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Revisiting our investment themes

05 July 2019

By Gerald Moser, Chief Market Strategist

In April, we defined our four investment themes for the next few months: 1) Investing in a late cycle; 2) Enhancing total return with carry and yield; 3) Inflation surprise risks; and 4) Tactical opportunities. The latest data and market developments reinforce our confidence in all our investment themes, except for inflation surprise risks, which we close today.

All data points to an extended late cycle

The data confirms that we are late cycle, but at the same time we do not see a recession on the horizon. Manufacturing data have been slowing globally and trade tensions threaten to deepen the issue. That said, European manufacturing seems to have reached a trough while US data weakness is payback for strong inventory built up in the six months to March.

We do not see a recession on the horizon.

The typical imbalances that end an economic cycle (corporate and/or household debt, housing market overheating or banking sector instability) are not yet observable and central banks turned ever more dovish in June. For this reason, we continue to recommend a quality bias in equities, despite high valuations, and recommend active strategies over passive ones. In fixed income, we think that emerging markets sovereign bonds offer attractive prospects at this stage of the cycle.

Inflation surprises less likely

Back in April, we thought that some indicators pointed towards risks of higher inflation. Extremely tight labour markets in a few major countries, risks of unanticipated higher commodity prices and flaring trade tensions were all risks that could have impacted inflation more than the market had priced. However, inflation figures continue to disappoint.

We do not see the inflation investment theme as compelling at this stage.

The global Citi inflation surprise index (see below), which compares actual releases to expectations, continues to be negative. Central banks in the US, Europe and Japan are struggling to get inflation back to their target. Wage growth remains muted, trade tensions are easing and oil prices are off their highs.

While inflation might still surprise to the upside, especially if trade tensions escalate, risks have faded. So we do not see the inflation investment theme as compelling at this stage.

Inflation continues to disappoint

Yield enhancement and tactical opportunities still relevant

We continue to seek strategies to enhance total return with yields and carry. The volatility increases seen across asset classes since April, which is typical of a late-cycle environment, provides opportunities to collect carry by selling volatility or getting higher coupons from products.

We favour dividend growers with strong free cash flow. In addition, the spike in volatility in the last three months provided tactical opportunities across asset classes. We will continue to look for those.

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Market Perspectives July 2019

Find out our latest key investment themes. As more dovish central banks and trade tensions drive sentiment, what are prospects for the rest of 2019?

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