Coffee Break 7/25/2016

The earnings season has started with the consensus expecting a -3% YoY Q2 results in the US (+1% without the energy sector). Close to 90% of companies will have published their earnings within the two coming weeks. Of all sectors, financials (banks) is the one that generates the most positive expectations. In part due to an improvement of the very grim outlook analysts had at the beginning of the year. As 2016 started with a mixture of concerns about:

• Banks having to comply with increasing regulations costly to implement;
• Capital markets activity as well as net interest margins being negatively impacted by near-zero interest rates;
• The energy sector being weighed down by persistently low oil prices leading to an increase in bad loans and
• Chinese economic growth.

On a positive note, China has released a series of reassuring economic data, nonetheless an official GDP growth target of 6.5% to 7%. In spite of an on-going CNY depreciation, an immediate near-term currency or foreign currency reserve crisis has dissipated. A weaker currency acts as major support for exports in a subdued global growth environment and the government will do everything it takes to create growth. But as China is the world's biggest exporter, its revenues also depend on global demand, making it dependent on the well being of the buying countries and not just a perfect combination of price, product and promotion.

In Europe, the ECB met last Thursday and Mario Draghi reiterated his current stance and left the ECB's monetary policy unchanged. An assessment of the impact on growth and inflation of the UK's decision to leave the EU is pending production. The new staff projections will be prepared for the next press conference scheduled for 8 September. It is possible that during that meeting the ECB will communicate a decision on an extension and conditions of its asset purchases programme, which is set to end in March 2017.

Our current investment strategy:

Legend
grey : no change
blue : new change

EQUITIES VERSUS BONDS

Visibility has been reduced by the outcome of the EU referendum in the UK. A nimble approach in our investment scenario will be warranted in the coming months as "Brexit" raises more questions than gives answers. We are reassured by the hands-on approach by central banks. The ECB met last Thursday and is cautiously awaiting the data it needs for an assessment of underlying macroeconomic conditions. Mario Draghi also signalled that the ECB was "ready, willing and able to act". The next ECB meeting is on 8 September, while the next FOMC is on 27 July and the Bank of England meets on 4 August.

Outside Europe,

• The macroeconomic news flow is in line with sluggish but positive growth.
• Stabilising macro indicators and the recovery in commodity prices have led to easing financial conditions compared to the start of the year.
• The BOJ has its policy rate anchored in negative territory while pursuing quantitative easing and potentially stepping them up, in particular following the recent JPY appreciation.
• The PBoC is set to continue its easing policy at a later stage.
• Emerging markets remain historically cheap and have been resilient in the Brexit aftermath. A combination of improving fundamentals, stabilising commodity prices and a still dovish Fed has further improved the region's attractiveness.
• Emerging markets are seeing investor inflows as "Brexit" has less impact on distant regions. In light of the latest economic news, we have increased our emerging markets exposure.

REGIONAL EQUITY STRATEGY

We have an underweight on equities mainly on European and UK ones. We were underweight before the referendum and will stay underweight UK for now.

• 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 slight overweight on emerging markets equities: the short-term evolution will depend on the evolution of the USD, a more dovish Fed and the global context. The solid momentum into H2 in China reassures us.
• We are neutral on Japan.

BOND STRATEGY

We have increased our exposure to emerging markets debt by adding to local and hard currency debt.

• In the light of "Brexit" uncertainties, we had recently increased our duration, as investors are looking for safe havens and policymakers keep an accommodative stance.
• We continue to diversify out of low/negative yielding government bonds:
  • We are positive on credit. In the current context, we see more potential in credit than in equities.
  • 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 re-rating of inflation-protected bonds over the course of the coming quarters.
  • Our constructive view on commodity prices is reflected in our exposure on emerging market debt, both in local and in hard currency terms.

• In the US, housing starts figures are on an increasing trend and came much better at +1.5% than market expectations of a 0.5% gain.
• In the UK, Markit Flash UK Composite PMI came in at 47.7 in July down from 52.4 and below expectations of 49.0. In particular, the Services PMI tumbled 4.9 points to 47.4.
• In the euro zone, Markit Flash Eurozone Composite PMI came in at 52.9 in July down from 53.1 in the previous two months but slightly above market expectations of 52.5. Both manufacturing and services components eased. 

Over the past week, commodities continued to disappoint, as the GSCI Light Energy lost 2.6%, though remaining positive (2.4%) on a year-to-date basis.

• Oil is set for a weekly decline (-2.2% last week) as the US heads to the end of the summer-driving season with ample crude and fuel stockpiles.
• US crude and gasoline supplies are at the highest seasonal levels in at least two decades. Record June consumption wasn’t enough to make a dent in stockpiles. Conversely, natural gas gained 2.3%.
• Gold headed for its first back-to-back weekly decline since May (-0.75%), with gains in equity markets and the USD hurting prices. Silver remained flat.
• It was a tough week for soft commodities. Corn fell, with improved US weather conditions. Indeed, moderate temperatures are best for the crops, while rains will keep any damage minimal. Overall, prices are down by 8% YTD. Wheat, soybean and cocoa ended in highly negative territory, respectively -4%, -7% and -6.3%.

EUROPE

Flattish performance for European equities with the Stoxx 600 closing at 340 up by only 0.71% for the week.

• European equities were largely mixed as a series of corporate earnings reports weighed on several sectors.
• 20% of Stoxx 600 firms reported so far with 55% beating earnings while only 47% beating revenue expectations.
• From a country perspective, the FTSE 250 underperformed following disappointing UK PMI data. This was not a surprise given the domestic exposure of this particular index. In contrast, the FTSE 100 outperformed thanks to Vodafone and the international exposure of the index given the weaker GBP
• At a sector level, Technology, Real Estate and Automobiles outperformed the benchmark (6.28%, 2.51% and 1.68% respectively) while Retail (-0.25%), Oil & Gas (-1.36%) and Basic resources (-2.46%) were clearly underperforming.

US

Positive performance for US equities with the S&P 500 closing at 2175 last Friday.

• US stocks recorded modest gains but took large-caps and mid-caps to record highs.
• The technology-heavy Nasdaq Composite index was boosted by the positive quarterly results of Microsoft and ASML Holding, which both beat earnings estimates.
• The overall figures of Q2 result remained, if not positive, not as bad as feared.
• Investors seemed to be supported by strength in the housing sector.
• At a sector level, IT, Utilities and Health Care outperformed the S&P 500 (2.02%, 1.46% and 1.24% respectively) while Consumer Staples (-0.58%), Industrials (-0.80%) and Energy (-1.31%) were underperforming.

EMERGING MARKETS

Emerging stocks were held steady but lacklustre for the week as concerns grew over delayed expanding stimulus by central banks around the world.

• Turkish stocks were set for their worst week since late 2008, having lost 14% as President Erdogan hinted that the state of emergency in the country might have to be extended beyond the original three months after the coup attempt.
• A fall in oil prices over the week also weighed on some EM oil producers like Russia and Malaysia.
• Eastern European markets rallied as Fitch rating agency held off cutting Poland's sovereign rating last week.
• At a sector level, Utilities, IT and Telecoms outperformed the index (1.15%, 0.72% and 0.42% respectively) while Health Care (-0.16%), Materials (-0.33%) and Energy (-0.63%) were underperforming.

RATES

The important downturn in core sovereign yields seems to have come to a halt for the moment

• Better risk sentiment; better US economic data and central banks in Europe (BoE, ECB) holding off extra easing measures for the moment are positive news.
• The ECB kept both rates and QE on hold last Thursday ECB meeting. We expect changes in QE parameters to be announced at the September ECB meeting.
• Among non-core countries, Spain outperformed supported by the successful 10Y syndication (6 bn issued with a total book size of EUR 28 bn.)
• Focus will now turn to the 27 July FOMC and on possible signs of future rate hikes.
• Core sovereign rates remained fairly stable, while among non-core countries Spain was the main outperformer.
• 10Y US, UK and German yields now stand at respectively 1.59%, 0.83% and -0.01%. Spanish 10Y spreads tightened while Italian spreads remained fairly stable, reaching 1.14% and 1.26% respectively. 

CREDIT

Credit markets have posted a positive performance last week as ECB's measures continued to drive Euro credit spreads increasingly tighter.

• The ECB meeting last Thursday was uneventful, although Mario Draghi said he backed public bailout for Italy's troubled banks under "exceptional circumstances".
• Cash spreads outperformed derivatives. Senior IG corporates spreads tightened by 5bps vs 3bps for iTraxx Main. Subordinated financials tightened by 9bps.
• If US macro data was rather positive, UK PMI showed a sharp contraction of business activity following the "Brexit".
• The Primary market reopened with a huge appetite from investors, with notably a EUR 30bn book order for Teva Pharmaceutical's EUR 4bn issuance. 

FOREX

The USD continued to trade in a range vs the EUR, as no surprises came out of the ECB meeting.

• The USD kept trading in the $1.10 range against the EUR, as the ECB took no action as expected, taking time to reassess the Brexit impact on economic outlook.
• The GBP dropped at the end of the week against the EUR and the USD, after PMI data pointed to an important deterioration in the UK's economy.
• Among emerging currencies, the TRL saw an important drop on the back of the political turmoil. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES