cut rates to match what the market has priced in as a recession is not around the corner yet. Meanwhile, the European Central Bank (“ECB”) is keen to pass the baton on to fiscal policymakers given weak demand. By geographic area, China’s economy is deteriorating further, suggesting yet again additional easing measures to support consumption and investment; Brexit remains a wild card with PM Johnson threatening a “do or die” no-deal exit on October 31; and heightened tensions in the Middle East and surging oil prices bring additional headwinds to global growth. Our investment recommendations are based on a short-term global slowdown and then stabilization – not a recession – in the U.S. and Europe.

Underweight global equities. Political and macro newsflow remain broadly negative, though central banks’ easing, subdued inflation and robust consumption remain supportive. We still prefer U.S. equities as the macro picture is brighter and earnings are increasingly geared towards the domestic market. We have downgraded eurozone equities to Underweight, at par with the Emerging Markets and Japan, as the trade war escalation, manufacturing downturn and slower growth are set to weigh on overall equity performance.

Prefer credit over bonds. The overall backdrop remains highly supportive for credit due to easing monetary policy, low default rates and the ongoing chase for yields. High-yield bonds should remain a sweet spot due to attractive carry and shorter duration. Bonds have, surprisingly, outperformed this year, but long-term yields are nearing a bottom and could easily rise on Fed repricing and reflation policies in the euro area. This also bodes well for emerging bonds, as central banks are keen to follow the Fed and yields will continue to attract positive inflows.

Gold as a safe haven. Appetite to hold gold in portfolios has surged given the negative yields for a third of all sovereign bonds. We deem gold an attractive hedge due to the lingering uncertainty and central banks’ diversifying reserves allocation out of the USD.
Market sentiment still highly sensitive to newsflow. We prefer to cut risk in our portfolios. The business cycle is in a later stage and fading out. Political risks still loom with the unsolved Brexit outcome, Middle-Eastern geopolitical tensions and trade war. Also, any, likely, downward revision to earnings forecasts could imply a derating given already stretched valuations...