CU T R I S K I N TO Y E A R- E N D
F O U R T H Q U A R T E R 2 0 1 9
GUILLAUME LASSERRE JEANNE ASSERAF-BITTON XAVIER DENIS
CIO for Active Investment Strategies Head of Market Research Head of Cross Asset Research
JEAN-BAPTISTE BERTHON PHILIPPE FERREIRA SOPHIE FOURNIER
Senior Strategist Senior Strategist Senior Strategist
GLOBAL GROWTH SLOWDOWN BUT NO RECESSION
PREFER U.S.EQUITIES
UW EZ AND EM EQUITIES
CONSTRUCTIVE ON HY CREDIT
AND EM DEBT
OVERWEIGHT L/S CREDIT
AND EM MACRO
OW MERGER ARBITRAGE
UW GLOBAL MACRO
I N V E ST M E N T ST RAT E G Y
LYXOR CROSS ASSET RESEARCH
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
Contact: [email protected] +33 (0) 1 42 13 31 31
Report views finalized on September 24, 2019
Important Notice: For investors in the European Economic Area, this material is intended for clients
(current or potential) who meet the definition of “Professional Counterparty” or “Eligible
Counterparty” under the Markets in Financial Instruments Directive (“MiFiD”), and any products or
services described falling within the scope of the MiFiD are only available to such clients. This
document is considered marketing communication within the meaning of the MiFiD.
CONTENTS
IN SUM 3
MACRO OUTLOOK 4
Trade war drags global growth down 4
FIXED INCOME 6
Rates 6
Corporate bonds 7
FOREIGN EXCHANGE 10
DM FX: reign of king dollar unchallenged yet 10
COMMODITIES 12
Brent: a short-lived premium 12
Gold: fundamentals underpin a gold hedge 12
Copper: in cross currents 13
DM EQUITIES 14
U.S. equities: numerous headwinds limit upside potential 14
Underweight EMU equities: downside risks still loom 16
Neutral on UK equities: still a messy Brexit 17
Japanese equities: still a “yen play” for this cyclical market 17
Emerging Market equities: more differentiation 18
ALTERNATIVE STRATEGIES 20
CTA strategies’ winning streak reaches a ceiling 20
L/S Equity: prefer Market Neutral L/S over Directional L/S 21
Event-Driven: prefer Merger Arbitrage to Special Situations 21
CTA/Macro at Neutral 22
Fixed Income (FI): Prefer L/S Credit to FI Arbitrage 22
DISCLAIMER 24
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
2
OUR MARKET VIEWS
OUR THREE-MONTH VIEWS
UW Underweight
N Neutral
OW Overweight
delta Since previous quarter
UW N OW
Equities
U.S. Industrials
U.S. Materials
EMU Equities
EMU Cyclicals vs Defensive
Japan Equities
EM Equities
China Equities
South Korea Equities
Mexico Equities
Thailand Equities
U.S. Equities
U.S. Growth vs Value
US. Small vs Large
U.S. Cyclicals vs Defensives
EMU Banks
UK Equities
Taiwan Equities
India Equities
U.S. Staples
EMU Large vs Small
Indonesia Equities
Brazil Equities
Russia Equities
Fixed
Income
10Y US Treasury
10Y Bund
EU Credit IG
US Credit IG
US High-Yield Credit
Italian BTP vs German Bund
EU High-Yield Credit
EM Debt
FXUSDJPY
USDCHF
EURUSD
GBPUSD
CommoditiesBrent
CopperGold
Hedge
FundsL/S Equity Directional
Special Situations
FI Multi-Strategy
Global Macro Systematic
Global Macro Discretionary
CTAs
L/S Equity Market Neutral
Merger Arbitrage
L/S Credit
EM Global Macro
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
3
IN SUM
A tug-of-war between macro and liquidity
Markets are again flirting near historical highs. The trade war escalation continues to weigh on
market sentiment while the rates pullback is underpinning risky assets’ valuations. Macro
readings point to a growth deceleration as manufacturing has entered recession territory and
services are edging down. The manufacturing slump should worsen in the short run, with growth
bottoming out only in early 2020. Corporate profit expectations are likely to be revised down as
growth sputters and tariffs hit margins. The Federal Reserve (the “Fed”) may be reluctant to cut
rates to match what the market has priced in as a recession is not around the corner yet.
Meanwhile, the European Central Bank (“ECB”) is keen to pass the baton on to fiscal
policymakers given weak demand. By geographic area, China’s economy is deteriorating further,
suggesting yet again additional easing measures to support consumption and investment; Brexit
remains a wild card with PM Johnson threatening a “do or die” no-deal exit on October 31; and
heightened tensions in the Middle East and surging oil prices bring additional headwinds to
global growth. Our investment recommendations are based on a short-term global slowdown
and then stabilization – not a recession – in the U.S. and Europe.
Underweight global equities. Political and macro newsflow remain broadly negative, though
central banks’ easing, subdued inflation and robust consumption remain supportive. We still
prefer U.S. equities as the macro picture is brighter and earnings are increasingly geared towards
the domestic market. We have downgraded eurozone equities to Underweight, at par with the
Emerging Markets and Japan, as the trade war escalation, manufacturing downturn and slower
growth are set to weigh on overall equity performance.
Prefer credit over bonds. The overall backdrop remains highly supportive for credit due to easing
monetary policy, low default rates and the ongoing chase for yields. High-yield bonds should
remain a sweet spot due to attractive carry and shorter duration. Bonds have, surprisingly,
outperformed this year, but long-term yields are nearing a bottom and could easily rise on Fed
repricing and reflation policies in the euro area. This also bodes well for emerging bonds, as central
banks are keen to follow the Fed and yields will continue to attract positive inflows.
Gold as a safe haven. Appetite to hold gold in portfolios has surged given the negative yields for
a third of all sovereign bonds. We deem gold an attractive hedge due to the lingering uncertainty
and central banks’ diversifying reserves allocation out of the USD.
Market sentiment still highly sensitive to newsflow. We prefer to cut risk in our portfolios. The
business cycle is in a later stage and fading out. Political risks still loom with the unsolved Brexit
outcome, Middle-Eastern geopolitical tensions and trade war. Also, any, likely, downward
revision to earnings forecasts could imply a derating given already stretched valuations.
Alternative strategies
We believe current conditions remain supportive for carry strategies such as L/S Credit and EM-
focused Global Macro. From a general standpoint, we prefer L/S Credit and Event-Driven to L/S
Equity and Global Macro/CTA. Recent changes include the upgrade of Macro strategies to
Neutral from UW, as these strategies hedge against potential trend reversals in fixed income.
We maintain an OW stance on Merger Arbitrage. The strategy offers a low correlation to equities
and a low volatility in returns. These benefits currently offset the headwinds related to the
slowdown in U.S. M&A volumes and tight deal spreads. We also remain OW on L/S Credit to
capture upside risks related to mild signals of improvement in economic activity, while reducing
volatility in portfolios compared to L/S Equity strategies. Finally, we have Directional L/S Equity
strategies at UW even though they have been defensive of recent. Yet, Directional L/S strategies
could suffer if risk aversion rises in the coming months, as we fear. We prefer low/vol defensive
strategies to cyclical/value ones. Along these lines, we have Market Neutral L/S at OW.
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
4
MACRO OUTLOOK
TRADE WAR DRAGS GLOBAL GROWTH DOWN
The trade war escalated again between the U.S. and
China with the scheduling of a new set of tariffs.
Although negotiations have resumed, the ongoing trade
war is weighing on manufacturing which is now
contracting. Services are also weakening but remain
underpinned by a more buoyant job market and
subdued inflation. We expect further macro momentum
softening in Q4 2019 followed by a bottoming out in
early 2020 and do not forecast a recession next year.
Six key features shape the overall macro backdrop
The trade war: the ongoing trade war has reversed
globalization with rising tariffs and protectionism. Trade
is contracting at a faster pace than during the soft patch
of 2015-2016 weighing on the manufacturing sector and
on global growth. A fragile trade truce could be achieved
between the U.S. and China, but this is not a done deal
as market hopes have been dashed a few times already.
Manufacturing recession: global manufacturing has
slipped into contraction territory and could go further
yet to reflect China’s transitioning to a service-based
economy – somewhat accelerated by the U.S. trade war.
Some recoupling between manufacturing and services
is likely as weak external demand is impacting domestic
demand. However, this could drive the U.S. or the
eurozone into recession next year.
Resilient services: services have slowed but have
remained resilient so far. Indeed, manufacturing
accounts for a small fraction of GDP – 10% in the U.S.,
but over 20% in Germany. Private consumption is well
supported across the board by rising consumer
purchasing power, fueled by job creations, nominal
wages gains and subdued inflation.
U.S. growth outperformance: Global growth is slowing
but some countries are more exposed than others.
Inward-looking economies with room for policy easing
should be more resilient and the U.S. fits the bill.
Conversely, the eurozone, Japan, and China are
definitely more exposed to the global manufacturing
downturn.
China stays afloat: Despite a steady growth declaration
China still has room for maneuver to support economic
activity. The trade war escalation is a further blow that
could be mitigated by additional currency weakening,
further monetary policy easing, and increased fiscal
stimulus, but risks remain tilted to the downside.
KEY VIEWS
Global economy is ebbing and heading towards
the slowest growth path since 2009.
Recession remains unlikely in 2020 given the
implemented fiscal and policy easing and macro
imbalances remain in check.
The trade war has escalated further but both the
U.S. and China are now contemplating the risks of
higher tariffs, paving the way for a fragile
compromise.
Manufacturing activity is in the doldrums as the
trade war takes its toll and capex is slowing.
Services sector, a less volatile component of
growth, remains well anchored by robust private
consumption.
Political risks remain on the radar, with Brexit and
renewed tensions in the Middle East.
Global trade slump weighs on exports
Source: Macrobond, Lyxor AM
Services resilient, manufacturing nosediving
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
5
No-deal Brexit risk on the rise: The short-term outlook
remains uncertain as the UK Prime Minister seems
committed to leaving the EU by October 31, whether
with or without reaching a deal. A general election is
probable by year-end but the government and the
opposition have yet to agree on a timing that suits both.
Although we still foresee a soft-Brexit outcome, the risk
of a hard Brexit has increased as a hard-line Tory
government would push ahead for Brexit at any cost.
Political risks fuel market anxiety
Since the Great Financial Crisis (“GFC”), political
uncertainty has structurally crept up. Indeed, the rise of
populism has encouraged rulers to adopt protectionist
measures, promote bilateralism instead of
multilateralism and become more interventionist in the
economic sphere. A push towards deglobalization has
been ignited with Brexit, the reshuffling of NAFTA into
USMCA and the U.S.-China trade confrontation,
amongst others.
So far, monetary policy easing has been instrumental for
mitigating the impact on financial markets but any
renewed uncertainty tends to spook markets. Investors
should continue to scrutinize the impact of politics on
markets.
Policymakers in action
Central bankers are feeling the political heat. As global
growth has been disappointing, and inflation has
undershot targets in most DM economies, central
bankers have returned to easing mode on the back of
growth and inflation downside risks. The Fed shifted its
forward guidance as early as January 2019 before
reversing the normalization trend by a first rate cut in
July and a second in September. Meanwhile, the ECB
adopted an easing package as inflation remains
stubbornly low and growth is sputtering.
Yet, fiscal policy seems a more appropriate tool to revive
a dwindling demand, notably in the eurozone. The
rebalancing of the policy mix will be a key factor to
stabilize growth in the months to come.
Consumer confidence remains high
Source: Macrobond, Lyxor AM
U.S. growth outperforms other DM economies
Source: Macrobond, Lyxor AM
China’s growth rebalance towards services
Source: Macrobond, Lyxor AM Policy uncertainty has risen since the GFC
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
6
FIXED INCOME
RATES
Lower interest rates: how effective?
Analysts are now questioning the appropriateness of
ultra-dovish monetary policies. As signs of secular
stagnation abound, low policy rates are sometimes
blamed for anchoring growth and inflation expectations
at low levels. By cutting rates or keeping them at sub-
zero, central banks’ stance may eventually feed into self-
fulfilling prophecies. There is no consensus on this view,
but it is clear that monetary policies have failed to hit
their inflation targets for a decade or more in the
eurozone and Japan. Concomitantly, negative rates
have negative side effects on financial institutions –
banks, insurers, or asset managers – and may also fuel
asset price inflation as investors consider leverage to
chase yields or keep up with surging housing prices.
Fiscal policy could in fact be coordinated with monetary
policy – a taboo so far for promoters of central bank
independence.
United States: markets drive Fed policy
Although the economy is still sustained, the Fed started
easing in July, after turning dovish early 2019. There was
little evidence of a softening at the time, but both the
July and September cuts were related to trade-related
downside risks to economic activity. True, inflation has
remained moderate despite the U.S. economy running
at, or close to, full capacity. While the core Consumer
Price Index ("CPI”) recently rose to 2.4% YoY in August,
core Personal Consumption Expenditures (“PCE”) -the
Fed’s preferred measure for underlying inflationary
pressure) has remained tame, at 1.6% YoY in July.
The inflation outlook remains dull as wage increases
have not accelerated as much as feared, oil prices
should remain range bound, and imposed tariffs have,
in final, had a minimal impact on consumer prices.
Indeed, markets are pricing in three additional rate cuts
by late 2020, so a rather dovish expectation. We expect
the Fed to trim rates by an additional 25bps by
December ending the mid-cycle easing path. The Fed
backtrack would offset most of the 100bps rate rise
observed over 2018. Growth should bottom out in early
2020 and market expectations of Fed cuts could be
reassessed.
KEY VIEWS
Central banks. Lower rates for longer as global
growth is sputtering and inflation remains
subdued.
Sovereigns. Long-term bond yields have moved
downwards, inflation prints are weak and a
slowdown looms. We are Neutral on UST and
prefer peripheral debt in the Eurozone.
Duration. We see limited risks of yield pickup in
the short run, but pro-active policies should lift
LT yields higher into 2020. We are Neutral.
Corporate debt. The chase for yield continues as
a rising fraction of bond yields are in negative
territory. Prefer HY versus IG, as net debt service
is at historical lows.
Emerging debt (in USD). Macro factors and
technicals are supportive. Monitor idiosyncratic
factors as investors may turn complacent in a
rock bottom yield environment.
Forward short-term rates track bond yields
Source: Macrobond, Lyxor AM
Markets still expect more rate cuts
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
7
Prefer short-dated Treasuries
U.S. 10-year yields crashed during the summer, breaking
down the 1.5% mark just as it had in 2016, as growth
concerns spiked within a context of trade war
escalation. Looking at yield components, the main
culprit for the fall is the drop in term premium, now at -
1.1%. Real short-term rates and 10-year inflation
breakevens have hardly moved. We see limited upside
risk to long-term yields as the Fed has returned as a net
buyer of U.S. Treasuries and the macro momentum may
worsen in the months ahead. So, we maintain a Neutral
stance on the long end of the curve. As we expect 10-
year yields to gradually pick up on a 12-month horizon,
we may also turn more defensive when growth
concerns are dispelled, and markets stop discounting
further cuts. Conversely, we keep an Overweight stance
on the 2-year yield as expected returns seem more
attractive both in the short and longer run.
Eurozone: ECB calls for fiscal policy action
The ECB released new macro forecasts pointing to
underwhelming inflation prints next year, with headline
inflation at 1.0% in 2020. The 1.5% forecast for 2021
seems like wishful thinking in the current context.
Eurozone central bankers are worried about a de-
anchoring of long-term inflation expectations as the
5y5y inflation swap has been hovering around 1.2%
since June. As the growth outlook is steadily
deteriorating, the ECB strived to meet market
expectations of a broad-based package. This would
include deposit rate cuts and a tiering system to
mitigate the impact of another QE program sweetener
for TLTRO operations with lower rates and longer
maturities.
However, monetary easing seems increasingly unable
to address Eurozone economic woes linked to weak
external growth and paltry credit demand. Mario Draghi,
the ECB Chairman at the helm of the institution until late
October, called for more fiscal activism, stating that
monetary policy was reaching its limits.
Such a rebalancing is not a done deal, as Germany, the
country with the best action potential, has been
dragging its feet to use fiscal stance as a policy tool. Yet,
the rapidly deteriorating business climate and the
urgency to address the global warming challenge
should push German leaders to increase public
spending to address environmental issues. A
reassessment of the EU fiscal rule book is already a hot
topic for members, but country positions strongly differ,
and Germany is set to remain a hawk.
U.S. term premium hits new record lows
Source: Macrobond, Lyxor AM
Eurozone inflation expectations fall further
Source: Macrobond, Lyxor AM
Liquidity is already abundant
Source: Macrobond, Lyxor AM
ECB struggles to revive credit growth
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
8
Spread compression ahead for BTP vs. Bund
Italy has been a laggard in terms of spread compression
between peripheral debt and the German Bund since
last Spring. For instance, Greece, which still faces a
massive debt overhang, has experienced a +200bps
compression and trades only 40bps above Italy.
We expect some additional spread compression in Italy.
The new coalition, shaped by the Five Star and the
Democratic Parties, should be more fiscally responsible
and keen to find some common ground with the EU’s
fiscal surveillance rules than the former collation. Yet,
the 2020 budget discussion will be a testing time for
both the coalition parties and the relationship with the
EU, given the remaining fiscal slippage. However,
several factors should continue to underpin the current
spread compression. In a nutshell, the restart of the
Asset Purchase Programme (“APP”) should be
supportive for peripheral bonds. We reiterate on
constructive view on the BTP/Bund spread.
CORPORATE BONDS
The hunt for yield continues as the drop in benchmark
yields is pushing investors to look for yield in credit
markets. The macro backdrop remains supportive to
the overall credit asset class, but we see credit risk as
more compelling than duration risk given the steady
overdone drop in benchmark yields. We maintain a
constructive view on credit markets but prefer the high-
yield buckets both in the U.S. and in the Eurozone where
we are Overweight. We maintain a Neutral weighting on
IG in EUR and USD and we still look for carry in the EM
space, and reiterate our Overweight stance.
Too early to move away from U.S. credit markets.
We still see potential in the short run despite greater
recession signals, with leading indicators pointing to a
likely spread widening in 2020. Financing conditions will
remain very accommodative. Growth is on a slowing
path, but a downturn is not in sight yet. High-yield
spreads are trading at fair value and default rates are
below historical average. Risk-adjusted returns tend to
favor credit versus equities in the current environment.
Eurozone HY to outperform IG
High-yield spreads have declined markedly since early
2019 but have now levelled off above the 300bps mark.
However, spreads have not returned to 2017 lows, and
thus offer some protection. We maintain our
preference for HY bonds, as carry is more attractive, but
also because IG valuation is certainly less stretched.
Growing share of negative yielding bonds
Source: Macrobond, Lyxor AM
Room for compression on BTP/Bund spread
Source: Macrobond, Lyxor AM
Spreads in line with expected default rates
Source: Macrobond, Lyxor AM
HY still outperforms in the FI space
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
9
The ballooned BBB-bucket over past years now looks
overcrowded and underpriced, pointing to some likely
downgrades. ECB easing measures with improved
TLTRO conditions and the reopening of APP bode well
in particular for the lowest rated issuers. However,
selectivity is advised as markets have become more
expensive.
EM debt remains attractive
Liquidity conditions are supportive although the trade
war and Chinese growth deceleration have created an
idiosyncratic risk to the asset class. With curbed inflation
in most EM countries, central banks are keen to follow
the path of rate cuts set by the Fed. Spreads have
remained rather stable and do no point to market
exuberance. A simple modelling using EM forex index,
U.S. Treasuries 10-year yield, commodity prices, macro
momentum, and China credit impulse point to a spread
level justified by macro fundamentals.
Technicals are also supportive with continuous inflows
into EM funds that reflect sustained investor appetite to
hold EM debt denominated in hard currencies. With the
EMBIG yield trading above 5%, this carry will remain
compelling enough to keep money flowing into EMs.
Prefer EUR HY to IG as BBB spreads are too tight
Source: Macrobond, Lyxor AM
Fundamentals justify EM debt spread levels
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
10
FOREIGN EXCHANGE
DM FX: REIGN OF KING DOLLAR
UNCHALLENGED YET
The dollar could still moderately appreciate, boosted by
its safe-haven status and the U.S. economic and
monetary differentials vs. its main trading partners. JPY
could also be boosted by safe haven flows and by the lack
of BOJ leeway. Downside risks remain in the eurozone,
but a lower political risk premium should keep the euro in
a trading range. A no-deal could be avoided on October
31st but lingering uncertainty should continue to cap GBP.
The trade-weighted USD: no weakness in sight
Most USD drivers remain supportive in the short run
though only moderately.
In recent weeks, the U.S.-China trade war showed signs
of easing (between the U.S. and China, Japan, and
Europe), while the odds of a no-deal Brexit on October
31 have risen. Yet, we doubt both these issues will be
resolved quickly. With the bulk of the U.S.-China trade
tariffs likely to remain in place, pressure on exports and
capex could continue to slow global growth.
Therefore, the search for safe haven is likely to
continue in the coming quarter, thus supporting the
dollar, as well as JPY and CHF.
As growth momentum and yield differential favor the
U.S. versus its trade partners, the USD is set to remain
well underpinned for the time being. Another QE in
Europe and other countries’ rate cuts are offsetting the
Fed’s cuts. The weighted yield differentials between
the U.S. and other G3 countries still shows a
comfortable 2% lead. Relative economic trends are
conveying a similar picture. The resilience of U.S.
consumption contrasts with the deceleration
observed in more trade-oriented economies such as
Germany, Japan, or China.
As a result, purchases of U.S. assets have intensified.
We observe that flows from petro-dollar recycling, or
from Asian investors, have all accelerated.
Dollar downside forces remain but have not gained
enough weight yet to sustainably challenge the reign
of the king dollar. Dollar market patterns also remain
adverse. Long dollar positions and long-term relative
valuations are increasingly stretched. However,
market patterns have historically been insufficient to
overwhelm fundamental forces. External and internal
KEY VIEWS
USD trade-weighted Safe-haven flows and
favorable economic and monetary differential
should lead to moderate dollar strength. Pressure
from deteriorating national balances and stretched
valuations are not strong enough.
EURUSD The ECB’s QE, Brexit uncertainties, and
German economic transition could continue the
downside pressure, but could be offset by the lower
Italian risk, disappointing fiscal expansion and
cheap valuations.
GBPUSD A no-deal should be averted by October
31, but all bets would be off in case of general
elections. A dovish BoE and signs of economic
deceleration could also cap GBP.
USDJPY The JPY remains hostage to its safe-haven
status and the lack of BoJ ammunition. We see
moderate downside for this cross.
U.S. vs. RoW macro differentials
Source: Macrobond, Lyxor AM
U.S. vs. RoW rate differentials
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
11
U.S. balances (including current account, budget
deficit, domestic debt leverage) continued
deteriorating. However, these long-term forces should
drag down the dollar, albeit over the medium term.
Finally, any new U.S.-China trade war escalation could
increasingly threaten consumers, which have been the
stronghold of the U.S. economy. The last targeted
tranches of imports from China are heavily geared
toward consumer discretionary and tech goods. The
dollar could start to peak if the tariffs announced for
December 1 were implemented.
In summary, we see continued dollar resilience,
especially against several cyclical currencies sensitive
to commodities, global trade and China. Conversely,
USD would weaken against other safe havens (JPY and
CHF) that strengthen when risk aversion mounts.
EURUSD: Range trading thanks to receding risks
The euro has steadily lost ground versus the dollar
over 2019 returning to levels unseen since 2017.
Lingering pressures could maintain a lid on the euro
despite its cheap valuation. The announced ECB’s
quantitative easing would match the Fed’s easing,
despite the limited expected impact of the package
on inflation and growth. The receding odds of a no-
deal Brexit on October 31 only temporarily improved
sentiment in our view. with uncertainty likely to come
back and forth slowing GDP growth in the euro area
amplified by the German recession will warrant
continuous monetary support
Yet, EUR downside seems limited. The risk premium
from the Italian political instability has faded.
Prospects of early elections are delayed for several
months at least. Talks of a meaningful fiscal
expansion will intensify but may eventually
disappoint. Speculative positioning remain euro
short. Finally, the bad news is already priced in.
We expect some range trading in the quarter to come,
with volatility paced by Brexit developments. We see
EURUSD at 1.09 in three months and 1.15 in one year.
GBPUSD: Brexit still the wild card
The standoff between the UK government, pushing to
achieve Brexit by October 31, and Parliament, a
majority of which is opposed to a no-deal, is not over
yet! PM Johnson lost key votes in Parliament and faces
legal challenges regarding its suspension. While
striving to reach an agreement with the EU, he will
probably seek to bypass legislation forcing him to
request a delay. If the PM refuses to abide, his
resignation or a no-confidence vote could be in the
cards.
Therefore, general elections are increasingly likely
by year-end, although the government and the
opposition will fight to set the date that suits them
best. Even if the fragmented opposition manages
to avoid a no-deal by October 31, it might fail to
campaign along coherent lines. A hard-Brexit Tory
government remains possible which may force a
withdrawal by year-end or early next year. The
probability of a disorderly exit remains below
50%, in our view.
Meanwhile, the political turmoil comes at a time
of a UK economic deceleration. This would also
contribute to cap any GBP valuation catch-up.
Accordingly, we expect GBP to hover in a 1.20-1.25
range in the coming quarter. We retain a GBPUSD
three-month target at 1.22. Longer-term targets
currently seem unreliable as they above all
strongly depend on the forthcoming political
developments.
USDJPY: Further downside
The slowing Chinese growth and trade war
uncertainties are likely to keep boosting domestic
repatriation flows (driven by a slight tightening in
the U.S.-Japan yield differential), while pushing
the BoJ for action.
However, there is only so much the BoJ can do to
reflate the economy. A small rate cut coupled with
a limited fiscal boost might not be decisive
enough to stem safe-haven flows. These are likely
to persist if economic global downside risks
worsen.
While supported by its safe-haven status, JPY
could also gain ground versus Asian currencies,
including CNY if trade tariffs rise further.
We see USDJPY at 105 in three months and 107 in
one year.
Receding odds for a Brexit as of October 31
Source: PredictIt, Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
12
COMMODITIES
BRENT: A SHORT-LIVED PREMIUM
Three days after the drone attack on Saudi key oil
infrastructures, which disrupted half of its production
and sent Brent above $70/b, the newly appointed
Saudi Energy Minister alleged that output would be
restored by month-end. Exports would be largely
unaffected, and the premium on oil prices is unlikely
to last without further geopolitical stress.
The U.S.’s maximum pressure policy on Iran seems to
have failed so far. If Iran is behind the attack, this
would stress its determination to deflect U.S.
pressure amid heavy economic sanctions. Ready to
risk retaliations, President Rouhani may be gambling
on Trump’s reluctance to get drawn into a military
conflict, while seeking leverage to negotiate the
nuclear deal. In response, the U.S. may increase
sanctions and pressure its local allies to retaliate,
starting with Saudi Arabia.
The vulnerability of Saudi’s oil infrastructures to
additional strikes and the likely response to the
recent attack – albeit cautious enough to avoid
inflaming the region – could keep Brent prices
around $65/b in the short run. This $5 premium
would be consistent with heightened tensions in the
Middle East and protracted uncertainties in Libya and
Venezuela.
In the medium term, we see Brent prices returning to
the lower range of our $60-65 range on a 12-month
horizon. Recent events are testing the solidity of the
OPEC+ alliance (and its output discipline), which
could be hard to rebuild if broken. Higher oil prices
could also encourage U.S. producers to increase
output, thus rebalancing the market. A structural oil
market oversupply and a slowing demand, caused by
the global economic deceleration, would also cap the
upside.
GOLD: FUNDAMENTALS UNDERPIN A GOLD
HEDGE
We have stayed Neutral on gold in H1. However, the
brutal trade war escalation since August, and
crushing bond yields, has led us to turn Overweight.
We reiterate our stance as we see further upside
potential.
KEY VIEWS
Brent. Heightened geopolitical tensions in the
Middle East warrant a modest risk premium.
Prospects of renewed strikes and a likely
response to the drone attack calls for a modest
premium. Brent would ultimately revert to the
low range of our 12M [$60-65/b] target
Gold. We still see a case for holding gold on the
back of low yield environment, downside
economic risks, and additional investors and
central banks’ purchase.
Copper. The backdrop would remain contrasted
amid adverse macro drivers and Chinese end-use
copper demand. We have a mild constructive view
as valuation is undemanding and long-term
demand is supportive.
Prices after major oil disruptions
Source: Macrobond, Lyxor AM
Slowing oil demand
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
13
Gold should also remain supported by the growing
stock of global debt trading below zero (~30%), and
investors are increasingly seeking alternative income.
Furthermore, there is room for extra gold allocation
and central bank purchases, which stand below
levels observed in previous late cycles.
Gold prices should benefit from a favorable
risk/reward asymmetry. The downside seems modest
at this stage as uncertainty remains elevated. Gold
offers protection in the event of a recession or should
trade negotiations fail.
Several factors could limit potential price rises,
namely the absence of market tightness, muted
inflation and the firmness of the dollar (which may
eventually cap the upside). We raise our 3M target to
$1600/oz, and our 12M target to $1700/oz.
COPPER: IN CROSS CURRENTS
The fundamental landscape should remain contrasted
in Q4, eclipsing the longer-term bullish drivers. Slowing
demand has led to some stock rebuilding. In particular,
demand from China has been volatile with only a
modest impulse to infrastructure spending. Meaningful
Chinese stimulus measures have merely matched the
various rounds of higher trade tariffs and have been
modest in infrastructures. The Chinese economy is only
just stabilizing, but not improving yet. At a broader
macro level, downside risks to the global economy,
muted inflation, and a firm dollar should not provide
tailwinds either.
In the short term, cheap relative valuations, oversold
technicals, and a persisting backwardation could
limit the downside.
We remain cautious given our base case of continued
trade frictions, and reactive rather than proactive
Chinese stimulus. A trade truce could provide the
conditions for a rally, but it is premature to be long in our
view. Our 3M and 12M copper targets stand at $5700/t
and $6000/t, respectively.
Gold and real yield correlation persists
Source: Macrobond, Lyxor AM
Central banks purchases have further potential
Source: Macrobond, Lyxor AM
Copper demand slowed in sync with global trade
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
14
DM EQUITIES
U.S. EQUITIES: NUMEROUS HEADWINDS
LIMIT UPSIDE POTENTIAL
The Fed and the trade war are the main culprits. While
the trade war is a drag on growth, so far Fed easing has
mitigated the impact on equity markets. However, both
the U.S. and China now seem keen to resume
negotiations to reach a truce. Yet, a tariffs elimination is
not on the agenda, so manufacturing and exports will
continue to slump.
The Fed is willing to provide preemptive cuts As such, we
expect the Fed funds rate to be lowered by 75bps in final;
this should help protect markets from a sell-off.
Nevertheless, the lingering political uncertainty and
dullish macro outlook suggest keeping a Neutral stance.
We expect a directionless market into year-end with
wobbles triggered by the trade war newsflow and other
political issues (Brexit, or Middle-Eastern geopolitics).
Corporate profit growth should continue to slow in
coming months as sales decelerate and margins come
under pressure from rising costs. We estimate that top-
line revenues should grow at a low single-digit pace this
year and next. We slightly downgraded our forecast to
include lower GDP growth, a still firm USD and range-
bound oil prices above 60 $/b.
Based on our proprietary model, we expect S&P 500’s
sales-per-share to grow 2.8% in 2019 and 4.1% in 2020,
a significant deceleration compared to 2018 (+9.3%).
Our forecast points to slightly lower EPS growth than
currently estimated by the consensus. We believe U.S.
companies could continue to buy back their stocks, with
an estimated accretion of 1%, albeit at a slower pace
than in prior years.
The critical point for earnings-per-share (EPS) is the risk
of further profit margin compression. Given the
sustained job market, wages are growing at 3% YoY,
faster than labor productivity (around 2%). Even if the
resulting rise in unit labor costs is partly passed on into
selling prices, margins should narrow. Overall, we
believe S&P 500’s EPS should hardly grow on average
this year before picking up slightly by around 4% next
year, giving little support to the equity market.
KEY VIEWS
UW Global equities. As global growth falters and
earnings forecasts are set to be trimmed, we reduce
risk despite broad-based policy easing.
Neutral U.S. Resilient growth, defensive features,
and a bias towards growth stocks make the U.S.
our preferred market among DM.
UW Eurozone. With manufacturing activity in the
doldrums, and fiscal stimulus still elusive, Eurozone
equities may feel the brunt of the global slowdown.
Neutral UK. A no-deal Brexit is still looming ahead,
but fair valuation, high yielding stocks and
sensitivity to the GBP could provide protection.
UW Japan. Valuation is undemanding, but the
macro outlook remains impaired by the trade war.
A yen appreciation is another downside risk.
Low single digit sales growth next year
Source: Macrobond, Lyxor AM
U.S. margins are under pressure
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
15
Given slower economic growth, higher input costs and
rising trade tensions, the bottom-up consensus has
revised down EPS forecasts for 2019 to 1.9%, from close
to 5% at the beginning of the year. Looking ahead, the
consensus still appears too optimistic with a 10% EPS
growth projection for next year. Further downgrades are
very likely in the coming months, so expect some
disappointments during the upcoming quarterly
reporting season.
Given lackluster profit growth, the stock market
performance has been driven mainly by higher
multiples since the beginning of the year. The price-to-
earnings (P/E) ratio of the S&P 500 has risen by 2pp to
17.4 from 15.4 early this year, contributing to 60% of the
total return year-to-date. As current valuations look
expensive – at well above 10-year averages – this gives
limited cushion in case of a negative surprise. We expect
some mild P/E compression by year-end due to lower
PMI prints and a rebound in inflation expectations.
Within sectors, we prefer selectivity and quality stocks.
As bond yields have decreased on the back of lower
growth expectations, investors are chasing for yields in
credit, and equities too. As global growth is ebbing,
investors remain stuck to stocks offering stable and
robust growth, warranting a steady outperformance of
the IT sector.
Too early for Value to outperform Growth: Neutral.
Growth stocks have outperformed Value stocks since
2009, the longest streak since the 1970s. U.S. Growth
stocks are expensive, with a relative trailing P/E at 1.6
versus Value stocks. However, they offer higher EPS
growth prospects than Value companies, an important
factor when growth becomes more sluggish.
Traditionally, weak economic growth and low bond
yields have not been supportive for Value stocks as
banks account for a significant fraction of the bucket.
Neutral U.S. Small caps versus Large caps. The Russell
2000 index grew 17.5% YTD, under-performing the S&P
500 that grew 19.6% YTD. Small caps valuation looks
attractive, at one standard-deviation below long-term
average.
However, the U.S. slowdown and rising wages do not
bode well for SMEs earnings growth. Although they are
less exposed to global trade uncertainty, they also have
less leeway to deal with rising cost pressure and to
preserve their profit margins than large caps.
Bottom-up earnings forecast too bullish
Source: Macrobond, Lyxor AM
Growth stocks highly priced versus value
Source: Macrobond, Lyxor AM
Wage growth detrimental to small caps
Source: Macrobond, Lyxor AM
U.S. equities more expensive than European ones
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
16
UNDERWEIGHT EMU EQUITIES: DOWNSIDE
RISKS STILL LOOM
Eurozone equities have been resilient despite
underwhelming macro prints and lingering political
risks, so far. From a total return perspective, the Euro
Stoxx is at par with S&P 500 posting a 21% jump YTD.
Eurozone stocks performance has been underpinned
by a pullback in yields and a softening euro. With a
growing fraction of bond markets posting negative
yields, investors are seeking dividend yield in the equity
space. However, we see risks tilted to the downside,
warranting an Underweight stance. Inflation remains
stubbornly low and the recent ECB package is unlikely
to lift it much higher. Growth is being hit by the trade
war, the manufacturing recession and political risks
(Brexit, Italy). Consensus forecasts have been reduced to
only 1.1% for 2020 GDP and could be downgraded
lower. From a bottom-up perspective, EPS growth
expectations currently above 10% for 2020 (after 1.2% in
2019) look too optimistic and could be trimmed.
Underweight EMU Cyclical versus Defensive. As the
business climate is worsening, we are keen to shift
exposure to defensive stocks. Cyclical stocks valuation
looks unappealing, while defensives could outperform
as a growth bottom is not yet in sight.
Overweight EMU Large caps versus Small caps. Small
caps relative performance versus large caps is mainly
driven by currency valuation. As we foresee the EURUSD
trading at, or below, current spot prices, we expect large
caps to outperform small caps. Yet, possible auto tariffs
and further weakening Chinese demand could be
adverse factors that require close monitoring.
Neutral on Banks, with a tactical Buy. Banks have
underperformed the market with a 5% total return fully
attributable to dividend distribution. Despite mainly
elevated dividend yields, the sector does not appeal to
most investors. Solvency issues have been addressed
and the share of non-performing loans is steadily
declining across the region. With the ECB’s new tiering
system on excess liquidity, the bank is signaling it is
addressing some side effects of negative yields. But the
sector remains plagued by weak profitability amid flat
revenue growth, rising regulatory requirements and
sticky operational costs. The modest uptick in bank
lending is insufficient to lift returns on equity, and
certainly not yet at par with the cost of equity. The
perspective of low rates for longer is a powerful drag on
the overall sector valuation, which may have fallen in a
value trap. All in all, we keep a Neutral stance on EMU
banks as most of the bad news looks already priced in,
and any positive surprise in terms of growth or, less
likely, regulations could unleash upside potential.
Low EPS growth undermines Eurozone
Source: Macrobond, Lyxor AM
Prefer defensive to cyclicals
Source: Macrobond, Lyxor AM
Weak EUR favors large caps
Source: Macrobond, Lyxor AM
Banks dependent on the macro outlook
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
17
NEUTRAL ON UK EQUITIES: STILL A MESSY
BREXIT
UK politics are still on shaky ground and investors
remain concerned about the Brexit outcome. Although
we believe a softer Brexit is more likely, the odds of a no-
deal Brexit have risen and have put UK assets under
pressure. Equity markets have underperformed
European peers and the GBP tested historical lows this
summer. UK stocks remain highly sensitive to oil prices
given the share of oil and commodity multinationals
stocks in the basket. They also appear negatively
correlated to GBP - currency weakness tends to boost
the equity market.
The uncertain environment has sent the UK economy
sliding, implying a drag on future earnings growth for
domestic focused companies. Note also that range-
bound commodity prices, in particular oil, are not
conducive to a strong performance of commodity-
related multinational companies listed in London.
However, UK equities could remain supported by fair
valuation, high dividend yields (around 5%) and a weak
pound.
JAPANESE EQUITIES: STILL A “YEN PLAY” FOR
THIS CYCLICAL MARKET
Japanese equities remain heavily driven by overall
market sentiment and global macro momentum.
The business outlook has deteriorated significantly on
the back of the global trade slump, diplomatic row with
South Korea, and a struggling overseas car market. As an
export-geared economy, the Japanese stock market is
highly dependent on global growth. The worsening
business outlook is driving down Topix EPS growth.
Also, the negative correlation between the yen and the
stock market is still elevated. As we expect a moderate
appreciation of the yen against dollar, this should impair
equity performance. The ongoing progress in corporate
governance aimed at improving stock holders return
and attractive valuation are not strong enough to offset
international headwinds. We remain on the sidelines
while maintaining an Underweight stance on Japanese
equities.
UK equities linked to oil and GBP
Source: Macrobond, Lyxor AM
UK stocks trade at fair valuation
Source: Macrobond, Lyxor AM
Japanese earnings driven by business outlook
Source: Macrobond, Lyxor AM
JP equities: still a currency play
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
18
EMERGING MARKET EQUITIES: MORE
DIFFERENTIATION
The Chinese long-term transition, firm dollar and
trade war could still weigh on EM economies - even in
the likely case of a truce. However, Chinese stimulus
measures and dovish EM policies will mitigate the
impact. We see more dispersion across EM markets,
given their sensitivity to trade, China and the dollar, as
well as uneven valuation and risk pricing. We are
moderately Underweight, with more differentiated
positioning by country.
EM EQUITIES: CONTINUED PRESSURE WITH MITIGATING FACTORS
EM economies haven’t reached their bottom yet
Forecasts for the real GDP in EM economies have been
cut by -0.3% in aggregate since the summer. We expect
continued pressure for three reasons.
First, the trade war should continue to hit exports and
Asian economies. The chances of a trade truce between
the U.S. and China are rising but a partial deal would not
lead to a substantial rollback of tariffs, while persisting
uncertainty should still weigh on corporate capex.
Second, China’s transition to a services-based economy
is a game-changer for global manufacturing and is not
over yet. Chinese growth is still decelerating despite
several broad-based easing measures, which is
spreading to most EM economies.
Third, a firm dollar, boosted by favorable economic and
monetary differentials as well as by safe-haven flows
could remain a drag.
Mitigating factors are pending
Since 2018 Chinese exports to the U.S. have weakened
by 8% and extra tariffs since September could cost
another -0.2% of Chinese growth (possibly -0.6% if a
maximum tariff escalation). China could keep adding
targeted stimulus, the size of which would be
determined by trade tariffs. Tax cuts, monetary easing,
infrastructure spending could absorb about half of the
impact. Weaker CNY (down -2% since July) would also
contribute in case of a full escalation scenario. These
measures will benefit most EM economies.
Moderate fiscal expansion and central bank rate cuts in
EM economies would also cushion their growth
slowdown. Rate cuts worth about -40bp in aggregate
are expected within the next twelve months.
Increased EM differentiation is in store
We expect EM economies to differ according to their
exposure to trade, China and the dollar. Supply
chains revamping would ultimately benefit Taiwan
(tech exports substitution), Vietnam (manufactured
goods), Brazil (agricultural products), or Mexico (a re-
export hub). Meanwhile, Argentina, South Africa,
Turkey, Indonesia, and South Korea would remain
sensitive to dollar trends and liquidity conditions.
Receding Trump’s trade negotiation leeway?
Source: Bloomberg, Lyxor AM
Chinese exports to the U.S. reduced by 8%
Source: Macrobond, Lyxor AM
Chinese stimulus failing to turn the economy yet
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
19
We also observe that trade risks are unevenly priced.
Trade-sensitive stocks are not factoring in extra tariffs,
while EM and Chinese equities might only partially price
in the global trade issues and China’s GDP at 6%. In
contrast, underperforming EM vs. developed markets
might be phasing out, on the back of more appealing
relative P/E multiples and dividend yields and fading EM
assets outflows.
We acknowledge that a U.S.-China trade truce could be
tactically supportive for EM markets. Yet, we remain
strategically UW for now and expect greater country
dispersion.
EM Asia
We are UW Chinese equities. China could seek to delay
any further tariff escalation without strategic
concessions. In return, the U.S. could keep most tariffs in
place but refrain from further increases. Increased
stimulus would partially offset the extra drag on China’s
GDP but would not fully overcome the slowdown
induced by the long-term Chinese transition. Greater
financial access will be a positive for the long term. A
fragile trade truce seems in sight, but we see limited
upside given the moderate trade pricing.
We remain OW on Indonesian equities. The macro pulse
is resilient. The trade war impacts are mitigated by
monetary easing and fiscal expansion, tame inflation
and low budget deficits. Key risks stem from the current
account deficits and the dried-up global liquidity. Long-
term upside will be provided by the U.S. and China
supply-chain revamping and Chinese investments.
Equities are cheap after the recent correction.
We downgrade Thai equities to UW. Economic and
export trends are weaker due to slower global demand
and tourism. The strong resilience to the trade war could
be tested by a new tariff escalation, though greater fiscal
support could mitigate the impact. The military junta
government should maintain stability and support
infrastructure initiatives such as China’s Belt and Road
initiative. But political risks will resurface ahead of the
2024 elections. Valuations have become rich.
We are Neutral on Indian equities. Key challenges
remain intact, such as to: 1) revive growth through
consumption, 2) fix high unemployment through
reforms, 3) fix a weak financial system and NPL, 4)
navigate the alliance with the U.S. while resisting
pressure on U.S. imports from India (a partial trade
agreement is imminent). Steps to reinforce territorial
integrity and the long-term Kashmir struggle imply
some tail risks. On the positive side, isolation from the
trade war, cheap valuations and an attractive tactical
backdrop are keepingus Neutral.
We are UW on South Korean equities. The country
would ultimately benefit from the tech supply chain
revamping but growth is slowing rapidly with the
ongoing trade war, slower growth in China and USD
strength. Japanese sanctions hitting South Korean
key industries (tech and chemicals) are likely to
worsen. The issue is not systemic, but is another
challenge. Equities are not cheap, margins are
declining, and a high beta to tech and China is
keepingus on the sidelines, for now.
Latin America
We upgrade Brazilian equities to OW. The economy
is accelerating, driven by capex and consumption.
Further progress will hinge on the pace of reforms.
Brazil is likely to benefit from the trade war, and
equities show limited correlation to China. Valuation
is increasingly stretched, but we see further upside
from lower rates supported by tame inflation.
We downgrade Mexican equities to UW. Despite
limited fiscal slippage and contained inflation, the
unfavorable backdrop from slowing U.S.
manufacturing, uncertain USMCA ratification, U.S.
upcoming election, and a negative macro pulse
makeus cautious. We see limited catalysts until
budget clarity improves. So far, the budget proposal
is based on an optimistic +17% in oil output.
Valuation is cheap but offers limited upside.
EMEA
We upgrade Russian equities to OW. The macro
pulse has lost traction, but fundamentals should
help weather sanctions and oil volatility. Case in
point: a low public debt, current account surplus
boosting FX reserves and assumed oil prices at only
$40/b. Russia is also strengthening trade ties with
non-Western partners. The U.S. or the EU do not
seem determined to escalate tensions. A lower risk
premium due to signs of détente, oil prices above
$60/b, affordable valuations, high carry, and Russia’s
relative trade war isolation all look attractive.
Dovish EM central banks
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
20
ALTERNATIVE STRATEGIES
CTA STRATEGIES’ WINNING STREAK
REACHES A CEILING
CTA strategies delivered buoyant returns in Q3 (+2.1%
up to September 17), according to Lyxor UCITS Peer
groups. CTAs were fueled by trends in fixed-income
markets and, to a lower extent, in FX and commodity
markets. The dramatic fall in bond yields more than
offset volatile equity returns following the escalation of
trade tensions between the U.S. and China in August.
But in early September, the bond trend reversal was
harmful for CTAs. Despite the severity of the hit (CTAs
down -5.1% between September 3 and September 17),
it did not erase gains achieved earlier in Q3.
Concurrently, L/S Credit and Global Macro strategies
also outperformed (+1.2%). The former benefitted from
supportive credit market conditions while the later,
despite being heterogeneous, appears to have
benefitted from a flattening Treasury curve in the 2s10s
segment and short positions on FX carry.
Going forward, we maintain exposure to “carry” via
strategies such as Global Macro in EM and L/S Credit. In
our view, the recent rise in bond yields is likely
temporary. The search for yield is thus an investment
theme likely to stay relevant in the quarters to come.
Concurrently, elevated political risks lead us to maintain
a defensive set of recommendations for the remaining
strategies. We maintain Market Neutral L/S Equity and
Merger Arbitrage at Overweight. Both strategies have an
equity market beta below 15% (based on monthly
returns of the HFRI over the past ten years). They also
offer a solid track record in bad times, when risk assets
suffer important losses. Along these lines, Directional
L/S Equity stands at Underweight. The strategy was
rather defensive in August, but is highly unlikely to
deliver positive returns if market conditions deteriorate.
We believe risks on equity markets are asymmetric at
present, with major markets close to all-time highs amid
a global manufacturing recession and elevated political
risks (trade wars, Brexit). We are concerned investors
might move earlier than usual over the course of Q4-19
to lock in their annual performance, after an exceptional
year for both equity and bond markets. Finally, CTA,
Global Macro and Special Situations stand at Neutral.
KEY VIEWS
L/S Equity (Neutral)
OW L/S Market Neutral
UW Directional L/S
Event Driven (Overweight)
OW Merger Arbitrage
N Special Situations
L/S Credit/FI Arb. (Overweight)
OW L/S Credit
N Multi-Credit FI Arbitrage
Global Macro (N)
OW EM Macro
N Systematic and Discretionary Macro
CTAs (Neutral)
Performance of Lyxor UCITS Peer Groups in Q3
Lyxor Peer Groups aggregate 241 liquid alternative
strategies (as of September 2019).
Source: Macrobond, Lyxor AM
Investment views on hedge-fund strategies
Source: Lyxor AM
UW N OW
Hedge
Funds
L/S Equity Directional Special Situations
FI Multi-Strategy
Systematic Macro
Discretionary Macro
CTAs
L/S Equity Market
Neutral
Merger Arbitrage
L/S Credit
EM Global Macro
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
21
L/S EQUITY: PREFER MARKET NEUTRAL L/S
OVER DIRECTIONAL L/S
Equity markets remain prone to sudden bouts of
volatility due to the likely escalation of trade tensions in
Q4-19, the global manufacturing recession and Brexit-
related tail risks. Such headwinds are counterbalanced
by Central Banks’ dovishness. Yet, we believe the
Federal Reserve is likely to act cautiously for now to keep
some ammunition to fight the next recession. Our views
thus maintain a defensive bias.
We stay constructive on Market Neutral L/S strategies
(OW) over Directional L/S Equity (UW) ones. The former
offers protection due to their low equity market beta.
This has helped protect portfolios during market selloffs
in recent decades. However, the strategy tends to have
a momentum bias in equity markets. Recently, several
strategies were negatively impacted by the momentum
reversal. We believe this shock is likely to be short lived,
however. Momentum stocks are currently tightly
correlated with low beta stocks, which we find
appealing due to elevated policy uncertainties.
Directional L/S Equity strategies have been resilient. We
estimate a stabilized market beta below 20% since May,
which was helpful when risk aversion rose in August.
Alpha generation from such strategies has improved.
Yet, if risk aversion rises in the coming months, as we
fear, Directional L/S strategies would suffer. Prefer
low/vol defensive strategies to cyclical/value ones.
EVENT-DRIVEN: PREFER MERGER ARBITRAGE
TO SPECIAL SITUATIONS
In Event-Driven, we maintain our preference for Merger
Arbitrage (OW) vs. Special Situation strategies (N) as
part of our defensive market bias.
Lower M&A volume in Q3 hit Merger Arbitrage
strategies and consequently deal spreads tightened.
Yet, deal spreads can be volatile and mid- to long-term
investment decisions should not rely solely on the level
of deal spreads.
Our appetite for Merger Arbitrage lies on its defensive
properties, which, in our view, are increasingly
appealing in a context of low or negative interest rates.
If trade tensions between the U.S. and China escalate
further, then the low beta/low volatility features of the
strategy will help protect portfolios.
Regarding Special Situations, we stand at Neutral. The
strategy has reduced its market exposure in a similar
fashion to Directional L/S equity strategies. Yet, its
market beta remains structurally higher than Merger
Arbitrage strategies and would thus face more hurdles
if market conditions deteriorate.
Prefer low beta vs. high beta L/S Equity strategies
Source: HFR, Macrobond, Lyxor AM
We assume the momentum crash to be short lived
Dow Jones market neutral indices. Source: Macrobond, Lyxor AM
U.S. M&A volumes eased during the summer
Source: Eikon, Macrobond, Lyxor AM
Deal spreads stand below the 3-year average
Deal universe includes spreads in the 0-30% range.
Source: UBS, Macrobond, Lyxor AM
0
1
2
3
4
5
6
7
8
9
Jul-16
Sep-1
6
Nov-1
6
Jan-1
7
Mar-
17
May-1
7
Jul-17
Sep-1
7
Nov-1
7
Jan-1
8
Mar-
18
May-1
8
Jul-18
Sep-1
8
Nov-1
8
Jan-1
9
Mar-
19
May-1
9
Jul-19
US M&A deal spreads (median, annualized, %)
3Y Average
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
22
CTA/MACRO AT NEUTRAL
Over the course of Q3, we neutralized our preference for
CTA vs. Global Macro to bring them both at Neutral at
present (from Global Macro at UW previously). We
maintain this stance.
The rationale for aligning the stance on CTA and Global
Macro was related to concerns about potential trend
reversals in fixed income. Bond yields reached
extremely low levels during the summer, in particular in
Europe. The upward trend in bond prices was stretched,
in our view, and we upgraded strategies providing a
hedge against a spike in bond yields, which materialized
in early September. Several Global Macro strategies
were positioned for such an event and benefitted from
it, while CTAs suffered a drawdown. Both strategies
remain complementary going forward.
CTAs’ elevated net long positions on fixed income have
normalized at lower levels since the late-summer spike
in bond yields. Meanwhile, the bleak macro picture and
elevated policy risks do not suggest they should
continue to rise sustainably in the short- to medium
term. We keep CTAs at Neutral. The strategy provides, at
the time of writing, a cushion against a “no deal” Brexit
thanks to limited positions on equities and short GBP vs.
USD trades in FX.
We also maintain exposure to EM-Global Macro
strategies (OW). The search for yield is an investment
theme which is likely to stay relevant for the quarters to
come as major central banks have engaged in
additional monetary easing.
FIXED INCOME (FI): PREFER L/S CREDIT TO FI
ARBITRAGE
Our views on L/S Credit have been constructive in
recent months, assuming that i) sovereign bond yields
are low and will remain so for longer; ii) carry strategies
such as HY Credit benefit from a portfolio rebalancing
effect, whereby low bond yields on safe long-term
securities compress the risk premia for lower graded
securities; and iii) L/S Credit strategies benefit from this
compression in risk premia while reducing volatility in
portfolios.
We estimate that L/S Credit strategies have halved
volatility in HY Credit returns over the past ten years.
We calculated that the information ratio of L/S Credit
has been close to 2, significantly above both the Euro
and USD HY ratio over the same period (1.2).
We downgraded the Fixed-Income Arbitrage strategy
in Q2 to incorporate carry strategies such as L/S Credit
and EM Global Macro. We maintain this stance going
forward.
The bond trend reversal was painful for CTAs
Total return, local currency indices. Standardized series
return a normalized series (mean is 0 & standard deviation
is 1). Sources: Bloomberg, Macrobond, Lyxor AM We stay OW EM-Global Macro strategies
Source: Macrobond, Lyxor AM HY spread tightening should support L/S Credit
OAS spreads vs. government benchmarks. Source: BAML,
Macrobond, Lyxor AM L/S Credit vs. HY: higher risk adjusted returns
Source: Macrobond, Lyxor AM
INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
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INVESTMENT STRATEGY INVESTMENT STRATEGY
By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
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By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019
25
the funds that comprise indices cited herein are suitable for U.S. Investors as a result of, among other things, the
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Lyxor Asset Management
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