Coffee Break 3/6/2017

At the beginning of the past week, investors were cautious ahead of Donald Trump’s address to Congress. During his speech on Tuesday, the US President outlined his priorities, namely rebuild infrastructures, repeal and replace the “Obamacare”, increase defence spending and enforce immigration laws. He nevertheless gave few details on the projected path to realise these objectives. Despite his announcement of an “historic tax reform” for both companies and households, he disappointed due to lack of details.

We will closely monitor incoming data and the Federal Reserve’s reaction, as Fed members, including Chair Janet Yellen, have influenced market expectations towards an immediate hike, ahead of the next FOMC on 15 March.

In this context, we have decided to maintain our overweight on equities and favour the US, Japan, the euro zone and the emerging markets.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are overweight in equities versus bonds:

• The macro news flow is still well-oriented. Data released in the first weeks of the year continue to surprise on the upside, confirming our view of a synchronised global expansion. In addition, the potential of US reflation through fiscal stimulus, tax cuts and regulatory easing in a robust labour market context has been confirmed by President Donald Trump during his address to Congress. Slippage in the expected timing of the fiscal stimulus is a risk, but the dose of US reflation is leading investors to postpone end-cycle anxieties.
• Central banks are decoupling but they mostly keep a dovish stance:
  • The ECB will keep a steady hand given political uncertainties and will extend its quantitative easing at least until December.
  • Waiting for more clarity on fiscal stimulus, the Fed indicated its intention to hike interest rates “sooner rather than later” according to Dallas Fed President Robert Kaplan. Markets continue to adjust Fed hike probabilities higher and are now positioned for a hike on 15 March. The Fed tightening cycle is at odds with accommodative policies in Japan, the euro zone and, to a lesser extent, the UK.
  • In Japan, BoJ governor Kuroda confirmed bond market interventions and yield curve targeting.
• Equities have an attractive relative valuation compared to credit, and their expected return should be boosted by the end of earnings recession in the US and Europe.
• Oil markets continue their rebalancing after the last OPEC agreement. However, US rigs have been re-opening, implying a greater production which could likely weigh on oil prices.
• Important political risks remain: upcoming elections in Europe (The Netherlands & France this spring and Germany in September) and “Brexit” negotiations. Moreover, the wide range of possible outcomes of Donald Trump’s presidency includes the risk of policy error.

REGIONAL EQUITY STRATEGY

• We have maintained our overweight on euro zone equities, as we expect a gradual improvement from the high discount due to political uncertainties.
• Without changing the overall equity overweight, we have further reduced our exposure on Europe ex-EMU equities and distributed the proceeds to both the US and Emerging markets.
• Recent news flow indicated that the triggering of Art 50 of the Lisbon Treaty might happen before the end of March. In this context, we keep an underweight position on UK equities. The uncertainties surrounding the conditions of “Brexit” and its impact on the economy are nowhere near resolved. We avoid domestically-oriented small and mid-caps and still have a relative value strategy long FTSE 100 against a short FTSE 250.
• We are overweight on US equities. Sound consumer expenditures consolidating oil prices and a post-election stimulus should support an improving US earnings outlook.
• We remain overweight on Japanese equities which we expect to benefit from an favourable domestic policy mix, stronger US growth and, ultimately, a weaker currency.
• We are slightly overweight on emerging market equities, as they appear less vulnerable than in the immediate aftermath of the US elections. Moreover, they still benefit from attractive relative valuations. US protectionist measures look less likely as Donald Trump did not announce anything new on trade during his address to Congress.

BOND STRATEGY

• We have maintained a duration underweight.
• We continue to diversify out of low/negative yielding government bonds:
  • We remain positive on inflation-linked bonds. We expect the recent rise in inflation expectations to be sustained as wages and consumer price inflation data rise gradually, led by the US. In addition, upcoming fiscal easing looks likely. The expected re-rating of inflation protected bonds is now well underway.
  • We have a relative value strategy: long German Bund / short French OAT due to increasing uncertainties surrounding the French election. We also see the strategy as a hedge against the European political risk.
  • We have a slight overweight in emerging market debt, both in local and in hard currency terms. Carry remains attractive and negative financial implications of the US presidential election, due to a stronger USD, are receding.
  • We are slightly positive on high yield, even as the significant spread tightening has reduced the potential, the carry remains attractive.

• In the US, consumer confidence unexpectedly increased in February with the Conference Board’s index rising to 114.8 (versus an estimated 111). It was the highest level since July 2001 as Americans grew more upbeat about present and future conditions.
• The ISM manufacturing index jumped to 57.7 in February, the highest since December 2014 and more than the 56.2 estimated by the consensus. US manufacturing expanded more than expected, driven by robust domestic demand and increased investment spending by the energy sector.
• In the euro zone, the markit PMI composite index rose to 56 in February up from 54.4 in the previous month. It was the highest reading since April 2011, driven by robust demand and exports.
• The flash CPI index hit 2% in February, up from 1.8% the month before. It was the highest rate since January 2013, largely due to rising energy prices, and was slightly above the ECB’s target of just below 2%. 

EUROPE

Positive week for European equities with the Stoxx Europe 600 up by 1.41%.

• European markets have been boosted by Chinese economic indicators
• Midweek, equity markets as a whole were up strongly, led by reflation hopes.
• Commodity-related and financial stocks led the market.
• By the end of the week, European shares retreated somewhat and volumes fell.

US

Slightly positive week for US equities with the S&P 500 up by 0.67%

• Rate hikes expectations have driven the US markets.
• The market’s biggest move came on Wednesday after President Trump’s anticipated first address before Congress.
• The Snapchat IPO was the major event of the week, with a subscription price of $17 per share, higher than expected

EMERGING MARKETS

Negative week for Emerging equities with the main index down by 1.29%.

• Asian markets followed Wall Street reversing from record high earlier this week.
• The latest data show that China’s economy is on stable footing, which should give officials more leeway to address financial risks and reforms at the annual National People’s Congress.
• India’s economy is expected to grow by 7.1% in the fiscal year through March and should bounce back from the demonetization period saw last year.

RATES

Sovereign yields moved higher over the week.

• FOMC comments and fading political concerns supported the markets.
• The spread between the OAT-Bund pulled back by 10bps while the front end of the German curve normalised after reaching all-time lows.
• The implied market probability of a rate hike surged following some Fed members comments and triggered a sharp increase on the 2Y US government bond rate.
• 10Y US, UK, Japan and German yields stood at respectively 2.50%, 1.19%, 0.07% and 0.35%.

CREDIT

Strong performance of the financial subordinated debt segment last week.

• Spreads on AT1 bonds tightened by 20bps on a weekly basis. The trend is similar for financial synthetic indices.
• On the corporate side, spreads were stable both for the cash and synthetic categories.

FOREX

EUR boosted against most of its peers last week.

• Partial fading in euro zone political risks boosted the EUR against all its major peers, except the USD and the MXN.
• The MXN had an excellent performance after US Commerce Secretary Wilbur Ross positive comments on the NAFTA deal.

COMMODITIES

Negative week for commodities with the GSCI Light Energy down by 0.29%. The index remains nonetheless positive for the year (1.59%).

• Energy underperformed most major commodities with Brent crude declining to just above the important $55 support level (the very bottom of its recent range) before bouncing off it.
• Base metals mostly strengthened as China announced temporary shutdowns heading into the annual National People’s Congress.
• Precious metals slid sharply on the Fed’s hawkish shift.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES