Coffee Break 4/18/2017

While French politics remain centre stage at least until the first round of the presidential elections next Sunday, geopolitical developments and US military manoeuvres in Syria and North Korea have further added to markets uncertainties. Volatility indexes have risen from historically low levels to their highest levels registered since the aftermath of the US presidential elections last autumn. At the same time, the USD has fallen below 110 JPY, also a level not seen since mid-November. These are good reasons to slightly reduce the equity overweight, though maintaining a positive stance on them.

From a regional perspective, we are overweight on euro zone and emerging market equities. Clearly, we expect the French elections to become a catalyst for renewed outperformance of euro zone equities. But recent polls have injected some uncertainties in the run-up to the elections, compared to the previous weeks.

Regarding bonds, we remain confident that longer-term US bond yields will be higher in the coming months, despite the recent long-term yield set-back. We expect the global economic expansion to continue and a limited rise in core inflation by fiscal easing, higher wages, less deflationary pressure in China and the prospect of protectionist measures.

In the coming weeks, we will closely monitor the first round of the French presidential elections as well as both ECB and BoJ meetings on April 27^th.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are overweight in equities versus bonds:

• The US cyclical expansion, the economic recovery in Europe, the global inflation momentum and a soft landing in China are all supportive for equities in a rising rates context. Both growth and inflation data have surprised on the upside, leading to higher nominal growth, which is ultimately supportive for corporate profits.
• Central banks’ actions are decoupling but their tone has turned less dovish:
  • The ECB has started the new downsized stimulus programme until December 2017, standing ready to increase the programme in terms of size and/or duration “if the outlook becomes less favourable or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation”.
  • After the Fed interest rate hike in March, two additional moves are expected this year by the central bank.
• Equities have an attractive relative valuation compared to credit, and their expected return should be boosted by the end of the earnings recession in the US and Europe.
• Oil markets continue their rebalancing. However, while OPEC members are bringing back oil production to more durable levels, US rigs have been re-opening, implying a greater production.
• Political events keep uncertainty levels high. The geopolitical tensions in Syria and North Korea, the US house’s failure to approve the healthcare reform, the UK officially triggering Art.50 of the Lisbon treaty and the first round of the French presidential elections, are all implying high dispersion of possible outcome. The political risk premium still weighs on European equities.

REGIONAL EQUITY STRATEGY

• We have maintained our overweight on euro zone equities. A more robust and geographically broadening economic expansion, as witnessed by the most recent PMI indicators, an accommodative central bank and a high valuation discount linked to political uncertainties underpin the attractiveness of the region’s risky assets.
• In the UK, with the official notification that the country would leave the European Union, we maintain an underweight position on equities. The uncertainties of the “Brexit” conditions and their impact on the economy lead us to avoid domestically-oriented small and mid-caps.
• We have taken partial profit on our overweight stance in US equities, bringing back our global positioning to neutral. US stock markets have benefitted from post-election optimism among consumers and businesses, but activity has yet to follow sentiment. The expected fiscal stimulus should support the earnings outlook further, but slippage in the expected timing represents a risk.
• We have a neutral view on Japanese equities. Stronger US growth and a supportive domestic policy mix are among the main performance drivers, but a weaker currency is warranted to gain more conviction.
• We hold an overweight on emerging market equities with India as our preferred market.

BOND STRATEGY

• We maintain our underweight on bonds and keep a short duration. With a more hawkish Fed and increasing inflationary pressures, we expect interest rates to maintain their uptrend. The improvement in the European economy could also lead euro zone yields higher, barring political risks.
• We have a neutral view on credit, as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
• We continue to diversify out of low/negative yielding government bonds:
  • We remain positive on inflation-linked bonds as we expect a rise in core inflation by fiscal easing, higher wages, less deflationary pressure in China and the prospect of protectionist measures.. Potential US protectionist measures are a wild card.
  • We have a relative value strategy: long German Bund / short French OAT due to increasing uncertainties surrounding the French elections. We 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. The carry remains attractive and negative financial implications of the US presidential elections, due to a stronger USD, are receding.
  • We are close to a neutral high yield exposure. The spread compression has exceeded our targets on both sides of the Atlantic.

• In the US, the Michigan sentiment preliminary index rose to 98 in April, from 96.9 the previous month, mainly due to more favourable views of current economic conditions.
• Initial jobless claims unexpectedly slipped by 1000 to a seasonally adjusted 234,000. The labour market is near full employment, with the unemployment rate close to a 10Y low of 4.5%.
• In the euro zone, the Sentix index rose to 23.9 in April, its highest level since August 2007, against a consensus of 21. Investor morale sharply improved despite uncertainties surrounding the French presidential elections.
• In Germany, the ZEW Economic Sentiment increased by 6.7 points to 19.5 in April. German economic confidence hit a 20-month high, supported by a strong growth in industrial production, construction sector and retail sales.

EUROPE

European equities ended the holiday-shortened week lower.

• Banking stocks acted as the biggest weight on European shares performance, mainly due to the rally in global fixed income markets.
• Mining stocks were also lagging with news of a contraction in industrial production also weighing on markets.
• The automobile sector was a bright spot at midweek, rising following strong Q1 earnings results from Daimler.
• Despite the upcoming elections in France, global investors seem to remain net buyers of European stocks.

US

US stocks ended lower for the holiday-shortened week.

• Trading volumes were exceptionally low early in the week.
• Small caps, which are typically more volatile, lagged their large caps counterparts.
• The technology-heavy Nasdaq Composite underperformed slightly, mainly due by weaknesses in semiconductor shares on news that Apple would develop its own chips for its products.
• After very nice earnings reports, Tesla’s market cap is now higher than Ford’s one, and equivalent to GM. A new giant is born in the Automotive industry!

EMERGING MARKETS

Geo-politics was a key factor for emerging markets performance last week.

• The meeting between Chinese and US presidents, the US missile attack in Syria and a US navy fleet heading for the Korean peninsula sent jitters across markets, with the Korean and Russian markets as the main victims.
• Emerging markets’ sentiment turned for the better towards week’s end as Donald Trump said to no longer consider China as a currency manipulator, and Brazil CB decided to cut interest rates with a full point, with more to come.
• One of the markets gaining the most last week was South Africa, recovering from the politically inspired correction of the previous week. 

RATES

Sovereign yields dropped further over the week as the risk off mood prevailed amid increased worries over France’s elections.

• The 10Y OAT-Bund spread widened back to 72bps over the week.
• 10Y US, UK, Japan and German yields stood at respectively 2.27%, 1.04%, 0.01% and 0.18%. 

CREDIT

Markets were generally in a risk-off mood last week.

• Polls indicating a rising momentum for Jean-Luc Melenchon in the French election and geostrategic tensions linked to Donald Trump’s tough stance on Syria and North Korea weighed on markets.
• Credit Spreads widened slightly with Cash markets (Investment grades +2bps vs govies and High yields + 4bps) outperforming derivatives (Itrax Main +3bps and Xover +12bps).
• Low volumes on the primary markets due to the holiday period.

FOREX

The JPY kept gaining versus major peers as the risk-off sentiment persisted on the market.

• The EUR and USD suffered as global yields went lower due to risk-off sentiment, the fading Trumpeconomics and rising geopolitics and political risks.
• The USD also fell following President Trump comments in the Wall Street Journal that the dollar was “too strong”.

COMMODITIES

Rising energy prices last week.

• Energy prices rose to a 4-week highs bouncing strongly on improving fundamentals and geopolitical risk fears rising due to the situation in Syria and North Korea.
• Base metals declined last week as the iron ore is now officially in bear market territory after falling by more than 20% from its 2017 highs.
• Precious metals, especially gold, rose on the return of geopolitical risks. 

UPCOMING FACTS AND FIGURES