Market overview

Lyxor Cross Asset Research Q1 2020 : Skating Onto Thinner Ice

Macro and Market Views 

The year may well end as it started: on a strong note. 2019 will probably be remembered as a year when it was very costly to be O/W cash compared to anything else. After such an exceptional vintage for both equity and bond markets, could the bullish mode turn sour in 2020? As the manufacturing recession is bottoming out, policy risks have eased and central banks remain accommodative, we struggle to find the catalysts to validate a bearish case. One thing that has made us uncomfortable going forward is the recent expansion of equity multiples, which will be unsustainable if bond yields normalize. EPS growth will have to take the lead, but we find consensus estimates to be overly optimistic. Provided that inflation prints remain below central bank targets, investors should nonetheless be rewarded for taking risks.


In 2020, we expect a mild cyclical upswing in the Eurozone, led by Germany, resilient growth in the U.S. and improvements in China’s economy. The policy mix remains highly accommodative almost everywhere, and the likelihood that the U.S. will partially roll back trade tariffs with China should help sustain global growth and consumer confidence. In that context, we believe that bond yields will normalize at a higher level, especially in Germany. The upside should be capped by persistent deflationary forces. Tactically, we like inflation breakevens in the U.S. We strategically maintain our constructive views on carry strategies such as HY credit and EM sovereign credit.

 

In equities, we believe that Eurozone markets could see a reprieve in 2020 after more than a decade of underperformance compared to U.S. stock markets. Euro STOXX 300 profit margins should hold up and Eurozone corporations are likely to benefit from their high operating leverage at a time of improving growth momentum. In our opinion, relative valuation offers some upside. We keep in mind that whatever the trigger, flows could act as amplifiers. Investors who fled Eurozone markets in 2018 and 2019 might be tempted to return. What could be this trigger? The shift in economic policy uncertainty could attract investors back to EMU stocks. All in all, we stand neutral on both U.S. and EMU equity markets but with a cyclical bias in the EMU with regards to sector allocation. We strategically upgrade Japanese equities to O/W. Our views are supported by valuation, accommodative fiscal and monetary policies, momentum, and the likelihood that value plays should be rewarded in 2020 if the expected cyclical upswing takes shape.


Alternative Strategies
We believe current monetary conditions remain supportive for carry strategies such as L/S Credit and EM-focused Global Macro. Event-Driven strategies should be supported by a different set of factors such as organic growth challenges and technological disruption. They encourage companies to consider M&A or ne  capital allocation strategies. Our stance on Global Macro and CTAs is constructive, though at Neutral. We find both strategies complementary.


Recent changes to our market views include the upgrade of Special Situation strategies to O/W, and the downgrade of Market Neutral L/S to U/W. Market Neutral L/S strategies are sensitive to sector rotations/momentum reversals which may continue as we expect the global manufacturing cycle to bottom out and bond yields to normalize at a higher level. In this context, we believe it is relevant to add beta via Special Situation strategies in Event-Driven, which we upgrade to O/W. We are comfortable with their bias in favor of smaller capitalizations and like the fact that they do not have a persistent momentum bias, which helps diversify this source of risk present in many L/S Equity strategies (U/W).