Coffee Break 10/31/2016

Over the past week, we saw a yield backup in developed markets. Some focus on recent firm economic data, including global flash PMI readings and an upside surprise from the UK GDP have pushed yields higher. Also, the Fed interest rate hike, the Bank of Japan’s curve steepening push and speculation on a potential ECB tapering after March 2017 fuelled some rotation out of bond proxies. The 10-year German yield jumped above 0.15%, while the US T-note is approaching 1.9%.

In this context, and anticipating an interest rate rise, we have reinforced our underweight in duration over the past weeks, while maintaining a diversification towards emerging debt, high yield and inflation-linked bonds.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : new change

EQUITIES VERSUS BONDS

We hold a slight overweight in equities vs. bonds:

• The macro news flow is in line with low but positive growth.
  • In the US, we expect accommodative monetary policy to prevail while Chinese authorities will continue to offer a supportive policy mix.
  • Europe is showing resilience following the "Brexit" referendum.
  • 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:
• Global growth indicators seem little affected by the "Brexit".
• The UK appears to be quite resilient in the immediate aftermath.
• Economic policy uncertainties have come down, but remain historically high with several political risks looming by the end of the year (US presidential elections, Italian constitutional referendum, possible new elections in Spain and “Brexit” negotiations).
  • The two-year “Brexit” negotiations should start by the end of Q1 2017.
  • US presidential elections have been perceived as the n°1 tail risk for investors over the past three months.However, Donald Trump’s popularity has decreased over the past weeks.
• Central banks keep a dovish stance, providing ample liquidity to the markets.Oil markets continue their rebalancing, and recent agreement expectations have led the way to higher prices. This is supportive for risky assets, particularly emerging debt, high yield and inflation-linked bonds. We expect a gradual increase in inflationary pressures and are confident in our inflation-linked exposure.
  • In the US, solid PMI’s and labour market data strengthen the case of a Fed rate hike by the end of the year.
  • The Bank of Japan innovated by yield curve targeting, while the ECB is expected to clarify its intentions.
• Oil markets continue their rebalancing, and recent agreement expectations have led the way to higher prices. This is supportive for risky assets, particularly emerging debt, high yield and inflation-linked bonds. We expect a gradual increase in inflationary pressures and are confident in our inflation-linked exposure. 
• Emerging markets face fewer headwinds, thanks to a stabilisation of commodity prices, a working Chinese stimulus and a cautious Fed that alleviates fears of USD strength.

REGIONAL EQUITY STRATEGY

• We are slightly overweight on euro zone equities to benefit from a better momentum. We do not observe any material spill over from the “Brexit” for the moment but a catalyst to step up our exposure is still lacking.We have maintained our underweight in UK equities. The government’s perceived hard “Brexit” stance weighs on UK assets, pushing the GBP to new lows, bond yields significantly higher and leading to a substantial equity markets underperformance in common currency terms.
  • We currently have a relative value strategy in favour of the DAX against the FTSE 250. We anticipate a struggling domestic UK economy following "Brexit".
• We have maintained our underweight in UK equities. The government’s perceived hard “Brexit” stance weighs on UK assets, pushing the GBP to new lows, bond yields significantly higher and leading to a substantial equity markets underperformance in common currency terms. 
• We have a neutral stance on US equities and Japan.
• Although emerging markets have now become a consensus trade, investors’ positioning keeps rising. Emerging markets remain our main conviction for the time being thanks to an improving economic and earnings momentum, the bottoming-out of oil and commodity markets, and attractive relative valuations. The region is more at risk should the USD appreciate too much or when US bond yields increase more than expected, which is not our base scenario.
  • We prefer India: economic fundamentals (expected economic growth at 7.8% with an inflation under control) are improving, both structurally and cyclically and the resilience of the Indian economy is supported by a domestic reform agenda, which makes the country less vulnerable to external influences.

BOND STRATEGY

• Anticipating an interest rate rise, we have reinforced our underweight in duration over the past weeks.
• We continue to diversify out of low/negative yielding government bonds:
  • We remain overall slightly short in duration.
  • We are particularly positive on emerging debt, both in local and hard currency. Emerging bonds are benefiting from inflows, as they provide an attractive yield compared to developed markets.
  • We are moderately positive on high yield. The significant spread tightening this summer has reduced the potential, but the carry remains attractive.
  • We are positive on inflation-linked bonds, as base effects (oil prices) have a positive effect. US headline CPI should come in above 2% in December for the first time since mid-2014 and should peak at levels close to 3% during Q1 2017. Euro zone headline CPI should rise towards 1.5% early next year, a level not seen in the region since end-2013. External prices pressures are starting to increase and inflation expectations are starting to bottom-out from extremely low levels.
• Regarding currencies, our main strategies are:
• Emerging market currencies, based on our conviction that the USK peak and the low in commodity prices are behind us.
• Commodity currencies, via NOK against CHF, to benefit from rising oil prices and an overvalued CHF that upsets the Swiss National Bank. 

• In the US, the economy grew at its fastest pace in two years during Q3 (2.9% YoY) thanks to a surge in exports and in inventory investment.
• US core capital goods orders unexpectedly fell in September as weak demand for computers and electronic products weighed on the so-called durable orders (-1.2% after three months of strong gains).
• In the euro zone, business activity expanded at its fastest pace so far this year in October. Markit's preliminary reading of the composite PMI jumped to 53.7 from Septembers 52.6 (far above the 50 points mark indicating growth).
• In the UK, Q3 economic growth slowed less than forecasted (0.5%). The expansion, though slower than the 0.7% in the three months through June, marked a 15th straight quarter of growth.

EUROPE

Negative performance for European equities with the Stoxx 600 closing at 341, down by 1.01% for the week.

• European equities lost ground last week on the back of continuing outflows from European markets towards emerging ones.
• According to Bank of America Merrill Lynch's European earnings season update, 32% of firms on the Stoxx 600 have reported earnings this season so far, and 60% of them have topped EPS estimates.
• The top sector on EPS beats was banks, with 85% of companies exceeding estimates.
• Surprisingly, across sectors, domestic stocks fared better globally than stocks exposed to any other region.
• At a sector level, Banks, Basic resources and Automobiles outperformed the benchmark (2.22%, 1.73% and 1.52% respectively) while Food & Beverages (-2.63%), Real Estate (3.10%) and Health Care (-4.26%) underperformed.

US

Negative week for US equities with the S&P 500 closing at 2126 last Friday.

• US stocks fell back last week as investors weighed in a stream of Q3 earnings reports.
• The technology-heavy Nasdaq Composite Index lagged large-cap benchmarks, held back by poor performance from heavily weighted Apple and Amazon.
• Last week's earnings reports were as usual a mixed bag, with positive surprises from large companies, such as Procter & Gamble and Merck, helping to offset some disappointments in the technology sector.
• At a sector level, Consumer Staples, Utilities and Financials outperformed the S&P 500 (0.97%, 0.86% and 0.58% respectively) while Consumer Discretionary (-1.98%), Health Care (-2.78%) and Real Estate (-3.40%) underperformed.

EMERGING MARKETS

Negative week for Emerging equities with the index closing down by 0.8% last Friday.

• Emerging markets stocks showed their first monthly fall since May as the appetite for riskier Emerging assets wavered.
• Concerns that China would allow the CNY to keep weakening put downward pressure on other Asian currencies.
• Brazilian stocks rose to nearly their highest level in four years on hopes that President Michel Temer would manage to pass tough austerity measures in Congress.
• Uncertainties over South Africa remained last week due to its struggling economy, the political instability and the fate of its investment grade credit rating which is under threat ahead of key reviews by Moody's and S&P.
• Philippine also had a difficult week as investors, especially overseas funds, have turned cautious as President Rodrigo Duterte's rhetoric has worried the market.
• At a sector level, Materials, Finance and Telecoms outperformed the benchmark (-0.26%, -0.54% and -0.62% respectively) while Industrials (-1.41%), Utilities (-1.54%) and Consumer Staples (-1.54%) underperformed. 

RATES

The past week has been marked by a high level of volatility on Global sovereign markets, with an upward trend both in the US and the euro zone.

• Anticipation of an upturn of inflation in the US with good macroeconomic figures (solid Q3 GDP at 2.9% vs. 2.5% expected) reinforced market expectations that the Fed will hike interest rates in December.
• In the euro zone, we observed the same trend with PMIs surpassing market expectations (53.7 from 52.6 last month). Stabilisation of oil prices also contributed to push nominal yields higher as market participants anticipated less accommodating monetary policies for the future.
• Over the week core sovereign rates turned higher with 10Y US, UK, Japan and German yields now standing at respectively 1.84%, 1.25%, -0.06% and 0.16%.

CREDIT

Credit market performed well during the first part of the week with both good macroeconomics data and corporate earnings, but suffered in the second part from the bund sell-off.

• Strong results in the continuity of the previous week, especially for financials, and macroeconomics figures surpassing market expectations contributed to the good performance of credit, but a bund selloff caused a downward trend on the second part of the week.
• In this context, Cash bonds (Investment Grade: -3 bps, High Yield: -10 bps) outperformed synthetic indices with Itraxx Main and Cross-over widening by +1.2bps and +9 bps respectively.
• The primary market was quite active (?6.2bn priced by Danone on Tuesday) but stayed relatively thinly active afterwards. All in all, more than ?24bn were priced in last week.

FOREX

The EUR was the main outperformer last week, supported by higher European rates.

• The USD performed well, as strong economic releases fuelled expectations of a December rate hike.
• EM- and Commodity-related currencies lost some ground as oil prices fell under 50$.
• The SEK depreciated sharply after a very dovish monetary policy meeting suggested that the RiksBank would not raise rates before at least 2018.

COMMODITIES

Commodities were stable over the week with the GSCI Light Energy up by only 0.5%. It nonetheless posted a positive return for the year (+3.6%).

• Crude oil prices fell by over 2.5% last week, pressured by growing doubts over the success of OPEC's plan to curb production.
• Copper, after hitting its support of $2, rose by about 4% on improved risk sentiment following positive global economic data and a softer USD.
• Arabica coffee prices surged by 4% to a 20-month high due to the strong BRL, which broke new 15 month highs, supported by expectations that the country's new administration would be able to pass spending controls. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES