Coffee Break 8/22/2016

Highlights

United States: Industrial production rose more than expected in July.
Euro zone: inflation is positive again following a surge in food prices.
Asset allocation: We are neutral in equities vs. bonds, and neutral in euro zone equities. We remain overweighed in emerging markets, both in equities and bonds.

Asset Allocation :

Over the past weeks, investor positioning has become less bearish. According to the last fund manager survey of BofA Merrill Lynch, global cash levels have declined this month, though remaining at a relatively high level.

Investors now see geopolitical and protectionist policies (due to the upcoming US presidential elections) as the largest risks to financial markets' stability. Our global asset allocation positioning is, however, consistent with a risk-on sentiment. This justifies our neutral stance in equities vs. bonds.

Our current investment strategy:

Legend
grey : no change
blue : new change

EQUITIES VERSUS BONDS

We currently have a neutral strategic positioning in equities vs. bonds:

The "Brexit" has increased the downside risk, but there is no spill over for now, as the growth deterioration remains contained to the UK and early indicators show global growth is little impacted.
The macroeconomic news flow outside the UK is in line with a sluggish, but positive growth:
- Improving macroeconomic indicators in the US and China mitigate the downside risks on a global scale.
- We remain nevertheless vigilant, as the depth, duration and diffusion of the "Brexit" confidence shock remains highly uncertain.
Central banks follow the financial crisis template.
- Led by the Bank of England, they provide ample liquidity and remain highly accommodative.
- The Fed left its rate unchanged at its last FOMC meeting. Janet Yellen’s speech at Jackson Hole on 26 August will give us more information on the normalisation path the Fed wants to pursue in the coming months.
Oil market continue its rebalancing, leading to a stabilisation of the commodity markets. This is supportive for risky assets, particularly emerging debt, high yield and inflation-linked bonds.
Emerging markets face fewer headwinds, thanks to a stabilisation of commodity prices, a working Chinese stimulus and a cautious Fed.
Although investor sentiment has improved recently, we remain vigilant, due to a busy political agenda (Russian parliamentary elections, regional elections in Germany, constitutional referendum in Italy and the US presidential elections).

REGIONAL EQUITY STRATEGY

We currently have a neutral weight in euro zone equities (since Wednesday 10 August). The European equity markets are close to key resistance levels. We are positioned to benefit from a potential extension of the recovery and have therefore neutralised our euro zone underweight.
We have maintained our underweight in UK equities.
We have a neutral stance on US equities, as the US market is less impacted and thus more resilient in the current market environment.
We have a neutral stance on Japan.
We are overweighed in emerging markets. Fundamentals are improving and valuation is attractive. A positive turn in flows and an attractive technical set-up shows a high re-rating potential.

BOND STRATEGY

We continue to diversify out of low/negative yielding government bonds:
- We remain positive on US corporate bonds, high yield bonds and emerging debt, both in local and hard currency.
- We are positive on inflation-linked bonds. We view the subdued inflation expectations as a temporary phenomenon and expect wages and consumer price inflation data to rise gradually. This implies a further re-rating of inflation-protected bonds over the course of the coming quarters.

Macro :

In the US, industrial production rose more than expected in July as according to the Federal Reserve, output increased by 0.7%, beating expectation of 0.3%.
US consumer prices were unchanged in July, following two straight monthly increases of 0.2%, while in the 12 months through July, the CPI rose by 0.8% after having increased by 1% in June.
In Germany, business morale continued to brighten in August. The ZEW economic sentiment index increased to 0.5 points. A separate gauge of current conditions jumped to 57.6 points, from 49.8 in July.
In the euro zone, inflation is positive again. Eurostat confirmed its initial estimate of a 0.2% rise in prices YoY in July, thanks to a surge in food prices. Core inflation was unchanged at 0.8% in July.

Equities :

EUROPE

Negative performance for European equities with the Stoxx 600 closing at 340 down by 1.72% for the week.

European equities slumped, weighed down by mining, banking, and insurance stocks, although a rise in oil prices supported some energy stocks.
All main country indexes were negative last week (FTSE, DAX, IBEX, FTSEMIB or CAC).
UK retail sales rose by 1.4% in July from the previous month (5.9% YoY) as overseas shoppers were lured by a weak GBP and domestic shoppers flocked to department stores and clothing outlets.
Investors are focusing now on the coming ECB meeting on 8 September (new easing measures?).
At a sector level, Oil & Gas, Chemicals and Basic resources outperformed the benchmark (0.20%, 0.04% and -0.58% respectively) while Banks (-3.27%), Utilities (-3.38%) and Insurance (-3.51%) underperformed.

US

Mixed week for US equities with the S&P 500 closing at 2184 last Friday.

Few moves last week on US markets with lacklustre trading volumes even for a month of August.
Even the positive trend in crude oil into bull market territory wasn't enough to move markets.
Only the Russell 2000 Index (small-cap shares) was marginally positive last week and outperformed large- and mid-cap indexes.
At a sector level, Energy, Materials and Industrials outperformed the S&P 500 (1.97%, 1.27% and 0.67% respectively) while Consumer Discretionary (-0.70%), Utilities (-1.29%) and Telecoms (-3.84%) were underperforming.

EMERGING MARKETS

Another slightly positive week for Emerging Markets equities

China stocks surged last week as the government decided to open its doors to its tech-heavy Shenzhen exchange and scrap important limits on how much foreigners can invest in the country’s stocks, to entice more global players into its markets.
Better than expected earnings release from large IT companies such as Alibaba, Netease and Tencent also fuelled the rally in Chinese equities.
Russia also showed strength as oil prices continued their current rally reaching new highs on speculations that Russia is working with Saudi Arabia to achieve market stability.
Turkey drifted lower after reports that the local police had simultaneously raided 44 companies in Istanbul and had warrants to detain 120 company executives.
At a sector level, IT, Energy and Consumer Discretionary outperformed the index (+1.48%, +1.07% and -0.01% respectively) while Telecoms (-0.81%), Materials (-0.95%) and Consumer Staples (-1.96%) were all below the benchmark.

Fixed Income :

RATES

Core global sovereign markets delivered mixed performances, while non-core spreads widening (mainly Portugal and Italy).

The minutes of the July FOMC meeting revealed a lack of consensus, making a September rate hike unlikely. Janet Yellen speech in Jackson Hole will be monitored closely to assess the short-term probability of rate hikes.
In Europe, the ECB minutes showed no signs of a new round of easing with surprisingly no discussion about tools or broader policy strategies.
In Spain, acting PM Mariano Rajoy will hold a confidence vote on 30 August, accepting Ciudanos conditions for support. This boosted Spain relative performance versus other non-core peers.
Global sovereign yields increased moderately, while non-core countries spreads widened with the exception of Spain.
10Y US, UK, Japan and German yields now stand at respectively 1.55%, 0.58%, -0.09% and -0.07%. Spanish and Italian 10Y yields also turned higher, reaching 0.93% and 1.11% respectively.

CREDIT

Probably one of the quietest week of the year on the corporate side.

Investment Grade credit spread unchanged at 108bp over Government bonds
European quarterly results are now over, with more positive surprises coming from the Financial sector (69% positive) while Telecom (55% negative) & Utilities (57% negative) slightly disappointed.
In terms of supply, no single issue in euro and SocGen launched a new Tier 2 in USD (oversubscribed 5 times). Demand remains weak with €190mio inflows in the asset class (lowest level post Brexit).

FOREX

In a context of low market activity and mixed asset classes performances, safe-haven currencies delivered the best returns last week.

The EUR and the CHF were the best performers amongst major currencies.
The GBP took a breather after two consecutive weeks of sharp depreciation and returned 0.87% against the USD.
The USD lost 1.4% against the EUR, as the minutes form the July FOMC meeting did not point to any imminent rate hike.
At the bottom of the table we found high-carry and EM currencies (BRL, KRW, AUD, MXN…) all delivering negative returns against the USD and the EUR.

COMMODITIES

Over the past week, commodities rebounded, as the GSCI Light Energy rose by 2.5% and posted a positive return for the year (+5%).

Both crude oil and Brent prices continued to rise as the prospect of an output freeze by major producers and the decline in the USD boosted prices.
Silver prices declined last week as investors continued to speculate over the possibility of a Fed rate hike in 2016.
Cocoa prices have been steadily rising since the end of July, after crop yields in West Africa were hurt by poor weather.