Global Weekly: Trade deal optimism rises

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Despite a string of company results and news flow on political topics, such as Brexit and the possibility of a US/China trade deal, returns on equity markets this week have been flattish. In a volatile environment, we continue to favour a neutral stance toward stocks.

At the beginning of the week, the US delayed increasing tariffs on Chinese imports after the US president signalled substantial progress in negotiations on topics such as intellectual property protection, farm good purchases and currency policy. The US and China will meet in March to negotiate a peace to their trade dispute. It’s a deal that would relieve the stock market. With the British Parliament’s 12-March Brexit vote on the horizon, Prime Minister Theresa May promised a vote to delay Brexit in order to prevent a non-deal exit. The increasing likelihood of a postponement and a new Brexit referendum supported British sterling this week.

One of the largest forklift and warehouse automation providers, KION AG, reported solid full-year 2018 results this week. Despite a slowdown of economic activity in continental Europe, KION was able to sustain growth in most of its core European markets. Revenues in 2018 increased by 5.2% and order intake surged by 8.5% -- all-time high levels. Kion’s proposed dividend rose by 21%, backed by good cash-flow generation prospects. In addition, there was a positive market reaction to Anheuser-Busch Inbev results. The results came in as expected and provided a reassuring outlook for 2019. Good steps have been taken on a planned deleveraging, through a lowering of the net debt/EBITDA ratio to 4.6, with a goal to decrease it to below 4.0 at the end of 2020. (EBITDA is earnings before interest, taxes, depreciation and amortisation.)

Mixed signals in bond markets

Credit markets have stayed on track, delivering excess return throughout all asset classes. This trend has been mainly supported by the accommodative message of the US Federal Reserve and the European Central Bank. At this stage, no rate hikes are expected in 2019. Given Fed Chief Jerome Powell’s current motto that the Fed will stick to its ‘patient’ stance and that its policy decisions ‘will continue to be data dependent,’ one could even consider the potential for the Fed to lower rates if recession looms. In the same accommodative state of mind, Powell also reiterated this week that the Fed is willing to adjust the nomalisation of its balance sheet, if necessary.

The credit market also benefited from positive news coming from the diplomatic world. Donald Trump has been tweeting encouraging messages regarding the trade dispute with China; and a constructive dialogue on Brexit seems to be taking over. German Chancellor Angela Merkel has said that ‘if Britain needs some more time, we won’t refuse; but we are striving for an orderly solution.’

As a result, spreads have tightened further throughout all asset classes and are back to where they were before the 2018 end-of-year stress. This low-rate, low-inflation environment is good news and supports investments in new corporate bond issuance. But the positive scenario may be facing challenges. Macro data remains weak, manufacturing data is deteriorating, especially in Europe, and the German Ifo business climate index declined for the sixth consecutive month – hitting its lowest level in more than four years. US retail sales dropped, Chinese growth weakened and none of the above mentioned diplomatic “trials of strength,” i.e. the trade war and Brexit, have been solved yet.

Regarding credits, fourth-quarter results were a mixed bag of satisfying and disappointing news. More importantly, many companies have lowered their 2019 growth targets. Regarding debt levels, the OECD published the report “Corporate Bond Markets in a Time of Unconventional Monetary Policy,” which highlights that total outstanding nonfinancial corporate bond volume has doubled since 2008 to USD 13 trillion. And, in many cases, these bonds are subject to material vulnerabilities, such as lower-quality covenants.

In a market giving mixed signals, we are trying to limit our exposure to risk in bond portfolios and are neutral on duration, i.e. sensitivity to interest rates. We continue to favour emerging markets, as we believe that emerging markets could perform better with higher economic growth potential. This is in comparison to high-yield corporate bonds, which we view as increasingly vulnerable, with an unattractive risk/return profile. While we believe that high-yield corporate bonds have shown their maximum spread performance and should find their resistance level, emerging-markets debt could move towards 2017 levels, which explains our preference for them.