Key points from around the globe.
1. US Economy
US GDP print on Friday was stronger than estimates, however this was mainly due to a decrease in net imports and a buildup of inventory of unsold goods, a factor that is likely to subside. On the other hand, the Core Personal Consumption Expenditures reading (an inflation gauge watched closely by the Fed) posted 1.3% vs. 1.6% forecast. This suggests that inflation may be moving away from the Fed’s 2% target. All this implies a continuation of the Fed’s dovish policy. Investors piled into safe government debt on the back of this economic data, sending the 10 year US treasury yield down to 2.5%. We don’t expect yields to move much higher from these levels unless and until we see any strengthening in growth and/or inflation outlook. The US Dollar has weakened after its rally early last week and we believe the strength was due more to positioning rather than a fundamental reason. Credit spreads remain on the tighter end, and we can expect spreads in the BBB and lower rated credits to selectively widen on the back of any economic data weakness but we don’t see any imminent change in credit markets.
2. US Equities
Stocks continue to flirt with all-time highs on the S&P 500. Tech giants, Facebook, Microsoft and Amazon have reported very strong results and we expect the same from Google later this week. Industrials and Energy sectors on the other hand have not put up such optimistic numbers and are a drag on stocks. Earnings growth estimates on the S&P 500 for 2019 now stand at a little over 9%. This is a decent number given the time of the cycle, however a) with the exception of the tech sector, this number is not primarily being driven by growth in the top line and b) we believe the number is on the higher end and earnings growth could come in lower. We have a neutral bias on US stocks unless the S&P 500 can convincingly break above this 2940 resistance level. In that case momentum can carry the index to 3000.
Chinese Equities on the Shanghai Exchange have retreated 7% from their impressive 32% year to date rally. This is a healthy and much needed correction, but it is also being driven by fears that the PBoC will reign in stimulus sooner than they should, putting the Chinese economic recovery at risk. We do not believe this to be the case. We think that the Chinese government cannot afford to impede the current economic trajectory, and will be very calculative and cautious in its approach to stimulus. We expect China to continue to show signs of recovery and will closely watch the manufacturing data coming out this week in support of this. If China gets going, it alone can drive global growth and uplift Europe with effects being felt as far as the US. Given the strong rally in EM assets this year, we would wait for a further pullback and coupled with strong data we would recommend buying EM.
European data still has to show convincing signs of growth and we believe China’s recovery can help that. Once data starts showing consistent signs of a cyclical uptrend (we expect this is second half of 2019) we will be bullish on economies like France that are relatively more diversified and are levered to global growth. We are not so bullish on Germany, given their heavy reliance on the Auto sector to drive growth. We do not think there will be any uptick in the car replacement cycle in the near future and since Germany is not primarily a domestic consumption driven economy we believe it will underperform its peers should global growth take off. We would remain cautious on European Equities till then but once the data confirms, we favor France and Spain. The European Bond space on the other hand continues to tighten due to a desperate search for yield.
The strong rally in oil has come to a halt and Brent has come off its highs. We believe supply expectations out of the US, Russia and Saudi will be enough to curtail any upside form here but still tight enough to present a floor to crude prices. We think Brent can settle in the high $60s which is decent for both producers and importers. On an interesting note, rig count in the US has continued its downward trend this year reflecting potentially weaker shale going forward. Trump has made it very clear that he opposes higher oil prices since they hurt consumption, but we do not expect an immediate supply response from OPEC+ to come through. We see better levels appearing in oil and oil related equities providing opportunities to add exposure.
Brazil has crossed its first of many hurdles in passing the much needed pension reforms. However the road is still long and bumpy and we will probably not get clarity on this issue till August. Argentina’s Equity and Bond markets have been very volatile last week. The shorter end of the Argentine sovereign curve offers significant value now, and its sell off is being driven solely by political uncertainty and the fears of a potential debt default rather than fundamental factors. Argentina has $72 billion in reserves (enough to meet short term liabilities) and a growing Current Account surplus driven not just by import contraction but by increasing exports, not to mention fiscal support from an IMF program. The upcoming elections in October present a risk to owning Argentine assets but we won’t be shy to selectively dip into securities showing clear signs of over-reaction.