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Investment Commentary




Central Bank Pivot Eases Financial Conditions Further

Financial markets are navigating a fundamental backdrop of weakening global manufacturing and underwhelming inflation expectations. In response, global Central Banks have continued to move back into easing mode. As a result, global sovereign yields have continued to drift lower. We note that some $13 trillion of debt globally is currently carrying negative yields; particularly in Europe. In the U.S., financial conditions remain accommodative with corporate credit spreads in check and real rates close to the zero bound. The U.S. monetary policy pivot has certainly supported asset prices year to date and encouraged a ‘grab for yield’ mentality. 

The question at this juncture is whether easier financial conditions and the recent U.S./China trade war pause at the G20 will be enough to sustainably lift global business confidence and related capital expenditures. From an earnings perspective, the bar for Q2 and Q3 2019 earnings growth for U.S. companies is low (flattish consensus growth expectations). However, for Q4 2019 and 2020 consensus expects 7% and 11% EPS growth respectively. With most of the global manufacturing surveys in contraction we see some risk for company CEOs to trim their annual guidance for 2019. Therefore, even though monetary easing keeps borrowing costs in check, the real test for global equities will be meeting and exceeding market expectations for earnings and free cash flows.





The fixed income market expects close to five 25 basis point Fed interest rate cuts by 2020. Market debate remains as to whether the Fed is about to undertake 2-3 ‘insurance’ rate cuts (similarly to 1995 and 1998); or whether it’s about to commence a full easing cycle in anticipation of an end to the business cycle scenario. At a minimum, we see the Fed reversing its Dec policy mistake by cutting rates by 25bps in its upcoming  July 31st  meeting. It’s plausible that the Fed will then be more gradualist in its easing trajectory for the rest of 2019; as it will likely be more reactive to any tightening of financial conditions and/or declining inflation expectations. The pace of Fed easing may cause a pick-up in asset price volatility in the coming months/quarters; which may enable us to deploy capital at better valuation levels across asset classes.

As we can see above, in a negative yield landscape there’s scope for U.S. Treasury yields to drift lower. Yet, at some point the market narrative will likely start changing to whether the Fed and other Central Banks are ‘pushing on a string’ as by historical standards borrowing costs remain extremely low. After an investing ramp-up in 2018 on the back of tax cuts, CEOs will likely remain fairly wary in their capital spending in 2019-20. Moreover, CEOs are facing increasing labor market constraints. Despite ample job openings the availability of qualified workers is becoming  an issue. The U.S. economy added 3.9 million jobs year to date vs. 4.5m over the same period last year. An inverted yield curve at the front-end of the Treasury curve and a deceleration in employed individuals justify the Fed’s policy pivot. Even as the latest NFP report came in strong at 224k (and threw off expectations for a 50bp cut in July), we note the divergence vs. the ADP private payroll and ISM employment reports. Therefore, maturing underlying demand will likely keep U.S. Treasury yields in check and thus income generating instruments in strong demand.





Lastly, we note that mixed inflation readings and leading indicators such as manufacturing new orders give fuel to the Fed to carry on with its policy pivot. Apart from the Fed’s official mandate of price stability and maximum employment, Fed chairman Powell has stressed the Fed’s resolve to ‘sustain the current economic expansion’. In our view, the Fed must be mindful of the corporate profit cycle; as GDP cycle swings are mainly caused by changes in private investment. As discussed earlier, street earnings expectations seem on the optimistic side for Q4 2019 and 2020. In fact, the street assumes mild margin expansion over the next 2 years. We see some margin risk to consensus margin expectations. From a portfolio perspective, we continue to be opportunistic in our security selection with a bias towards industry leaders with more defensible and sustainable earnings/margin profiles. At the sector level, we continue to favor secular growth themes e.g. in the tech, communication services and healthcare sectors. As the upcoming earnings season is approaching, we are on the lookout for any opportunities from market over-reactions to margin misses or changes in company guidance.



In conclusion, asset prices across a variety of asset classes and financial conditions have benefited from a material shift in global Central Bank policies in 2019; and a consequent decline in sovereign bond yields and corporate credit spreads. With subdued equity and interest rate volatility, we look forward to any volatility episodes in the coming months. Particularly, if underlying fundamentals don’t fully meet market expectations and/or if the timing and magnitude of the Fed easing policy creates any back-up in Treasury yields.


Christos Charalambous CFA

Senior Strategist

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