Coffee Break 5/15/2017

As equity markets had already integrated the election of Emmanuel Macron as the new French president, markets remained more or less unchanged in the immediate aftermath of the election. They focused instead on the large amount of earnings publications. As of last Wednesday, 67% of the Stoxx Europe 600 companies that had already reported earnings, surprised positively by 11%. Ex-energy, earnings growth is at a solid 17%, confirming the current upturn. This comforts us in our conviction towards euro zone equities, in which we have an important overweight. While keeping a high conviction in this regional preference, we are missing a new catalyst for tilting global markets either way. Our understanding is that economic policy risks keep rising on the other side of the Atlantic.

Markets have also priced-in a Fed interest rate hike in June. Central banks will have an important role in the coming months, and not only in the US. We expect the ECB tapering likely to take centre stage in the second half of the year. We therefore keep our underweight on bonds and a short duration.

In the coming weeks, we will continue to monitor any new development regarding central banks’ stance, upcoming European elections and “Brexit” negotiations.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are neutral on equities as we keep a portfolio protection and hold a short duration on bonds:

• The US cyclical expansion, the economic recovery in Europe, the global inflation momentum and decent growth in China are all supportive for equities in a rising rates context. Data released so far this year confirm our view of a synchronised global expansion. We think that the euro zone and emerging economies are best placed to leverage on these dynamics.
• Central banks are expected to be at the forefront in coming months:
  • The ECB left its monetary policy unchanged, making no changes to its key interest rates or bond buying programme. ECB President Mario Draghi has put emphasis on the importance of wage growth - which is likely to turn very slowly – confirming a dovish posture relative to the data for the long run. However, QE tapering should become a central theme after the summer.
  • After the Fed interest rate hike in March, two additional moves are expected this year, starting in June.
• Equities have an attractive relative valuation compared to credit, and their expected return should be boosted by the end of the earnings recession in the US and Europe.
• Oil markets continue their rebalancing. However, while OPEC members are bringing back oil production to more durable levels, US rigs have been re-opening, implying a greater production.
• There is a risk of policy error in the medium term. The geopolitical tensions in Syria and North Korea, the slippage in the timing of the fiscal stimulus, and “Brexit” negotiations are all implying high dispersion of possible outcomes, including a misallocation of resources.

REGIONAL EQUITY STRATEGY

• We remain overweight on euro zone equities. The French election outcome led to a sharp decline in the political risk premium. A more robust and geographically broadening economic expansion throughout the region and an accommodative central bank underpin the attractiveness of the region’s risky assets. Furthermore, profits are revised upwards while relative valuations are attractive and non-resident flows are picking up gradually.
• We maintain our negative stance on UK equities. Besides the uncertainty surrounding the “Brexit” negotiations, earnings growth will no longer benefit from GBP depreciation as the base effect will fade after June. Also, stabilising commodity prices are not supporting earnings growth anymore and domestic fundamentals are weakening while downside risks remain.
• We keep our neutral stance on US equities. We are waiting for more clarity on fiscal stimulus and see the narrowing gap on the downside between survey optimism and actual activity as a tactical warning on US equities. Reflation trade positioning has reversed back to early-November levels.
• We have a neutral exposure to Japanese equities. Stronger global growth and a supportive domestic policy mix are among the main performance drivers, but a weaker currency is warranted to gain more conviction.
• We hold an overweight on emerging market equities, with India as our preferred market.

BOND STRATEGY

• We maintain our underweight on bonds and keep a short duration. With a hawkish Fed and continuing inflationary pressures, we expect interest rates to maintain their uptrend. The improvement in the European economy could also lead euro zone yields higher as political risks recede.
• We continue to diversify out of low/negative 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 remain positive on inflation-linked bonds as we expect a rise in core inflation by fiscal easing, higher wages, less deflationary pressure in China. Potential US protectionist measures are a wild card.
  • We took some profit on our relative value strategy: long German Bund / short French OAT but keep a small position as a hedge against the European political risk ahead of the June Parliamentary elections.
  • We have a slight overweight in emerging market debt, both in local and in hard currency terms. The carry remains attractive and negative financial implications of the US presidential elections, due to a stronger USD, are receding.
  • We are close to a neutral high yield exposure. The spread compression has exceeded our targets on both sides of the Atlantic, but the carry remains attractive.
  • On the currency side, we partially cut our exposure to the NOK. Oil prices have declined recently and broke down the support, thus weighing on the NOK. We hold a lower underweight on GBP ahead of the upcoming British elections. 

• In the US, the preliminary Michigan consumer sentiment index hit 97.7 in May coming from 97 in April. Households turned more bullish on their income expectations.
• Initial jobless claims unexpectedly fell by 2,000 to a seasonally adjusted 236,000. The US economy is pointing to a tightening labour market and rising inflation that could spur the Federal Reserve to raise interest rates in June.
• In the euro zone, industrial production unexpectedly fell for the second consecutive month in March. Output slipped by 0.1%, coming short of a +0.3% consensus expectation, due to a dampened energy output.
• In Germany, the economy picked up speed in the first quarter. Europe's biggest economy grew by 0.6% from the quarter before, the strongest quarterly growth since Q1 2016. On a annualised basis, Germany’s economy grew by 1.7%.

EUROPE

Slightly positive week for European equities.

• European markets traded with low volumes and low volatility, after the strong rise following Macron’s victory in the French Presidential elections
• German stock index DAX 30 reached a record closing high midweek and the UK's FTSE 100 was on track for its third consecutive weekly increase.
• Markets were boosted by positive economic news, including lower unemployment figures along with expectations that euro zone economic growth should be stronger in 2017.

US

Slightly negative week for US markets.

• The major benchmarks were mostly lower for the week with only the Nasdaq Composite recording a gain.
• Poor performance from blue chips Disney and Boeing weighed on the narrowly focused DJIA and small caps also underperformed.
• Strong economic data helped the markets, with weekly jobless claims falling at their lowest in 40 years.

EMERGING MARKETS

Fourth week of gains for Emerging markets equities.

• In South Korea, the local index broke the historical high level as liberal President Moon Jae-in was elected. He promised a strong fiscal policy and a structural reform to boost up the depressed economy.
• Other Asian economies also showed a clear recovery sign with Thailand’s Q1 growth expected to have expanded at its fastest pace in four years, while Malaysia’s central bank held interest rates steady, predicting growth to strengthen.
• Brazil rose to a more than two month high as markets were optimistic about the pension reform passing congress.
• At the end of the week, the volatility of the market rose following the firing of the US FBI director by President Trump.

RATES

Sovereign yields remained flattish over the week following the French Presidential elections.

• Agencies and Supranationals piled into the primary market as the French tail risk had been removed from the market.
• In the US, Bond yields initially moved higher but finally ended the week flat as US CPI prints came in below consensus for April.
• 10Y US, UK, Japan and German yields stood at respectively 2.34%, 1.10%, 0.03% and 0.40%.

CREDIT

Credit spreads kept on tightening last week.

• Credit spreads tightened vs the cash market with -5bps for Investment Grade and -11bps for High Yield, therefore outperforming derivatives (flat for iTraxx Main and +4bps for Xover)
• The strong return of issuers on the primary market (27bn on EUR corporate and financials) has been well absorbed by investors with order books generally 2.5x oversubscribed.
• General Electric tapped the market with a jumbo 4 tranches 8bn issuance.

FOREX

Return of the risk appetite following the positive outcome of the French Presidential elections.

• In this environment, carry currencies such as the BRL and the MXN performed well, roughly +2% each versus the EUR.
• On the opposite, the CHF was the major looser reacting to Central Banker comments (overvalued currency) and favourable EUR sentiment post-election. 

COMMODITIES

Oil prices ended the week on an upward mode.

• Both Brent and WTI were boosted last week by reports that US inventories were falling more than expected.
• Gold price was supported by the falling USD.
• Cotton futures dropped to their lowest in a month last week after the latest US crop report added to a recent bout of profit-taking by traders.

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES