Coffee Break 10/16/2017

Over the past week, investors continued to follow the escalating tensions between the Spanish central government and Catalonia. However, we expect macro-financial risks linked to the repercussions of the Catalan independence referendum to remain contained. On the medium-term, we remain confident on solid economic fundamentals in Spain, as growth has been remarkably resilient to political uncertainty. Nevertheless, on the short-term, we think it is premature to commit any risk budgeting to Spain as an independence declaration would likely prompt Madrid to seize power from Barcelona, which could exacerbate the tensions. We keep our positive stance on equities unchanged.

Separately, we expect markets to turn their attention to the 19th Congress of the Communist Party in China. President Xi, facing slower structural growth due to demographics and productivity, is expected to announce an expansive global agenda, based on digitalisation and anti-pollution policies. He has also made stability a priority and the recent track record is rather positive. As the party will replace five of the seven members of its standing committee, the leadership transition could show strongman politics replacing prior consensus-driven practice. Beyond short-term headwinds from a potentially stronger USD, our investment conclusion is that emerging markets’ growth will remain sustainable.

This week, we will follow the EU council summit, as progress regarding the “Brexit” negotiations will be monitored.

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.
  • We concentrate our portfolio’s regional positioning on the euro zone, Japan and the Emerging markets. While we are still positive on Japan, we suspect that Emerging Markets could face some headwinds given the strengthening of the USD.
• Central bank stimulus will fade gradually:
  • The Fed is starting its balance sheet reduction this month.
  • The ECB will likely announce its tapering this month.
  • Overall, central banks are confident on the synchronised global growth context and are prudently adopting a tightening bias.
• Equities have an attractive relative valuation compared to credit. .
• The main risks for equity markets remain (geo)political, with different degrees: Catalonia, the Chinese congress, North Korea. We add the US to the list, where the monetary policy uncertainties due to the upcoming reshuffle of the Board of Governors of the Federal Reserve adds to the fiscal policy uncertainties but should be clarified in the coming weeks.

REGIONAL EQUITY STRATEGY

• We continue to favour euro zone equities. Earnings momentum remains strong. As a result, the expected price/earnings for the coming twelve months will probably remain around their long-term mean next year. Sentiment has improved and flows have been returning. The pause in the recent increase of the EUR acts as a support after a more challenging summer for EMU equities.
• As a result of the strengthening USD and technical indicators, we are reducing our exposure to Emerging markets equities down to “neutral”.
• As we are gearing towards a soft “Brexit”, we are adopting a neutral view on GBP.
• 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 keep our neutral stance on US equities. There is an execution risk in the announced fiscal stimulus and pro-growth policies. Nevertheless, on the policy mix, we see progress on fiscal stimulus along with a tightening Fed. 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 BoJ will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY. Despite the elections next Sunday, political risk should be limited.

BOND STRATEGY

• We are negative on bonds and have a low duration. We expect rates and bond yields to resume their uptrend from this month’s low, driven by a tightening Fed, and potential upcoming inflation pressures. The improvement in the European economy could also lead EMU yields higher.
• 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.
• On the currency side, we expect the EUR/USD exchange rate to strengthen over a 12 month horizon after a temporary weakness. 

• In the US, the preliminary Michigan consumer sentiment index surged to a 13-year high of 101.1 in October, from 95.1 in September and beat the consensus estimate of 95. The low unemployment rate, post-hurricanes recovery efforts and falling gasoline prices were among the main drivers.
• US initial jobless claims decreased by 15,000 to a seasonally adjusted 243,000, the lowest level since late August, as the impact of the hurricanes was fading.
• Industrial production across the euro zone rose more than expected in August, underlining the region’s improving economic prospects. The index rose to 3.8% YoY, above the consensus estimate of 2.6% and slightly higher than the July’s figure of 3.6%.
• Investor confidence strengthened as the euro zone Sentix index reached a 10Y high in October with 29.7 points amid an improving economic momentum.

EUROPE

European stocks ended the week just above positive territory.

• Defensives were the clear winner and outperformed cyclicals.
• The SMI, due to its defensive nature, and the IBEX, on easing Catalan headlines, outperformed.
• Euro zone banks were the worst performers, dragged by peripherals lower bond yields, flattening curves and ECB news.
• Utilities bounced from recent weakness and were boosted by positive performance from RWE, E.ON and Iberdrola.
• Personal & household goods outperformed also following the better than expected Q3 estimates from LVMH, supporting the whole sector.

US

Fifth consecutive weekly gain for US large-caps.

• Last week saw the release of the first Q3 earnings reports.
• Consumer staples performed well, boosted by the announcement by Wal-Mart that the retail giant would launch a massive share repurchase programme.
• JPMorgan Chase and Citigroup lead the financials sector down after reporting lower fixed income trading revenues and higher set-asides for credit card losses.
• Health care services stocks stumbled early in the week on the back of reports that President Trump would act to loosen regulations to allow less comprehensive and cheaper insurance plans.

EMERGING MARKETS

Emerging Markets equities boosted by optimism over the global growth.

• South Korean equities led broad gain across emerging markets as Samsung electronics posted record breaking financial results.
• Taiwan also showed its strength as stocks in Apple supply-chain stock such as Largan and Merry electronics strongly rebounded.
• South Africa jumped to historical highs as the Supreme Court of Appeal upheld a High Court ruling to reinstate corruption charges against unpopular President Jacob Zuma. 

RATES

Global bond markets experienced some volatility following the events in Catalonia.

• As the Catalan declaration of independence was suspended last Tuesday, markets saw some compression in the Spanish/German 10Y spread.
• On Friday, yields rallied after the ECB’s dovish communication indicating that some officials were considering cutting the QE programme to €30bn (from €60bn) for at least nine months.
• 10Y US, UK, Japan and German yields stood at respectively 2.29%, 1.37%, 0.05% and 0.41%. 

CREDIT

The political turmoil in Spain didn’t impact spreads both on cash and synthetic markets.

• In Europe, cash spreads narrowed very slightly, with the Investment Grade index continuing its flattish trend (standing at 95 bps).
• The synthetic market remained stable over the course of the week with the Itraxx Main and Itraxx Xover at respectively 56 bps and 246 bps. 

FOREX

The EUR gained slightly last week on easing Catalan fears.

• Combined with disappointing US inflation report, the EUR/USD jumped to 1.1880 last Friday.
• The GBP headed for its first weekly advance in a month as market pricing for a rate increase by the BoE climbed.
• Nevertheless the GBP remains vulnerable to any headlines related to the complicated “Brexit” negotiations.
• The USD also lost against the JPY and other Asian currencies after People’s Bank of China made a fresh call to open up the nation’s financial sector.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES