2019 H2 Outlook:

Building for resiliency

Sébastien Galy, Sr. Macro Strategist at Nordea Asset Management

With a trade war likely intensifying between the United States and China, we suggest building for resiliency by choosing a product mix that either reduces risk somewhat or diversifies it, such as some long-short equity strategies. We see ahead of us a G20 meeting that is a make or break for the US-China trade war and the odds are that it is a break. China’s population is being warned of a Long March, code words for great hardship, while official papers iterate “Don’t say that we didn’t warn you”, words first said before China attacked India. A widening of US tariffs to all of China’s exports would likely trigger a devaluation of the renminbi that would start a chain reaction. The US would likely intensify tariffs and some factories would move out of China.

The clash of Titans

The conflict between China and the United States is that of two vast giants vying for supremacy which means that commercial considerations can become secondary to national security ones. As we head to the G20 meeting, neither side seems to be softening its stance and yet the threat of extending the tariffs to China’s total exports to the United States stands in the balance. An olive branch is possible, e.g. the promise of buying soybean, but is unlikely to make much headway. The impact on Chinese growth would be sizable if we postulate that actual growth is around 4.5%. Estimates of the impact of the tariffs vary from less than 1% to 2% over two years.

The clock has started ticking for low margin Chinese producers. Take for example a t-shirt produced in China: a 25% tariff wipes out the profit margin of the US retailer while the local manufacturers likely have a limited ability to absorb the extra cost. Now think of industries that are uncertain if tariffs will be modulated up or down in the next few years — they will also look for alternative production sites such as Vietnam, itself at risk of being branded a currency manipulator. Faced with such a ticking clock and lower export demand, China is likely to let its currency weaken most likely by ten percent – not enough to create a dollar debt repayment crisis but partially stemming a credit crisis. This would lead Asia Pacific currencies to weaken and the dollar to rise. Currency intervention would limit imported inflation in countries such as Indonesia. Such consequent dwindling demand for short-dated US Treasuries should have a limited impact.

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US equities – through the eye of the needle

The impact of the tariffs should intensify next year creating a shock on growth stocks, such as Apple, and consumer goods, such as Nike and some hotels. IT stocks could stay turbulent at a time when the equity market is partially priced in for a deal. Retaliations are likely to be concentrated on prestige stocks, e.g. FedEx, currently targeted by a probe, and Apple, which competes with Huawi.

Hence, a more defensive portfolio mix is likely a good idea heading into the G20 meeting, but beyond the eye of the needle the outlook for growth stocks is encouraging. Looking at the US economic landscape, we see that US growth led by services should stay resilient. For sure the Chinese slowdown and tariffs will start to hit manufacturing, but the US is essentially a service economy. The shock is a tad deflationary for the economy while tariffs imply a bit of imported inflation that should increase with the widening of the tariffs. The Fed will merrily ignore it and will stay increasingly focused on the persistently low level of inflation. This is a function, in large part, of the cost cutting of huge behemoths in mature sectors. They slim down, adapt and innovate (e.g. McDonald’s ordering booth). The result is a more productive economy and a Fed that may well be on the way to issuing more than the two rate cuts expected by the market, rate cuts that would support equities.

US fixed income

In US fixed income, the theme is now of a recession in 2021. Common sense is a sometimes uncommon virtue and it is often best to be pushed by the winds. Australia’s economic expansion is in its 27th year, admittedly propelled in part by the emergence of China and its undervalued currency. The US business cycle is not driven by mining, but rather is driven in large part by services and these are very persistent. What changes is their nature. Apple emerges and starts to fade somewhat. Uber reaches a more mature stage, still delivering negative cash flows and its IPO proves an unhappy outcome. Amazon and Aldi move into US retail to shake it to the core while companies in mature sectors try to cut costs and innovate. As a consequence, productivity is showing ever more signs of rising in the United States, a feature that should broaden to other countries. From a fixed income portfolio position, expectations of a recession compounded by an Emerging Market shock would make absolute fixed income return strategies appealing as hedging US fixed income has some cost.

Indian equities

The election of Narendra Modi provides for a stable political platform. Consumer demand has cooled down somewhat given the cash crunch from the shadow banking sector. However, we view this to be transitory as the situation is addressed. A consumer rebound as part of a wider one driven by infrastructure and government spending should help earnings to bottom up. Demographics, as well as past and future reforms, should also help growth. Hence, we see Indian equities staying at expensive levels eventually helped by a rebound in earnings while INR stays largely stable weakening a bit versus the US dollar.

European equities

The European equity market is at risk of a slowdown in Emerging Markets and the low probability of tariffs from the United States. This is partially priced in. What is not priced in is the intensification of the US/China trade war, which will have an impact from car exporters in Germany to European banks doing business in Asia and generating much income there.

That said, the European economy is doing increasingly better driven by a number of countries, though not Germany for now. This continued rebound should have a positive impact on earnings. Valuations are becoming cheaper in Europe and, with the intensification of the trade war, this is likely to increase. But beyond the G20 meeting likely lies a land of opportunity both in the Eurozone and Nordic countries.

European Fixed Income – Credit in demand

European fixed income should provide a refuge in such an initially difficult environment and we prefer covered bonds from Denmark to Italy given their extreme safety and the odds of more ECB easing. The Italian curve in its midsection is still attractive for patient investors waiting for bonds to mature. We do not think that the more hawkish Erkki Liikanen, likely the next ECB president, will fundamentally change ECB policy. He will likely be reluctant to ease but, faced with persistently low inflation, will eventually do so. The tool of choice will unlikely be negative interest rates given that they target the EUR (the US is focused on that), but also because they are deeply unpopular in Germany. What is more likely is credit easing, which should compress credit risk premiums in the Eurozone.

Conclusion: Building for resilience          

We suggest building for resilience into the G20 meeting. The US-China trade war is yet to peak, but once it has, it will offer significant opportunities from Europe to the US and India.

Note: This is a NAM macro view, not the official Nordea view.

About Nordea Asset Management

Nordea Asset Management (NAM, AuM 217.2bn EUR*), is part of the Nordea Group, the largest financial services group in Northern Europe (AuM 300.2bn EUR*). NAM offers European and global investors’ exposure to a broad set of investment funds. We serve a wide range of clients and distributors which include banks, asset managers, independent financial advisors and insurance companies.

Nordea Asset Management has a presence in Cologne, Copenhagen, Frankfurt, Helsinki, London, Luxembourg, Madrid, Milan, New York, Oslo, Paris, Santiago de Chile, Singapore, Stockholm, Vienna and Zurich. Nordea’s local presence goes hand in hand with the objective of being accessible and offering the best service to clients.

Nordea’s success is based on a sustainable and unique multi-boutique approach that combines the expertise of specialised internal boutiques with exclusive external competences allowing us to deliver alpha in a stable way for the benefit of our clients. NAM solutions cover all asset classes from fixed income and equity to multi asset solutions, and manage local and European as well as US, global and emerging market products.

*Source: Nordea Investment Funds, S.A., 31.03.2019

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches, subsidiaries and representative offices. This document is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. Consequently, the information contained herein will be superseded in its entirety by such Offering Memorandum or contractual arrangement in its final form. Any investment decision should therefore only be based on the final legal documentation, without limitation and if applicable, Offering Memorandum, contractual arrangement, any relevant prospectus and the latest key investor information document (where applicable) relating to the investment. The appropriateness of an investment or strategy will depend on an investor’s full circumstances and objectives. Nordea Investment Management recommends that investors independently evaluate particular investments and strategies as well as encourages investors to seek the advice of independent financial advisors when deemed relevant by the investor. Any products, securities, instruments or strategies discussed in this document may not be suitable for all investors. This document contains information which has been taken from a number of sources. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information and investors may use further sources to form a well-informed investment decision. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment. Prospective investors or counterparties should also fully understand the potential investment and ascertain that they have made an independent assessment of the appropriateness of such potential investment, based solely on their own intentions and ambitions. Investments in derivative and foreign exchange related transactions may be subject to significant fluctuations which may affect the value of an investment. Investments in Emerging Markets involve a higher element of risk. The value of the investment can greatly fluctuate and cannot be ensured. Investments in equity and debt instruments issued by banks could bear the risk of being subject to the bail-in mechanism (meaning that equity and debt instruments could be written down in order to ensure that most unsecured creditors of an institution bear appropriate losses) as foreseen in EU Directive 2014/59/EU. Nordea Asset Management has decided to bear the cost for research, i.e. such cost is covered by existing fee arrangements (Management-/Administration-Fee). Published and created by the Legal Entities adherent to Nordea Asset Management. The Legal Entities are licensed and supervised by the Financial Supervisory Authority in Sweden and Luxembourg respectively. The Legal Entities’ branches, subsidiaries and representative offices are licensed as well as regulated by their local financial supervisory authority in their respective country of domiciliation.  Source (unless otherwise stated): Nordea Investment Funds, S.A. Unless otherwise stated, all views expressed are those of the Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and representative offices. This document may not be reproduced or circulated without prior permission. Reference to companies or other investments mentioned within this document should not be construed as a recommendation to the investor to buy or sell the same but is included for the purpose of illustration. The level of tax benefits and liabilities will depend on individual circumstances and may be subject to change in the future. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and/or representative offices.

 

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