Coffee Break

Last week in a nutshell

• Overall, markets were dominated by a spike in volatility as uncertainty about a soft landing in the US weighed on investors’ minds. A continued unwinding of the JPY carry trade further strengthened the sell-off effect.
• The latter also caused the worst decline in Japanse stocks since 1987. However the BoJ was able to bring some stability after sending out some dovish signals pledging to refrain from hiking when markets are unstable.
• Later in the week, better than expected jobless claims (233k vs 240k) in the US brought some relief on the markets, reducing fears of recession.
• Kamala Harris has chosen Tim Walz, the governor of Minnesota, as her running mate. He is expected to broaden Kamala Harris's electoral base among rural voters.

Investment convictions

Core scenario

• Despite uncertainties rising over a weakening of the US economy, we keep our central scenario of a soft landing.
• US Private domestic demand continues to grow at a solid pace while consumption is only slowing gradually. Also, if composite business activity indicators are volatile, they remain at expansionary levels. Finally, among the weakness in China and doubt over the US consumer, earnings and profits remain resilient.
• In the US, growth forecasts are increasingly influenced by political and monetary factors. EU growth is dependent on a pick-up in consumer activity, while China's growth remains subdued.
• The cooling of inflation – and core inflation – is a synchronised global development. Supportive (i.e. lower) inflation news also paves the way for European central banks (e.g., ECB, BoE, SNB, Riksbank) to further cut interest rates in Q3. With several emerging market central banks already cutting since 2023, the long-awaited global easing cycle is on its way.

Risks

• Looking ahead, we caution against policy decisions that lead to higher tariffs and a tighter labour market in the US, which could ultimately lead to rising inflation again but also would impact economies open to trade.
• A change in the White House and the reprioritisation of US economic policy could affect the speed and extent of monetary easing in case of a second Donald Trump presidency.
• Continued unwinding of carry trades, combined with the rise in the Yen, could lead to further stress on the markets.
• The recent snap elections have put France in an unprecedented situation: a coalition must be formed to provide political stability in a context of limited fiscal space to boost supply. Next year, we see a risk of downgrade or a negative outlook in all scenarios as the debt ratio rises.
• In China, economic activity remains fragile and price developments remain deflationary as consumer confidence remains low. Additional tariffs could jeopardise continued recovery.
• Geopolitical risks to the outlook for global growth remain tilted to the downside as developments in the Middle East and the war in Ukraine unfold.

Cross asset strategy

1. Since mid-July, among political turmoil on both sides of the Atlantic, we have begun to reduce risk in our portfolio and are now neutral.
2. The recent correction in equities and bonds, triggered by recession fears in the US and the Bank of Japan rate hike, seem excessive to us. However, we keep our neutral stance as we believe markets are unlikely to recover quickly, as further unwinding of carry trades could take place, triggering heightened volatility spike on the markets.
3. We prefer developed markets vs emerging markets and especially US equities and UK equities which are more defensive. We turn tactically neutral on Japan which should suffer from any further JPY strengthening.
   • In the US, the Q2 earnings season is supportive but data from the technology sector reports are not comparable to former quarters. We therefore locked in our profits and have a neutral positioning on the sector.
   • In the UK, valuations remain attractive with the potential for multiple expansion and the BoE poised to cut interest rates.
   • In Japan, exiting the multi-decade long deflation as well as corporate governance reforms bearing fruit should more than counterbalance a less dovish Bank of Japan. However current carry trade unwinding is a headwind.
   • In the euro zone, while tail risks in France have diminished, the surprise victory of the left-wing alliance and a hung parliament imply political uncertainty. A higher risk premium remains justified.
4. In the equity sector allocation:
   • Given current market volatility, we added defensive plays in portfolios.
   • We have increased our position on Healthcare. Q2 earnings indicate that the normalisation of overearning from COVID, due to destocking excess inventories and demand for COVID-specific products, is mostly complete. On the contrary we decreased our allocation to small caps which could suffer from liquidity shortage in August if further stress resurface on the markets.
5. In the fixed income allocation, with monetary policy easing and heightened uncertainty, government bonds are an attractive investment as they offer a hedge in a multi-asset portfolio. Also we see little room for credit spreads to tighten further:
   • We favour carry over spreads, with a focus on quality issuers: we maintain our long duration bias via Germany and the UK.
   • We are neutral on US duration.
   • We have a relatively small exposure to emerging markets sovereign bonds amid very narrow spreads.
   • We are neutral on investment grade and high yield bonds, regardless of the issuers’ region.
6. We keep an allocation to Alternative investments and to gold.

Our Positioning

Taking into account current market volatility, we reduced our overall exposure to equities, with an overall equity weighting fairly close to neutral, with protection on European and US equities.
Within equities, we have chosen to be more defensive in Europe and increased our exposure to UK equities relative to the euro zone. In our sector allocation, we also had tactically reduced our exposure to US mega-cap companies and the technology sector while we have increased our exposure to Healthcare, which also has defensive qualities. We decreased our exposure on small and mid-caps as they offer little protection in heightened volatility episodes.
With regard to our bond exposure, as outlined in our outlook for the second half of the year, we anticipated that the correlation between equities and bonds should revert to negative again as inflation normalises, enabling safe bonds to resume their protective role within a diversified portfolio. We therefore maintained a long duration exposure with a focus on German bonds. Simultaneously, we remained neutral on corporate investment grade and more cautious on global high yield.