Coffee Break 1/2/2017

In the past weeks, the US elections appeared to have represented the catalyst for a significant upward movement in equity values and bond yields on a global scale.

But the latest central banks' assessments have clearly revealed a decoupling in global monetary policies. We expect this unusual feature to be among the most significant market drivers in 2017.

In addition, we continue to scrutinise to what extent fiscal policies are able to take over the baton from monetary policies. There are great expectations for the new US administration, contrasting with little expected margin of manoeuvre in European countries. This represents a major change compared to the same period last year and might lead to complacency at a later stage.

We have learnt in 2016 that markets adjust extremely rapidly to new, unexpected, market conditions - this feature is likely to stay with us in the new year.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are overweighed in equities versus bonds:

• As a result of the US elections, the prospect of increased fiscal stimulus has risen considerably, given Donald Trump's programme. The dose of US reflation is leading market participants to postpone end of cycle anxieties. However, the wide range of possible outcomes of the upcoming Trump presidency includes the risk of policy errors. Misallocation of resources, potential protectionist measures or an interest rate shock would significantly tighten monetary and financial conditions, potentially impacting stock markets.
• The macro news flow is still well-oriented as shown by various sentiment surveys and supported by a strongly positive market sentiment both in US and Europe. We expect a stronger US growth and believe in a potential US reflation.
• Central banks are decoupling but they mostly keep a dovish stance:
  • The ECB will keep a steady hand given political uncertainties and extended its quantitative easing at least until December 2017.
  • The Fed tightening cycle is at odds with accommodative policies in Japan, the euro zone and the UK. The Fed increased rates by 25 bps and surprised markets by becoming more hawkish. It forecasted three interest rate hikes in 2017.

• Oil markets continue their rebalancing after the last OPEC agreement. But, greater producer response in the US and the strength of the USD could likely weigh on oil prices later on next year.
• The key risks are political risks, including the upcoming elections in Europe, "Brexit" negotiations and geopolitical tensions.

REGIONAL EQUITY STRATEGY

• We have maintained our slight overweight on euro zone equities, as we expect a gradual improvement from the high discount due to political uncertainties.
  • We still have a relative value strategy in favour of the DAX against the FTSE 250.
• We have maintained our underweight in UK equities. A deterioration in domestic UK macro indicators should hit the FTSE250 with significant domestic exposure. 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 slightly overweight on US equities. We expect a stronger growth and a rise in corporate earnings in the prospect of post-election reflationary policies and consolidating oil prices.
• We are positive on Japan. The country benefits from an aggressive domestic policy mix, stronger US growth and a weaker currency.
• We have maintained a neutral positioning in emerging markets

BOND STRATEGY

• We have maintained our short duration on US Treasuries.
• We continue to diversify out of low/negative yielding government bonds:
  • We have maintained an overall below-benchmark duration as we expect stronger inflation figures (oil prices, wages) and US fiscal policy easing to push bond yields higher.
  • We still have a relative value trade: long Italian yields / short Spanish yields.
  • 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 could rise gradually (The US should be the first to be impacted). In addition, upcoming fiscal easing looks likely. This implies a re-rating of inflation protected bonds over the course of the coming quarters.
  • We have reduced our overweight on emerging market debt, both in local and in hard currency terms in the aftermath of the US presidential election as a stronger USD and higher US yields imply downward pressure on emerging currencies which might add up in capital outflows.
  • We are slightly positive on high yield, even as the significant spread tightening has reduced the potential, the carry remains attractive. 

• In the US, jobless claims decreased by 10.000 to a seasonally adjusted 265.000. It was the 95th straight week that claims were below 300,000, signalling a still healthy labour market.
• The US consumer confidence hit its highest level since January 2001, to 113.7 from an upwardly revised 109.4 in November.
• In the euro zone, consumer confidence rose for a fourth consecutive month to -5.1, according to the flash consumer confidence indicator. It was the strongest reading since April 2015.
• In Germany, the Ifo Business Climate Index increased to 111 in December from 110.4 in November and above market expectations of 110.7. 

EUROPE

Slightly positive performance for European equities with the Stoxx 600 closing at 361, up by 0.4% for the week.

• Subdued trading was the hallmark of the week.
• Mining stocks helped at the start of the week, as a recovery in commodity prices continued.
• Italian and Spanish stocks were weak at midweek, as some cyclicals and banks fell.
• At a sector level, Basic Resources, Real Estate and Utilities outperformed the benchmark (2.17%, 1.84% and 1.42% respectively) while Chemicals (0.14%), Automobiles (-0.81%) and Banks (-1.26%) underperformed.

US

US equities ended the year on a negative note with the S&P 500 closing at 2239 last Friday (-1.1%).

• US stocks declined in light trading over a shortened holiday week.
• The technology-heavy Nasdaq Composite, which has lagged in the postelection rally, again trailed and ended the year with the smallest gain.
• Sentiment may have been dampened by news over declining home sales in November.
• Another important factor in the selling appeared to have been major rebalancing from investors to reflect recent equity appreciation.
• At a sector level, Real Estate, Health Care and Utilities outperformed the S&P 500 (1.24%, -0.08% and -0.21% respectively) while IT (-1.38%), Energy (-1.45%) and Consumer Discretionary (-1.60%) underperformed.

EMERGING MARKETS

Positive week for Emerging markets equities with the main index up by 2.7%.

• Traders took their profits on Russian assets after the United States imposed sanctions on Russian intelligence agencies over their alleged involvement in hacking US political groups during the 2016 elections.
• Brazil rose the most among EM stock markets as prices of iron ore soared and crude hit its highest level of the year.
• Chinese steel rebar (reinforcing steel) also jumped following a week long selloff, supporting shares of miners and steel companies.
• Turkey was one of the weak spots in emerging markets, with slow progress on reforms and sluggish growth.
• At a sector level, Health Care, Consumer Staples and Finance outperformed the index (3.29%, 3.17% and 3.14% respectively) while Utilities (2.10%), Industrials (1.58%) and IT (1.18%) underperformed. 

RATES

Sovereign markets delivered positive performances over the week, while non-core spreads were stable with limited impact seen so far from the Monte dei Paschi di Siena bail-out.

• In a low liquidity (end of year) environment a general downturn in yields was witnessed, with the UK outperforming.
• The Italian government approved a state bailout plan for Monte dei Paschi di Siena, making partial use of a € 20 bn fund approved last month.
• Global front-end break-even inflation performed well, supported by the further upturn in oil prices.
• 10Y US, UK, Japan and German yields stood at respectively 2.48%, 1.25%, 0.03% and 0.19% last week.
• Spanish and Italian 10Y yields also turned lower to 1.79% and 1.33% respectively. 

CREDIT

Quiet week with extremely low volumes.

• In this context, spreads remained unchanged to slightly tighter.
• The new flow continued on Monte dei Paschi di Siena with the ECB asking now for €8.8bn of capital increase compared to the previous € 5bn. According to the ECB, using 2016 stress tests, the capital shortfall for the Italian bank would stand at around €8.8bn.
• The market did not react to the news and continued to grind tighter. 

FOREX

The USD depreciated against almost all major currencies last week.

• The depreciating USD was due to quarter- & month-end portfolio rebalancing contributing to modest USD selling, in a context of very thin liquidity.
• The SEK was amongst the best performer of the week, as the recent RiksBank meeting was viewed as hawkish by market participants. 

COMMODITIES

Over the past week, commodities were slightly positive with the GSCI Light Energy up by
1.5%. For the year, the index ended on a positive performance (+5.7%).

• WTI gained 1.3% last week and was on track for its biggest annual gain since 2009 after the OPEC agreed to cut crude output to reduce a global supply overhang.
• Raw sugar posted over 8% of return last week, climbing to its highest level in more than two weeks on growing expectations that India’s crop may be smaller than expected.
• Coffee prices extended their gains while cocoa slide to its lowest level since April 2013 on anticipated oversupply. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES