Coffee Break 2/20/2017

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:

Legend
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.

BOND STRATEGY

• 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.

• In the US, initial jobless claims rose by 5,000 to a seasonally adjusted 239,000 for the week. Claims have been below 300,000, a threshold associated with a strong labour market, for 102 straight weeks.
• The US industrial production declined by 0.25% in January as unseasonably warm weather caused a major drop in utilities output. Capacity utilisation also slightly declined to 75.4%.
• The euro zone industrial production fell by 1.6% in December MoM. YoY output nevertheless advanced by 2%, slightly above consensus expectations of a 1.7% increase.
• In Germany, the ZEW economic sentiment dropped more than expected in February (to 76.4 from 77.3), as expectations were dampened by the recent weak economic data.

EUROPE

Slightly positive week for European equities with the Stoxx Europe 600 up by 0.77%.

• Mining and automobiles drove momentum early in the week.
• But by the end of the week, energy and mining where pulled down by the stronger USD.
• Carlos Tavares, PSA’s CEO, met the British Prime Minister to discuss the acquisition of Opel/Vauxhall as fears about consequences on the employment side are rising in the UK and Germany.

US

Positive week for US equities with the S&P 500 up by 1.51%

• The large-cap Dow Jones Industrial Average generated the best returns while the small-cap Russell 2000 Index lagged.
• Strong performance from biotechnology and pharmaceutical stocks drove gains for the health care sector.
• Financials were boosted by the increasing interest rate margins.
• US Core retail sales increased by 0.6% in January.

EMERGING MARKETS

Slightly positive week for Emerging equities with the main index up by 0.97%.

• Capped gains for Emerging stocks last week on the back of data showing Chinese consumer inflation quickening to the fastest pace since May 2014 while factory prices rose at their quickest rate since mid-2011.
• While this shows China is at no risk of a big slowdown, it will confirm Beijing's recent shift to a tighter monetary policy stance.
• Brazil rose up to its highest level in a year as the lower house of Congress voted to reopen an amnesty program for undeclared assets held abroad.
• Turkey stabilised after the government said it was studying the foreign currency debts of its private sector and will introduce new regulatory measures in March.

RATES

Greek bonds again in the spotlight.

• Greek government bonds sold off as hopes faded for securing an agreement with the country's creditors at this week's Eurogroup meeting.
• Few changes for US Treasury yields last week . A rally on Friday drove yields lower, offsetting yield increases earlier in the week.
• 10Y US, UK, Japan and German yields stood at respectively 2.41%, 1.20%, 0.08% and 0.3% last week.

CREDIT

Another volatile week with the French political risk leading the sentiment.

• Spreads are fairly unchanged to slightly wider on the French names.
• Financials companies continue to publish good set of results for Q4 2016.
• On the supply side, very strong interest on new primary issues of from Petroleos Mexicanos.

FOREX

Poor performance of the GBP due to weaker economic data (retail sales, jobless claims).

• Rising risk aversion benefited the JPY, mainly because of political risks in Europe (French Election, Greek Debt).

COMMODITIES

Negative week for commodities with the GSCI Light Energy down by 1.15%. The index remains positive for the year: 2.42%.

• First weekly decline in five weeks for US crude, as the market is weighting rising drilling and record stockpiles.
• Unusually mild temperatures are forecasted in the US Midwest and could potentially advance the growth of the region's winter wheat.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES