Weekly investment views across key regions

Short-term Brexit noise, risks facing investors and how to manage them, and more weekly insights from around the globe.

 

Asia

More policy support ahead after mixed 3Q

China's economic slowdown continues. The world's second largest economy grew 6.0% y/y in 3Q, after expanding 6.2% y/y in 2Q. This drop was expected given the trade headwinds pulling down certain segments, and in our view justifies the use of further policy support in the quarters ahead.

Weakness has been most acute in investment and trade. For the former, fixed-asset investment (FAI) growth continues to slide, slowing to 5.4% in January–September from 5.5% in January–August. Growth was dragged down by manufacturing but partially offset by property and infrastructure. Manufacturing FAI growth dipped further to 2.5% y/y in September from 3.6% y/y in August, reflecting slowing industrial profit and export growth because of higher tariffs.

For the latter, export growth slipped further to –3.2% y/y in September, from –1% y/y in August, due to softer external demand and higher tariffs. The contraction was led by a further deterioration in exports to the US (–22% y/y vs. –16% y/y in August), as the additional 15% US tariff was imposed which covered about USD 130bn of Chinese goods. Meanwhile, import growth contracted for the fifth month to –8.5% y/y in September, after stabilizing at –5.6% in July and August. Both are likely to stay weak for the rest of the year.

Not all is doom and gloom, however. Retail sales appear to be stabilizing with growth of 7.8% y/y in September (from 7.5% y/y in August). And we expect growth to stay at around 8% y/y for the full year thanks to the resilience of consumer staples.

Specifically, auto sales – the largest component (11%) of overall retail sales – fell less in September (–2.2% y/y vs. –8.1% y/y in August), mainly due to a favorable base effect. The deceleration of oil product sales also tapered to –0.4% y/y, from –1.2% y/y in August, due to higher oil prices following the supply shock in Saudi Arabia. Sales of housing-related items, such as furniture and household electronics, improved due to better home sales in recent months. Sales of consumer staples, such as food, beverages, cosmetics and daily use goods, softened but still grew by high-single digits to a low-teen rates.

So given the ongoing downward pressure on the Chinese economy, we expect monetary and fiscal easing to continue. Monetary policy will likely remain broadly accommodative, with the scope and scale contingent on trade talk progress and economic performance. The 1-year medium-term lending facility (MLF) rate was cut by 5bps to 3.25% (from 3.3%) on 5 November, the first reduction since early 2016. While the cut was mild, it signals the People's Bank of China's continued easing bias amid market concerns over relatively neutral monetary action this year and rising bond yields in October. The lower MLF rate could help reduce the next loan prime rate (LPR) fixing on 20 November, which was held flat at 4.2% in October. We expect another 5–15bps of MLF rate cuts for the rest of year.

The previously announced targeted reserve requirement ratio (RRR) cut of 50bps for city commercial banks took effect in mid-October, with the next 50bps to come in mid-November. We expect another 50–100bps (less than 50–150bps previously) of general RRR cuts for rest of the year due to recent positive progress in the Sino-US trade talks. Credit growth held relatively steady at 10.8% y/y in September versus 10.7% y/y in July and August; we expect it to stay at 10–11% over the year's remaining months given the measured policy easing.

Fiscal policy, meanwhile, will likely focus on supporting infrastructure investment. To do so, local government bond issuance in 4Q will use the leftover quota from last year and some (reported up to CNY 1trn) of next year's quota, after this year's CNY 3.1trn quota ran out in September.

Signs of stabilization are emerging, in large part thanks to policy support. So we expect GDP to grow 6.1% this year, in line with the government's 6–6.5% target.

Author

Yifan Hu, Regional CIO and Chief China Economist

 

Emerging Markets

CEEMEA: Well positioned to overcome upcoming challenges

The credit fundamentals of key economies in Central and Eastern Europe (CEE), the Middle East, and Africa (collectively CEEMEA) have remained fairly stable this year. The region's GDP growth will likely slow to an average of 2.7%, down from 3.2% last year. The impact of trade tensions on investment, the ongoing slowdown in the Eurozone, and a more challenging backdrop for the energy market have served as impediments and remain major risks particularly for CEE and oil-driven economies in the region.

Inflation has fallen even lower and enabled many central banks to cut interest rates to support credit growth, and government fiscal metrics have remained stable on aggregate thanks to prudent fiscal management and healthy nominal GDP growth. The ongoing public and external deleveraging in Croatia, Hungary, Russia, and Egypt, together with sound macro policies, has led to credit rating upgrades in those countries.

Reforms and ongoing economic diversification efforts in Bahrain, Kazakhstan, and Morocco have helped stabilize their economic and credit outlook. Conversely, the lack of reforms in Oman, South Africa, and Turkey has led to negative rating actions and increased concerns about government debt sustainability.

Elsewhere in the Gulf, years of fiscal reform have stabilized credit fundamentals and lowered fiscal breakeven oil prices, but Fitch unexpectedly cut the ratings of Saudi Arabia in the wake of the attacks on Saudi Aramco's oil facilities. Elevated external debt and geopolitical risks have kept Turkey on its negative rating trajectory despite growing signs of economic stabilization there. Lastly, in sub-Saharan Africa, Kenya, Ivory Coast, and Nigeria show continued resilience.

We expect the stabilizing trend to continue, so we remain fairly upbeat on the region overall. Credit fundamentals and possibly credit ratings, in our view, are likely to improve in Egypt, Croatia, Kazakhstan, and Israel, while Turkey, South Africa, and Oman are likelier to suffer a further deterioration of theirs absent significant shifts to their policy framework.

The good news is that the major central banks in advanced economies will likely adhere to their accommodative policy stance for longer. So fiscal spending should remain affordable. Most policymakers in CEEMEA countries will have enough fiscal leeway, and those hesitant to engage in structural reforms might feel less urgency to initiate (often painful) economic adjustments. The extent of fiscal flexibility differs from country to country, depending on government debt burdens, budget balances, and potentially available sovereign assets. It is limited in South Africa, Bahrain, Oman, Egypt, and Kenya, for instance, and more expansive in Russia, Kazakhstan, Poland, and select Gulf countries (Kuwait, Qatar, and the UAE).

For an in-depth analysis on the region and specific countries, read "CEEMEA sovereign monitor: Well positioned to overcome upcoming challenges" published 4 November 2019.

Author

Michael Bolliger, Analyst

 

Europe

Filtering out the Brexit noise

We can say with reasonable certainty that at some point in the next few months the UK will leave the EU with an agreement. Moreover, the UK's departure will likely be on the basis of the recently renegotiated Withdrawal Agreement. But this doesn’t mean that Brexit will cease to influence markets and, crucially, the outlook for the European and UK economies. Far from it. This current stage is just the divorce—deciding who gets the house, the wedding china, and the collection of old DVDs. Agreeing on the long-term economic, regulatory, and security relationship between the two parties—divvying up access to the kids—is still yet to start, and it is likely to take longer than many currently anticipate.

And as we've learned throughout the Brexit process so far, time is not on the side of the negotiators. Deadlines have a habit of arriving before negotiations are even close to completion. Given the potential economic consequences of negotiations failing, investors and businesses across Europe are becoming rightly nervous, which leads to volatile moves in markets, as well as real effects on the economy.

Many assume the next "deadline" in the Brexit process will be at the end of next year when the transition arrangement between the EU and the UK is set to end. The reason it's called a "transition arrangement" is because it's meant to encompass the finite period during which the UK negotiates the terms of its final deal with the EU, a deal that it will then enter into at the end of December 2020. This is neither the time nor the place to ponder whether the EU and the UK can negotiate a fully operable trade, economic, and security partnership in such a short span. Let's just say the chances are almost zero.

And if a deal for a future relationship fails to materialize, then the UK will leave the transition period and default to WTO terms of trade with the EU. Welcome back our old friend, "no-deal Brexit." But there will be an extension to prevent this, right? There are provisions in the Withdrawal Agreement for both sides to agree to an extension that could last up to the end of 2022, but the UK has to ask for the extension by July of next year. Thus, the deadline for the UK to avoid a no-deal Brexit at the end of 2020 may arrive just months after the UK finally enters into the transition period.

So, while no-deal Brexit fears have rightly faded in recent weeks, they could return before we know it, and it would be unwise to relax too much. With regard to investments, we recommend remaining fully diversified, both across assets and across geographies. And we favor investing for the long haul, filtering out the short-term noise.

Author

Themis Themistocleous, Regional CIO Europe

 

United Kingdom

Something changed

The Monetary Policy Committee (MPC) at the Bank of England (BoE) met last week for is regular interest rate setting meeting. Something changed, and it wasn’t just the rebranding of the Quarterly Inflation Report, which now goes under the moniker "Monetary Policy Report" (MPR – another acronym for the collection). The big change was that the MPC were not unanimous in their decision to keep interest rates on hold. Two members of the MPC voted to cut interest rates by 25 basis points this month, a move that surprised both us and the markets in general.

The overall message from the MPC was a downgrade to the outlook for economic growth in the near term, but a recovery thereafter. The downgrade to GDP growth was largely expected as there is no escaping the fact that momentum in the global economy has waned. Regular readers will be aware that I am often at pains to stress that for a small, open economy like the UK the global backdrop is crucial. Indeed, the MPC attributed three-quarters of the downgrade to their growth forecasts to the global backdrop. The rest of the adjustment came from a combination of fiscal measures already announced by the government (positive) and a clarification on their assumptions on Brexit (negative).

There was a downgrade to inflation also, but a lot of this can be attributed to one-off factors such as the decline in oil prices and utility bills, the latter resulting from regulatory price-caps. Inflation is, on the BoE's estimates, expected to trough at a little over 1% in the first half of next year before gradually returning to target. Crucially, the MPC now expect inflation to undershoot (just) their 2% target if base rates are held at 0.75%.

Altogether, this was a dovish report from the MPC, certainly compared to recent history. Does this mean the Bank is on the verge of cutting rates? The market reaction to the meeting would suggest that this is still far from a forgone conclusion. And when considering the outlook, it is easy to understand why.

To me, what the MPR highlights more than anything else are the paths ahead, which could easily see the Bank's newfound dovishness hastily reverse. If the global backdrop stabilises, and the most recent signs here from the US-China trade spat are more encouraging, then this would remove some of the downside risks. Rates staying on hold is more likely in such an environment. If downsides risks grow, then the MPC will probably cut.

Domestically, the general election will be in focus, but the outcome here is also two-sided. If there is a Conservative victory and a deal to leave the EU is passed quickly, the government's focus will switch to the domestic agenda. If the early days of the election campaign are anything to go by then we should expect more fiscal easing, a slightly stronger economy, and a BoE on hold. A hung parliament and further uncertainty probably delays the potential for fiscal stimulus and could result in a rate cut.

The changes we saw from the BoE last week will not be the last. But having certainty on which direction the moves take remains as unclear as ever. When the BoE next meets on 19 December at least one unknown (the election) will have passed. Whether that changes anything remains anyone's guess.

Author

Dean Turner, Economist, UBS AG

 

United States

From Chance to Choice

We just recently completed our annual CIO Forum with events in both Los Angeles and Washington. In contrast to last year’s program, which focused upon the transformative impact from innovation and rapid technological change...

...this year’s events centered around the theme "Risk: From Chance to Choice." Throughout these sessions, we addressed some of the most critical challenges facing investors today, including the unstable geopolitical setting; polarizing domestic political environment; fragile global economic outlook; shifting technological landscape; evolving field of sustainability and governance; challenging business environment; and complex market backdrop.

While a casual glance at the program's title may suggest a fairly gloomy affair, our conversations throughout the day were instead lively discussions that highlighted the sorts of opportunities and innovations that often emerge from both adversity and upheaval. We explored some of the means by which public officials, business leaders, policymakers, scientists, activists, investors, and consumers are acting to remediate or neutralize some of today’s most daunting challenges. These include not only adapting to new realities, but also altering the dynamics to create whole new opportunities for growth and advancement.

At the very beginning of what I consider to be one of the most thoughtful and comprehensive historical accounts of risk, "Against the Gods," author Peter Bernstein offered the following conceptualization of human development that I find especially enlightening: "The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk: the notion that the future is more than a whim of the gods and that men and women are not passive before nature."

Think about this for a moment.

It's not technological, cultural, political, or even social developments that mark modernity, but rather the evolution in our understanding of the concept of risk. That’s because without an awareness of the nature, sources, and magnitude of risk, there would be no advancement in any of these other fields. So questioning—and then openly challenging—long-held notions of how and from where threats emanate, marked the first serious attempt at understanding and managing risk. It was this critical leap that enabled mankind to advance on what has been a progressive path of development across a whole host of human endeavors.

But a final breakthrough truly opened up a whole new avenue of exploration into the concept of risk: the role that we—humans—play in this ever evolving process. Because while the probabilities and payoffs for any outcome may be known to all participants, each individual may still value and assess them quite differently. This means that some may be willing to pay to insure against an outcome, while others may actually look to sell them that insurance.

It is this subjective element—the human element—that makes risk management so complex, but also so potentially rewarding. Greater awareness of the sources and nature of threats; the ability to incorporate probability theory into our outcome assessments; and finally a firmer grasp of the subjective human factor have supplied us with the essential building blocks for risk management.

Over the next week, I’ll be sharing some additional perspective on some of the insights offered by both the participants during our panel discussions as well as the interactive feedback from our forum attendees. But the key takeaway from our conference was for me the realization that we must constantly adapt in order to enhance our ability to manage and even benefit from risk, if we are to successfully keep pace with the diversity and complexity of the threats we face.

There’s nothing gloomy about that…

Author

Michael Ryan, CFA, Chief Investment Officer Americas


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