Coffee Break 11/20/2017

The breakdown of the preliminary talks to build a coalition in Germany will not alter the fact that Equity markets are currently experimenting some volatility. This correction seems somewhat severe for European markets, as they registered a second straight weekly loss. Many reasons have been brought up to explain this correction. As we are nearing the end of the year, some managers appear to lock in this year’s positive performances and create outflows by selling.

More fundamentally, the US - and then the European - high yield bond markets have been ruffled last week following the discussions between the US Senate and the House of Representatives on the proposed tax reform that includes a limit on the available tax deduction for net interest expense to 30% of Ebit. Additionally, a series of disappointing earnings publications for many issuers with decently large capital structures have also hurt the high yield performances.

More generally, it is becoming clear that the House and the Senate have yet to find an acceptable compromise on the tax reform, leading to uncertainty until the issue is resolved. As a result, the USD has sharply depreciated against the EUR at the start of last week, impacting euro zone companies.

Finally, the oil price decrease, based on stronger US production, lower demand expectations by the International Energy Agency and doubts about the extension of oil output cuts at the coming OPEC meeting at the end of the month are adding to the reasons to take some profits.

Looking forward, and if the context does not change materially (i.e. a supportive growth / inflation combination with higher visibility on monetary policies), the current setback could represent an opportunity to buy back some euro zone equities. Clearly, disappointing news out of Germany over the week-end will have to be digested first.

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 and Japan. 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.
  • The ECB has announced that it will pursue its quantitative easing but cut the amount to EUR 30bn in January 2018. Asset purchases will continue for at least 9 months 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 current context offers a good mix of growth and inflation, coupled with a high visibility on monetary policies by central banks. We nevertheless tactically increased the partial hedge on our euro zone equities exposure.
• 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 the GBP depreciation, weakening the repatriation of overseas profits realised by UK corporates.
• We remain neutral on US equities. Doubt on the timing of the Trump tax reform and on a possible compromise between the House and the Senate, create uncertainty.
• 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. The correction on US high yield observed last week could be attributed to the on-going negotiations surrounding the Trump tax reform which could include a limitation on the deductibility of interest payments.

• In the US, industrial production increased by 0.9% MoM in October, following an upwardly revised 0.4% rise in September. It is the largest gain in industrial output since April, as factories finally returned to normal operations after the hurricane season.
• In the US, inflation rate rose by 2% YoY in October below September’s 2.2% and in line with market expectations. 
• In the euro zone, the second preliminary GDP growth estimate, confirmed an annualised economic Q3 growth of 2.5%. Economic indicators have also confirmed the on-going economic acceleration with a 3.3% rise in industrial output in September. 
• Another publication showed consumer prices increased by 1.4% YoY in October, below September’s 1.5%, but in line with previous estimates.

EUROPE

Negative week for European equities.

• European indices started the week sharply lower as bond curves flattened, commodities sold off and investors took some profits.
• The SMI was the only relative performer due to its defensive nature and supported by Novartis, Roche and Nestle.
• The FTSE MIB was dragged down by the Italian banks and ENI.
• On the sector side, the heavyweights technology names, SAP, ASML & Infineon outperformed and supported the index.
• Energy companies underperformed dragged by Arcelor Mittal and mining names.

US

Flattish large caps equities last week but rebound for the smaller ones

• Chinese industrial production data caused a modest rotation toward safety (defensive utilities and consumer staples) at the start of the week.
• The week also saw low trading volumes in anticipation of the upcoming Thanksgiving holiday season.
• Energy stocks were notably down as oil prices reversed some of the rally that began in early October.
• Thursday brought a solid rebound in most indices but due only to short covering from investors as well as a general move to buy on the dip.
• Small caps outperformed as investors sought out lagging segments in the market.

EMERGING MARKETS

Positive end of the week for emerging equities.

• Emerging markets stocks recovered on Friday after having started the week on the wrong foot after Chinese economic data showed the world’s second-largest economy cooled further in October.
• The main equity index rose thanks to solid gains in major Asian bourses with Taiwan and Hong Kong up, boosted by tech heavyweight Tencent Holdings.
• South Africa, Russia and central Europe also edged higher.
• India posted some of the day’s biggest gains after Moody’s upgraded the country’s sovereign bond rating for the first time in nearly 14 years. 

RATES

Core markets eased slightly last week.

• Peripheral yield spreads to Germany were stable last and Greek bond yield spreads to Germany narrowed on the back of the €30bn swap of PSI bonds in order to boost market liquidity and prepare the exit from the bailout program in August.
• On the other side of the Mediterranean sea, Portugal’s yields dropped by 9 bps.
• On the data front, euro zone real GDP increased by 0.6% QoQ during Q3 (2.5% YoY in Q3) with Germany GDP growing at 2.8% YoY beating estimates.
• In the US, core CPI surprised to the upside with a level of 1.8% YoY vs. 1.7% expected.
• 10Y US, UK, Japan and German yields stood at respectively 2.36%, 1.31%, 0.022% and 0.37%.

CREDIT

Volatile week for credit markets

• A volatile week on Credit markets with some correction observed during the first half of the week, especially on High Yield, mainly explained by specific stories and profit taking.
• Cash spreads widened, with the Investment Grade and High Yield indices moving respectively from 89 bps to 92 bps and 263 bps to 275 bps over the week.
• Synthetic markets widened as well over the first half of the week but finally ended flat.
• The High Yield market was still the more affected asset class with the Itraxx Xover moving from 244 bps to a max of 251 bps over the week to finally . 

FOREX

Strong EUR last week after better than expected Q3 GDP.

• Some bullish comments by ECB members and strong German GDP print provided momentum to a broad-based euro strength.
• The worst performers were the Scandinavian and antipodean currencies after a series of economic data fell below expectations and commodity prices declined.
• The JPY ended the week stronger after the BoJ reduced 1-3yr JGB purchases for first time since April. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES