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2019/03/11
MONTHLY INVESTMENT OUTLOOK - by Cédric Ozazman, Nicolas Besson & Marco Bonaviri

Are risky assets disconnected from fundamentals? At the end of February, global equities are up 11%, high-yield bonds surged by 6.26%, and the credit segment in its whole is enjoying solid gains on the back of spreads tightening. The U-turn in the Fed’s monetary policy helped investors, lowering the probability of an imminent recession, restoring confidence, and sparking the current powerful rally in equities. Consequently, as earnings growth prospects have been revised down since the beginning of the year, the S&P 500 benefitted from a multiple expansion of 2.2 points, from 14x FW earnings at the Christmas Eve trough to 16.2x FW PE, back in-line with the 5-year average. 

In the meantime, global economic indicators are still pointing to significant strains. China and Europe are facing a manufacturing recession, and are entering the contraction zone according to the latest PMI surveys which tumbled below the 50 mark. South Korea’s economic activity or Baltic dry index prices, which are good proxies for tracking trade growth prospects, are also negatively oriented, emphasising that the global economic situation is still exhibiting numerous signs of slowdown. Why, then, aren’t risky assets concerned by the deterioration of the manufacturing activity?

The resilience of the service component of the PMIs composite is one explanation. 
For example, German spreads between service and manufacturing figures reached 8 points (exhibit 1), highlighting an unusual divergence by historical standards. It means that despite some clear macroeconomic headwinds, the German consumer has not been impacted yet as it benefitted from the low unemployment rate, which translated into some wage increase. The second explanation justifying the current risk-on mood is based on the fact that financial markets are anticipating a better economic outlook for the second part of year. A potential trade deal between China and the US or a soft Brexit will obviously remove uncertainties and restore confidence among CEOs. Moreover, as European economic indicators are so depressed, economists’ consensus reset their expectations to the downside, leaving some room for positive surprises.

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