Coffee Break 27/11/2017

For now, financial markets have chosen to ignore the German situation as the thinking goes that Chancellor Merkel will ultimately muddle through. This kind of political uncertainty remains manageable and is not disrupting the course of Europe’s economy. Clearly, there is currently a pre-eminence of economic strength over political worries, illustrated by last week’s indicators, signalling a growth pick-up this winter. The euro zone composite flash PMI rose to 57.5 from 56 in October, surpassing the consensus expectations of 56 while the German IFO index unexpectedly hit a new record high, thanks to a strong domestic economy and a stronger global economy.

More globally, we note that investors currently worry more about issues outside the equity market as in its November fund manager survey, BofAML revealed that the “biggest tail risks” were a Fed/ECB policy mistake, followed by a crash in global bonds and a crash caused by the “market structure”.

We would agree that a medium-term “risk on” stance enables investors to capitalise on a robust economic environment and a relatively good visibility on the upcoming policy mix.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We have tactically reduced our exposure to euro zone and Japanese equities in the most conservative profiles of our traditional funds. While we are positive on equities and still positive on both regions, we approach the end of the year and want to lock in our gains while using cautiousness.

• Global economic momentum is accelerating further 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, durable goods orders unexpectedly fell by 1.2% in October after three straight months of gains, as demand for transportation equipment tumbled by 4.3%. This preliminary figure was below the consensus estimate of 0.3% and followed an upwardly revised 2.2% increase in September.
• The Michigan Consumer Sentiment index rose to 98.5 this month and remained largely unchanged in 2017, which reflects US consumers' increasing confidence and certainty about their income and employment prospects.
• In the euro zone, the Markit’s composite flash PMI increased to 57.5 this month, its highest since April 2011, and signals further broadening economic growth.
• In Germany, sentiment among businesses is very strong amid the collapse of the “Jamaica” coalition talks, as the Ifo Business Climate index jumped to a new record high of 117.5 in November from 116.8 the month before. This was due to far more optimistic business expectations.

EUROPE

European indices ended the week higher.

• The FTSEMIB, the Italian banks and the CAC 40 boosted the markets.
• Total, on stronger oil prices, and Arcelor Mittal, on higher iron ore prices, also supported the indexes.
• The FTSE 100 underperformed dragged by Centrica’s profit warning.
• Basic Resources strongly outperformed as investors appeared to be shrugging off the pullback in Chinese markets and focusing on the expected pickup in demand of industrial commodities into 2018.

US

US stocks rose in a holiday-shortened week of light trading.

• Small-caps and the technology-heavy Nasdaq Composite performed especially well, the latter helped by the strong performance of several technology and Internet-related giants, namely Facebook, Apple, Alphabet (Google), and Amazon.
• Consumer discretionary stocks were generally strong helped by favourable forecasts for the extended “Black Friday” shopping season.
• Financials lagged as long term interest rates fell, auguring poorly for bank lending margins.

EMERGING MARKETS

Emerging market stocks extended their rally for a fourth straight week.

• Chinese mainland stocks recovered from their steepest fall in 18 months, roiled by the government pledging fresh steps to reduce financial risks.
• Equity markets in Chili had a difficult week as the leftist presidential candidate Alejandro Guillier said he was open to eliminating the country’s quasi-private pension fund system for a state-run model.
• Russia, on the other hand, showed its strength after Bloomberg reported that Russia and the OPEC had outlined a deal that would extend current production limits though 2018. 

RATES

Yields in core markets were broadly unchanged over the week.

• The release of the ECB minutes highlighted solid growth, increasing confidence that “inflation dynamics would strengthen over time” and that it remained “contingent on a substantial degree of monetary policy”.
• On the data front, the euro zone PMI surged to its highest level since April 2011.
• Overall yields in core markets were broadly unchanged over the week while peripheral spreads tightened versus Germany.
• 10Y US, UK, Japan and German yields stood at respectively 2.33%, 1.26%, 0.02% and 0.35%.

CREDIT

Credit markets had a mixed week with riskier assets outperforming.

• Both cash and derivatives outperformed last week in a context of political uncertainty in Germany.
• High Yield and Investment Grade cash spreads tightened by 9 bps and 1bp respectively, while iTraxx Xover and Main tightened by 4bps and 1.5 bps
• The primary market’s activity was rather subdued, with half of the previous week’s issuance, as Thanksgiving drew closer.

FOREX

The dovish stance of the Fed pushed down the USD vs its main peers last week.

• The EUR also appreciated due to the sharp rise of the euro zone PMI in November .
• Commodity related currencies strengthened following the crude oil and base metals rally.
• The JPY ended the week stronger, after reports that the BoJ would steps back from its QE. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES