Coffee Break 11/28/2016

Over the past week, the Merrill Lynch's fund manager survey confirmed the strong change in investor positioning after the election of Donald Trump. Contrary to the trends observed so far during this year, an asset rotation has started with investors shifting their bond exposure (mainly US) to equities. Given the fact that this rotation doesn't seem stretched, we believe there is further room for an outperformance of equities. This is a good reason to maintain our slightly positive stance in equities.

From a regional point of view, Japanese equities also look attractive. Japan is among the largest beneficiaries of the regime change in the US and benefits from a weaker JPY, and a supportive fiscal and monetary policy mix. Also, Japanese equities offer a hedge against a stronger USD and decorrelated performance.

In the short term, we will closely watch the outcome of the Italian constitutional referendum on 4 December.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are now slightly overweight in equities versus bonds:

• The macro news flow is in line with low but positive growth.
  • In the US, we expect a tightening FED in a "high pressure economy" and a rate hike by the end of the year.
  • Chinese authorities will continue their proactive fiscal policy and prudent monetary policy measures.
  • Europe is showing resilience following the "Brexit" referendum.
  • In the UK, GDP growth should reach 1.4% in 2017 and 1.7% in 2018, as announced in the UK's Autumn Statement.
  • The stabilisation in commodity prices mitigates downside risks on a global scale.
• The medium to long-term economic risks have increased due to the various political events:
  • While the possible outcome of the Italian referendum on 4 December is unclear, a resignation of Matteo Renzi and new elections have a low probability. But a recapitalisation of the banking sector should take place before the year-end.
  • Donald Trump's election increased market uncertainties.
  • Last Wednesday, the UK chancellor Philip Hammond has delivered his first Autumn Statement. As expected, he stated that the government is no longer seeking a budget surplus in 2019-20, but remains committed to return public finances to balance "as soon as practicable". Along with weaker GDP growth and higher inflation, government finances forecast to be £122bn worse off until 2021 than forecasted in March's Budget. Debt-to-GDP would also peak above 90%.
• Central banks keep a dovish stance, providing ample liquidity to the markets.
  • Japan's policy mix is realigning. Fiscal policy is turning looser with potential bigger stimulus and yield curve targeting through unlimited bond buying, ensures a further improvement of financial conditions. Inflation numbers released for October showed the first rise in eight months in headline inflation while core price deflationary pressures eased.
  • The Fed is still on track for a rate hike and markets now fully price this for December.
• Oil markets continue their rebalancing. However, risks persist regarding the effective implementation of the oil production freeze agreement. Even though Iraq and Iran had expressed optimism recently on prospects for a deal, Iran has repeatedly said it wants to return to its pre-sanctions production level of 4M barrels/day before agreeing to a cut. Iraq's foreign minister has however reiterated a need to repair the budget owing to the fight against Islamic State. Furthermore, US oil production is likely to rise if the Trump administration acts in favour of drilling, as could be expected.

REGIONAL EQUITY STRATEGY

• We have maintained our slight overweight on euro zone equities.
  • We still have a relative value strategy in favour of the DAX against the FTSE 250.
• We have maintained our underweight in UK equities.
• We have a slight positive stance on the more defensive side of the US equity market.
• We are positive on Japan. The country benefits from a realignment of its policy mix and is a beneficiary of the regime change in the US.
  • Japanese equities not only benefit from a weaker JPY and accelerating economic activity abroad, but also offer de-correlated performances.
  • The US' supplement of reflation is a rescue for the credibility of Japan's efforts.
  • Investor positioning in Japanese equities is still limited.
• We have maintained a neutral positioning in emerging markets to protect our portfolio against possible protectionist measures.
  • We still prefer India thanks to improving economic fundamentals, both structurally and cyclically.

BOND STRATEGY

• We now have stronger conviction on a longer-term rise in US bond yields and therefore have a short position on US Treasuries.
• We continue to diversify out of low/negative yielding government bonds:
  • We have maintained an overall below-benchmark duration.
  • We currently have a relative value trade: long Italian yields / short Spanish yields:
    • Italian spreads have widened significantly approaching the constitutional referendum and the yields look attractive, especially compared to Spanish yields, where all the good news has already been incorporated in the market and instability could reappear quickly.
  • We remain positive on inflation-linked bonds. Consumer prices should continue to rise thanks to base effects related to the oil price rebound, an increasing wage pressure in a US economy that is close to full employment and increasing producer prices in China. As a result, we expect a sustained rise in US inflation expectations that are still too low.
  • We are tactically neutral on emerging debt. The carry trade looks less attractive in the post US election environment.
  • We are slightly positive on high yield. The significant spread tightening has reduced the potential, but the carry remains attractive.

• US durable goods orders rose by 4.8% in October driven by stronger demand for commercial aircraft. This is 1.5% higher than the expected increase.
• The Michigan index of consumer sentiment hit 93.8 in November, up from 87.2 in October's final reading.
• In the euro zone, economic activity accelerated in November and the preliminary PMI composite increased to an 11-month high of 54.1. This is 0.8 points better than the consensus forecast.
• In Germany, business confidence continues to be good with the Ifo Business Climate Index remaining unchanged at 110.4 points after seasonal adjustment correction in November.

EUROPE

Slightly positive performance for European equities with the Stoxx 600 closing at 342, up by 0.90% for the week.

• On the back of low trading volumes, European stocks were supported by strong performances from energy and mining companies.
• The rally in the US and hopes over the OPEC’s upcoming meeting would result in a production cutback boosted markets.
• Italian banks were pressured by concerns about the impact of the country’s constitutional referendum on 4 December.
• At a sector level, Basic resources, Oil & Gas and Industrials outperformed the benchmark (6.95%, 2.47% and 1.73% respectively) while Banks (0.10%), Construction (-0.38%) and Health Care (-0.52%) underperformed.

US

Positive week for US equities with the S&P 500 closing at 2213 last Friday.

• Third consecutive week of positive returns for US stocks on a shortened trading week due to the Thanksgiving holiday. Trading volumes were nonetheless solid early in the week.
• Optimism that the domestic economy is strong enough to withstand the coming Fed rate hike and higher borrowing costs drove sentiment upwards.
• According to FactSet, corporate earnings for the S&P 500 rose by 3% during Q3 on a YoY basis, reversing a streak of five quarterly losses.
• At a sector level, Telecoms, Energy and Materials outperformed the S&P 500 (5.18%, 2.71% and 2.48% respectively) while Consumer Staples (1.04%), IT (0.81%) and Health Care (-1.45%) underperformed.

EMERGING MARKETS

First weekly gain in more than a month for Emerging markets equities.

• Investors are returning to riskier assets while a number of currencies pulled away from record lows thanks to the USD taking a break from its relentless rally.
• Indonesian stocks posed the lowest close in 4 months as the IDR weakened to a near six-month low on foreign investor selling.
• The Philippines is ground zero for the rout as resurgent USD and Manila’s still-expensive stock market has made it even more vulnerable, with the PHP plunging to an eight-year low.
• Russia, however, is the “Trump Trade” in the emerging market as the market expects the country would benefit from the Trump Presidency.
• In India, equities ended the week by rising the most in the emerging market index on Friday, paring a weekly decline.
• At a sector level, Materials, Energy and Finance outperformed the benchmark (3.99%, 2.65% and -2.02% respectively) while Consumer Discretionary (0.12%), Industrials (0.03%) and Telecoms (0.02%) underperformed. 

RATES

The past week has been marked by robust macroeconomic publication in US and the euro zone.

• Robust Macroeconomic publication in the euro zone with November with the PMI higher than expected. In the US, sales of existing home reached 5.6M (+2% in October with 5.43M expected).
• Rumours concerning changes in the ECB securities lending conditions on Wednesday pushed global rates upward.
• Uncertainties around the Italian referendum brought some volatility and spread vs Germany and other peripherals continued to widen.
• Inflation expectations rose further especially in the US and the euro zone, while the trend was less obvious in the UK.
• Over the week, 10Y US, UK, Japan and German yields stood at respectively 2.37%, 1.41%, 0.03% and 0.24%. 

CREDIT

Credit cash market suffered during the week despite robust macroeconomic publications in the US and the euro zone.

• Rising government yields (Bund +5bp) and concerns on the Italian referendum which could bring some volatility had still a negative impact on Credit investors who reduced their exposure on risky assets.
• The primary markets remained open despite the US Thanksgiving holiday. New issues reached over EUR 8bn and investors were keen for financials names with the success of senior bonds issued by BNP Paribas and UBS.
• Investment Grade indices were quite stable with IG credit slightly widening by 1 bp while the Itraxx Main index was flat. 

FOREX

JPY suffered heavy losses against the USD, as expectations of a FOMC December rate hike pushed US yields to their highest in a year, widening real rates differential between the US and Japan, and therefore fuelling demand for the greenback.

• Commodity-related currencies (AUD, NZD, NOK) were amongst the weeks' top performers, helped by expectations of an OPEC agreement on output freeze.
• The EUR remained stable against the USD, despite uncertainties surrounding the outcome of the Italian referendum.
• In EM-FX space, BRL, RUB and COP all suffered and the TRY was the worst performer, despite a 50b increase of its Central Bank' monetary policy rate. 

COMMODITIES

Positive week for commodities last week with the GSCI Light Energy gaining 2% and remains positive for the year (+3.3%).

• The Brent rose by close to 5% last week, while the WTI lost about 2%. Prices were impacted by the growing consensus that the OPEC would strike a deal to cut crude oil production.
• Copper prices gained 5% last week, with expectations of growing demand from top-consumer China and an increase in infrastructure expenses in the US after Donald Trump’s victory.
• Natural gas prices went up last week by close to 4% as cooler forecasts continued to raise expectations for demand. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES