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Holding on to hope

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Equity markets have now fully recovered lost ground caused by the US raising tariffs on Chinese imports in early May.

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Holding on to hope

Equity markets have now fully recovered lost ground caused by the US raising tariffs on Chinese imports in early May. Bullish sentiment has been fueled by expectations of a US-China trade talk reboot and cuts from central banks. Earnings momentum is improving after the US Q1 earnings season delivered good news in terms of profits and first Q2 publications looking good. The bond market, however, tells a different story. Inflation expectations have subsided, especially in the eurozone, signaling a bleak macro outlook. Central banks have turned more dovish as below-target headline inflation is offering some scope for lower policy rates.

Macro readings remain mixed. Manufacturing confidence is still sliding as the trade war has created greater uncertainty, dragging down investment plans. Although growth leveled off in the spring, it was then hit by the trade war escalation, leading to a string of underwhelming macro readings. Services, which mainly depend on private consumption, have started to edge downwards. A supportive policy mix and tamed inflation have propped up activity overall, but the effects of the latest round of tariff hikes have not yet been felt.

We are keeping Global equities at Neutral. Abundant liquidity has lifted equities to year-to-date highs and should remain a strong support in the short run. However, we maintain a defensive stance from a country and sector perspective. We are prudent on Japanese and Emerging Market (“EM”) equities, as the trade war is a powerful headwind for these markets. We prefer high quality and high dividend stocks that offer attractive alternatives for investors searching for yields. 

Meanwhile, we see signs to double down on credit. The current environment is very supportive for corporate bonds (credit). Low inflation, dovish central banks, and limited default risks are all arguments for increasing credit exposure. The hunt for yield is still on. Falling sovereign bond yields are pushing investors to seek lower-rated bonds. Credit spreads are stretched, but monetary policies should keep them tight. We have adopted a neutral duration on US Treasuries, as upside risks on yields seem contained. Emerging Market debt, which has performed quite well year-to-date, should continue to do so as the Federal Reserve’s easing bias brings support to the asset class, as well as issuers. 

Beware of a shift in sentiment. Risk appetite is currently being bolstered by monetary policies. However, downside risks abound: geopolitics, with rising tensions between Iran and the US; trade, as US-China disputes may not be resolved as fast as investors hope; and macro, as the weakening manufacturing cycle could spill over to services. For these reasons, investors should prepare to reduce risk if downside risks start to materialize.