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  Markets turning more risk-averse

The VIX touched lows we hadn’t seen since January. However, by mid-August markets turned more risk-averse, impact by ongoing trade tensions and a currency crisis in Turkey. Divergence in economic and earnings growth was reflected in equity markets. Despite some high-profile misses, the strong US earnings season is boosting investor confidence. Thus, in the past month US equities have outperformed, while emerging markets lagged. Government bond yields have retreated somewhat, while credit spreads widened a bit. We have left investment strategy unchanged. We have a neutral view on equities, with a preference for the US and emerging markets over Europa and Japan. We view commodities and real estate as positive, but we are negative on government bonds and credits

Solid earnings support US equities

It were the misses making headlines this US earnings season. Facebook saw the biggest loss in market value (>$100bn) in a single day after disappointing investors, Netflix and Twitter were the other negative contributors to the somewhat negative view on tech over the last weeks. Nonetheless earnings were strong overall and sentiment recovered. The S&P saw a 25% growth in Q2 EPS and is approaching the highs reached in January. Revenue was comparably strong with a rise of 10%. European earnings growth is more modest at +5% as there is no tailwind from the corporate tax break in the US. However given the decline in economic growth momentum the numbers look solid. There were a few red flags from corporate guidance, some manufacturing companies are signaling trade tariffs may feed into their bottom line. All in all, this supported our positive view on US versus European equities.

“We are still positive from a contrarian perspective; we think markets have oversold as the fundamentals have not weakened enough to justify the sell-off.”

Not all quiet

Most of us may be on holiday, but there were some stories to follow this month. The weak performance in emerging markets was driven by worries about the resilience of Chinese growth, which we think might be overdone. The negative headlines on trade and tariffs as well as a strengthening US dollar also hit merging markets. The decline in the yuan has investors on edge as it may signal a response to heightened trade tensions, but the latest data is showing that it is not causing capital outflows from the country. The commitment of the Chinese government to keep the currency stable and boost fiscal stimulus should help to support sentiment. Nevertheless, spreads on US dollar denominated emerging market bonds spiked to levels not seen since early 2016. For equities, economic growth looks okay, but a slowdown in earnings growth and downward revision to earnings expectations are worrying. We are still positive from a contrarian perspective; we think markets have oversold as the fundamentals have not weakened enough to justify the sell-off.

Markets have been contaminated by Turkey’s currency crisis. We think most of the aspects are idiosyncratic though. Turkey’s current account deficit is much bigger than any other emerging market we follow. Only Argentina comes close. Moreover, Turkey used relatively more short-term dollar funding to cover the deficit. And the political pressure on the central bank not to hike interest rates, challenging its independence when inflation has soared to 16%, is also negative. It were political and trade tensions with the US that sparked the crisis, sending the Turkish lira down 30% in ten trading days, before the currency recovered some ground. Economic contagion should be limited, as even for the eurozone Turkey is a minor trading partner. Overall, emerging currencies depreciated about 5%, but letting currencies float and applying supportive domestic policies, such as Indonesia’s rate hike, should limit the damage.

Finally, the UK government continues to struggle with the Brexit deal and prime minister May appears stuck between a rock and a hard place as she tries to find support in her government. Markets are pricing in a bigger chance of a hard Brexit, the pound is drifting lower.

Disclaimer
Kempen Capital Management N.V. (KCM) is licensed as a manager of various investment funds and to provide investment services and is subject to supervision by the Netherlands Authority for the Financial Markets. This information may not be construed as an offer and provides insufficient basis for an investment decision.

The Asset Allocation  Desk

Marius Bakker
Ivo Kuiper
Joost van Leenders

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