Coffee Break 11/13/2017

A decent earnings season in the US, Japan and Europe and continuing solid macroeconomic data have resulted in another upward path for the stock markets, giving positive returns to their investors.
As markets are trading at all-time highs and going into the final weeks of 2017, we are eagerly looking for a trigger which could disrupt markets from their current bullish mode. Investors are now largely positioned for above-trend growth coupled with below-trend inflation. As for inflation, we think it is not dead but rather hibernating. Clearly, as financial risks are broadly in check, we think that the consensus market perception is too benign on the global bond yield outlook in spite of relatively clear central banks’ guidance. In particular, the Fed and the BoE have indicated their ability to pursue interest rate hikes in 2018. Those recent announcements have validated our view of a temporary USD appreciation, adding a tailwind for both regions’ equities into the end of the year.
Tensions in the Middle East between Saudi Arabia and Iran have accelerated the rise in the price of oil, up by 20% in just two months.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are positive on equities and remain negative on bonds, maintaining a short duration:

• Global economic momentum is accelerating further with economic news-flows surprising on the upside, adding to the ongoing good earnings season. However, geopolitical risks remain an obstacle with increasingly tense relations between North Korea and the US as well as in the Middle East, between Saudi Arabia and Iran.
  • We concentrate our portfolio’s regional positioning on the euro zone, Japan and the Emerging markets. While we are positive on Japan, we suspect that Emerging Markets could face some headwinds if the USD strengthens.
• Central bank divergence becomes more obvious:
  • The Fed has started its balance sheet reduction and forecasts another rate hike in December.
  • Although, the ECB has announced that it would start its balance sheet reduction next January, asset purchases will continue for at least 3 quarters in 2018 and interest rates increases should not happen before the second semester of 2019.
• Equities have an attractive relative valuation compared to credit.

REGIONAL EQUITY STRATEGY

• We remain positive on euro zone equities which are supported by a strong economic and earnings momentum and relatively attractive valuations. The recent decline of the EUR/USD provides additional support, confirmed by the latest earnings reports, which were in line with analysts’ targets.
• We have kept a neutral tactical stance on emerging markets equities, as a result of the USD stabilisation and technical indicators.
• We remain negative on UK equities. Beyond the difficult “Brexit” negotiations, the shift in the BoE’s monetary policy stance has put a halt to GBP depreciation, weakening the repatriation of overseas profits realised by UK corporates.
• We remain neutral on US equities. There is an execution risk in the announced fiscal stimulus and pro-growth policies. We note that the House and the Senate Budget Committees both approved versions of the FY 2018 budget that included general directions to act on tax reform.
• We are positive on Japanese equities. A strengthening growth and a supportive domestic policy mix are among the main performance drivers and we have gained more conviction that the Bank of Japan will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY. Furthermore, Japanese earnings remain positive so far without depreciation of the JPY.

BOND STRATEGY

• We are negative on bonds and have a low duration. The improvement in the European economy could also lead EMU yields higher.
• With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to continue their uptrend from September’s low.
• 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 diversification to emerging market debt, as the on-going monetary easing represents an important support.
  • We are more or less neutral on high yield. 

• In the US, initial jobless claims came out at 239K in line with the forecast of 236K. Claims have been below 300K for 139 straight weeks, the longest stretch since 1970.
• The University’s of Michigan consumer sentiment index reached 97.8 in November from 100.7 in October 2017. It remains nonetheless above the 2017 average of 96.8.
• In the euro zone, the Markit PMI Composite Output index stood at 56 in October after September 4-month high of 56.7. Although the rate of output growth eased slightly, it remained among the fastest registered over the past 6.5 years.
• The Markit Services PMI Activity Index was published at 55, in line with the flash estimate of 54.9 and September’s final reading of 55.8. Output growth lessened from the previous month while new orders rose firmly.

EUROPE

European indices declined last week.

• European stocks saw their biggest plunge since August on a global consolidation following the rally of recent months.
• The IBEX was the worst performer while the FTSE was a relative performer.
• Cyclicals strongly underperformed on the risk-off sentiment with automakers lagging, dragged by the downgrades on Peugeot and Renault.
• Real estate and utilities outperformed while banking names bounced back slightly from recent weeks’ weaknesses.

US

Modest losses for US stocks last week.

• Financials companies underperformed last week as prospects for tax cuts diminished.
• Investors grew more defensive and favoured consumer staples stocks.
• Energy stocks were especially strong at the start of the week in response to the arrests of numerous members of the royal Saudi Arabian family. The sector fell back later on in the week due to news of a rise in US oil inventories.

EMERGING MARKETS

Another positive week for Emerging markets stocks.

• Markets were boosted by encouraging Chinese inflation and producer prices data.
• In emerging Europe, inflation in the Czech republic hit a 5Y high, bolstering expectations of a rate rise and sending the local currency to its strongest against the euro since 2013.
• Russia rallied, led by financial companies, as a rumour of a Sberbank dividend hike was spread.
• Brazil showed big fluctuations as investors worried that the plans to streamline the social security system might be difficult.

RATES

Bond markets saw a rather volatile week, with bond yields eventually rising after two weeks of strong rally.

• Rising oil prices and overall good inflation data do point towards a general increase in yields, though fiscal stimulus in the US is still yet to be confirmed, with Jerome Powell, the newly nominated chairman of the Fed, being an advocate of slow and gradual hikes.
• Additionally, uncertainties continue to arise as a result of political tensions emanating from Iran-Saudi Arabia tensions in the Middle East and its subsequent effect on the region.
• 10Y US, UK, Japan and German yields stood at respectively 2.37%, 1.31%, 0.043% and 0.39%. 

CREDIT

Investment Grade markets saw slight widening last week, as rate markets saw yields move upwards.

• In addition to profit-taking after the post-ECB rally, markets will be cautious over the progress of tax reform in the US after it emerged a Senate bill would delay tax cuts to 2019.
• Following several weeks of spreads narrowing in credit markets, last week saw a widening affecting the synthetic market where the Itraxx Main rose to 51 bps
• The movement was more significant in the High Yield market with the Itrax Xover moving from 224 bps to 244 bps over the week.

FOREX

The USD lost its momentum last week.

• Negotiations on US corporate tax reform seemed more complicated than expected and weighted on the USD last week.
• After a dovish hike by the Bank Of England the week before that disappointed markets and political uncertainties in Mrs May’s government, the GBP gained some ground on better economic data and positive outlook on the “Brexit” talks with the European Union.
• EM currencies were a mixed bag as commodity currencies (BRL, COP, MXN) performed well against the USD while Asian ones (PHP, INR, CNY) suffered. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES