Coffee Break 9/4/2017

The latest North-Korean hydrogen bomb test, preceded last week’s missile launch over Japan’s northern Hokkaido island into the sea caused a further escalation of geopolitical tensions. In response to this event, the United States restated that “all options were on the table”, and the UN Security Council “strongly condemned” the launch. As a result, European equity indices fell in an initial reaction and tested key support levels last week.

Separately, a new string of economic data such as US consumer confidence and labour market figures, German IFO Business Climate and EU Economic Confidence data and Japanese retail sales underlined forcefully that the global economic expansion has gathered further momentum over the summer. In the face of rising (geo)political uncertainties, this is remarkable and reveals the resilience of the current stage of the business cycle.

In this context, the investment rationale set out end-June on Italian equities and euro zone banks has paid off, leading us to lock-in the realised profit on these trades.

This week, we will closely follow the ECB meeting this Friday, as well as geopolitical developments.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We have tactically reduced our equity exposure, though maintaining an overweight stance. We remain negative on bonds, while keeping a short duration:

• The robustness of the global economic news flow is supportive.

The outlook for the world economy appears solidly anchored above 3% for both this year and the next, while inflationary pressures remain subdued.
• Most recent data confirmed that both the euro zone and Japan are expanding above their potential, while the US is exiting its soft patch experienced earlier this year.
• Emerging markets benefit from tailwinds like stabilising commodity prices, a weakening in the USD and a decline in inflationary pressures, such as in Brazil, India and Russia.
• In this context, we concentrate our portfolio’s regional positioning on euro zone, Japan and emerging markets.
• Central bank dovishness to recede only gradually:
• The meeting in Jackson Hole has confirmed that removing policy accommodation will be gradual.
• ECB tapering announcements should occur after the summer, in line with economic robustness in the region – but the ECB will take into account the recent rise in the EUR exchange rate. This week’s ECB meeting should give more clarity as the inflation projection is likely to be cut.
• Equities have an attractive relative valuation compared to credit.
• The main risks for equity markets remain political and have switched from Europe to the US:
• The Italian risk on a medium-term horizon appears manageable and is already priced in by the markets, while the German elections should not materially alter the outlook for the continent.
• In the US, the risk of legislative delay in pro-growth policies has increased further. Furthermore, we see that expectations for more clarity on both domestic and international issues in the foreseeable future have fallen significantly.

REGIONAL EQUITY STRATEGY

• We have tactically reduced our euro zone exposure, though maintaining an overweight. Within the region, we locked-in our profits on Italian equities and banks, as we reached our target.

• We maintain an underweight on Europe ex-EMU, especially the UK. The deterioration in the “Brexit” negotiations, the difficulties to setup new trade relations (e.g. with Japan) and their impact on the economy pushes us to avoid the region. Renewed weakness in the exchange rate might constitute a temporary support for earnings growth expectations.
• We keep our neutral stance on US equities. There is a considerable execution risk in the announced fiscal stimulus and pro-growth policies. Also, debt ceiling discussions and a potential government shutdown will be followed closely.
• We hold an overweight in Japan. A strengthening global growth and a supportive domestic policy mix are among the main performance drivers and we have gained more conviction that the BoJ will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY.
• We maintain an overweight on emerging market equities. They benefit from attractive valuations in a robust global growth context. China should not trigger a systemic risk this year and recent data are rather supportive, leading the IMF to revise upward its medium term growth expectations (on average from 6.0 to 6.4% for the years 2017 to 2021). Furthermore, its relative economic and political stability, added to its long-term systematic approach partly justify our overweight stance on emerging markets.

• BOND STRATEGY

  • We maintain our underweight on bonds and a short duration. We expect rates and bond yields to resume their uptrend from June’s low, driven by a tightening Fed, and potential upcoming inflation pressures. We expect rising wages and potential stimulus to push inflation higher, although it takes longer than expected to materialise. Potential US protectionist measures are a wild card (NAFTA renegotiation, China).
  • We continue to diversify out of low yielding government bonds:
    • We have a neutral view on credit, as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
    • We have a diversification in inflation-linked bonds.
    • We keep our overweight on emerging market debt, as the on-going monetary easing represents an important support.
    • We are close to a neutral high yield exposure.
  • On the currency side, we maintain a lower USD overweight exposure, as the EUR/USD exchange rate broke key resistance levels, and remain short GBP vs. EUR.

• In the US, non-farm payrolls increased by 156,000 in August after a downwardly revised 189,000 gain in July, but were below the 180,000 expected. Meanwhile, the unemployment rate slightly rose to 4.4% from 4.3% in prior month.
• US manufacturing activity rose to its highest level in more than six years, with the ISM index reaching 58.8 in August, up from a reading of 56.3 the previous month and higher than the consensus estimate of 56.5.
• In the euro zone, the manufacturing PMI came in at 57.4 in August, in line with flash reading and up from 56.6 in July. This was the strongest figure since 2011 as robust demand and rising employment underpinned a solid improvement in overall operating conditions.
• The euro zone inflation (1,5% YoY) hit a 4-month high in August due to an increase of energy prices. However, the core inflation which excludes volatile items such as energy and food, remained flat at 1.2%.

EUROPE

European equities ended the week higher.

• Recovering from a sharp drop earlier in the week following the latest North Korean’s missile launch, European stocks finished the week with modest gains, helped by strong but in line European PMIs.
• London's blue-chip FTSE 100 ended the week higher, boosted by mining companies and a strong domestic manufacturing output report.
• Retail was the worst performing sector dragged down by Carrefour’s profit warning and Dixons Carphone, downgraded by numerous brokers after its recent profit warning.
• Basic Resources were boosted by higher underlying commodity prices.

US

Positive performance for US equities on light trading week.

• Large-cap indexes and the technology-heavy Nasdaq Composite performed well last week and where close to their all-time highs.
• Technology stocks were boosted by the strong performance at midweek from Facebook, Amazon, Netflix, and Alphabet.
• Health care shares were supported by the announcement of Gilead Science’s planned acquisition of rival Kite Pharma.
• Hurricane Harvey had an immediate effect on the energy sector, with gasoline futures reaching a two-year high in response to a massive shutdown in refinery production.

EMERGING MARKETS

Flattish week for Emerging Markets.

• Emerging equities retreated early in the week after the latest missile test In North Korea.
• After this sharp sell-off where Korean stocks lost 1.6% markets clawed back during the week.
• Egypt, Russia and Thailand outperformed last week, while the Czech Republic, Mexico and Indonesia lagged.

RATES

Geopolitical tension came back into focus after the latest incident in North Korea.

• US and core euro zone bonds have been caught between the stronger tone to the economy thanks to better inflation and macro data (putting upwards pressure on yields), and rising geopolitical tensions which have boosted demand for safe havens.
• During the Jackson Hole meeting, central bankers maintained a collective silence regarding monetary policies.
• Developed government yields generally moved lower (US and Japan) while the German and UK rates were rather stable. 10Y US, UK, Japan and German yields stood respectively at 2.13%, 1.06%, 0.00% and 0.39%.

CREDIT

Hurricane Harvey, the missile launch by North Korea and rising leverage in the US did nothing to rattle US credit markets which remained stable last week.

• On the other side of the Pond, European cash spreads moved a little wider, with the Investment grade index extending the bearish trend of the past three weeks (standing at 101 bps). It could continue to do so on heavy issuance expectations.
• The synthetic market on the other hand tightened with the Itraxx Main down by 3 bps and the Itrax Xover narrowing by 8 bps.

FOREX

The USD hit its lowest level against the EUR since 2015.

• The USD reached 1.20 last week before rebounding on the back of the improved US GDP growth which was revised upwards in the second quarter.
• EM Currencies continued their rise against the greenback, especially the CNY and the RUB.

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES