Coffee Break 2/27/2017

Over the past week, the BofAML Manager Survey has confirmed rising inflows and a bullish equity positioning. However, equity positioning is not yet exuberant given the fundamental improvements observed over the past 12 months. European equities have not yet sustained any outperformance despite the favourable international and domestic context, as investors remain cautious due to widespread political risk. Economic data continue to remain supportive, but the recent bond yield decline clearly signals increased caution on the rising political risk in France. The decline in bond yields is in favour of an extension of the equity uptrend. Moreover, robust data continues to be a major performance engine for risky assets.

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

This week, we will closely monitor Donald Trump’s speech before Congress on Tuesday, and Janet Yellen’s communication on the future monetary policy path on Friday.

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. We are looking forward to the implementation of an increased fiscal stimulus in the US. 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.
  • In the US, markets are pricing two Fed hikes in 2017 and another two in 2018, below the median Fed projection. Following the Humphrey-Hawkins testimony, markets have adjusted Fed hike probabilities higher. Recent FOMC minutes nevertheless showed little indication on the timing of the Fed’s next move. They also suggested that the Fed should begin discussing changes to the existing reinvestment policy “at upcoming meetings.”
  • 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. Risks include potential US protectionist measures.

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, the preliminary Markit Composite PMI index dropped to 54.3 in February from 55.8 in January due to a broad-based weakening of business activity growth. The drop in the flash PMI numbers suggests that the post-election upturn has lost some momentum.
• The University of Michigan’s Consumer Sentiment Index dropped to 96.3 from January’s 98.5, which was the highest since 2004, and resulted from the enthusiasm for the new administration’s economic policies. The index was however better than the Reuters consensus estimate of 96.
• In the euro zone, the flash consumer confidence index showed that consumer morale dropped to -6.2 in February from an upwardly revised -4.8 in January. It was the weakest reading since October 2016.
• The Markit euro zone PMI Composite index came in at 56.0 in February, according to the preliminary flash estimate, up from 54.4 in January. The pace of the economic growth improved markedly to hit a near six-year high.

EUROPE

Barely negative week for European equities with the Stoxx Europe 600 down by 0.06%.

• Banking and Automobiles sectors pulled the markets down.
• The rate of positive surprises in earnings reports is historically high in Europe, with 57% of reporting companies beating expectations.
• Investors seem to come back to European stocks, with massive inflows in European Equity funds over the week.
• Political uncertainties still remain, but most PMI indexes are on positive territory throughout the whole region.

US

Slightly positive week for US equities with the S&P 500 up by 0.69%

• Most indexes ended the holiday-shortened week mixed.
• Weakness in some technology and biotechnology companies kept the Nasdaq Composite Index to a minimal gain.
• Positive earnings from Wal-Mart and Home Depot supported the consumer discretionary sector
• Higher oil prices also boosted the energy sector.
• Financials were also boosted by the increasing interest rate margins.

EMERGING MARKETS

Slightly positive week for Emerging equities with the main index up by 0.51%.

• Emerging stocks have gained over 10% YTD, helped by improved macroeconomic data worldwide and higher commodity prices.
• The new US Treasury Secretary, Steven Mnuchin, said that any policies enacted by Donald Trump would have a limited impact this year. This positive comment on the future of NAFTA led to a market rally in Mexico.
• Greece rose last week as the president of the Eurogroup, said enough common ground had been found to return to Greece to discuss a new package of reforms.
• Chinese shares listed in Hong Kong also touched a 5 month high, reassured by a run of relatively robust economic data. 

RATES

Global sovereign rates rallied over the week.

• In the US, Fed minutes revealed that many participants are in favour of rising Fed funds rates “fairly soon” if growth should maintains its positive momentum.
• In Europe, there were some flight to quality flows due to political uncertainty. This led to a strong rally in German bonds with Schatz yields reaching a record low at -0.95%.
• 10Y US, UK, Japan and German yields stood at respectively 2.33%, 1.08%, 0.06% and 0.19%.

CREDIT

Credit markets showed some resilience last week.

• The increased perception of political risks in France weighed on credit markets: Investment Grade spreads widened by 2bps and High Yield by 6bps vs govies.
• In this context, supply increased by €7bn only, with notably a new issue from Belgian bank KBC and a green bond from Swedish SEB.

FOREX

Poor performance of the SEK last week.

• The dovish speech by Riksbanken members in order to cool down market expectations on a potential rate hike in Sweden weighted on the local currency.
• The MXN performed well following the Banxico intervention (50bps rate hike) and constructive political meeting with US administration officials.

COMMODITIES

Negative week for commodities with the GSCI Light Energy down by 0.52%. The index remains nonetheless positive for the year (1.88%).

• Energy managed to rise after crude inventory stats revealed a surprise inventory draw.
• Gasoline lagged, as it appears that US refiners are coming back on line after maintenance season.
• Base metals were weaker across the board as they slumped after recent very strong gains.
• Precious metals mostly traded higher, with the decline in bond yields and the USD providing a boost.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES