Over the past week, investors’ attention shifted to the semi-annual testimony of Fed chair Janet Yellen to Congress. She acknowledged better economic data, both at home and abroad, but, despite her more hawkish-than-expected tone, US equity markets have reached new highs. Moreover, as the dollar index remained broadly stable, emerging markets appear less vulnerable than in the immediate aftermath of the US elections. Potential protectionist measures remain, but the probability of an immediate and outright US-China economic and trade fight has decreased lately.
In this context, we have decided last week to increase our emerging markets equities exposure to slightly overweight.
In the coming weeks, we will closely monitor Donald Trump’s speech before Congress on 28 February and Janet Yellen’s communication on the future monetary policy path on 3 March.
Our current investment strategy on traditional funds:
grey : no change
blue : change
EQUITIES VERSUS BONDS
We are overweight in equities versus bonds:
- The macro news flow is still well-oriented. Global growth is expanding in a synchronised way. 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 market participants 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 is in no hurry to hike. The Fed tightening cycle is at odds with accommodative policies in Japan, the euro zone and the UK. 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.
- 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.
- As the triggering Art 50 of the Lisbon Treaty is looming, we keep an underweight exposure to 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 have increased our emerging markets exposure, as the region 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.
- We have maintained a significant 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.