Coffee Break 29/05/2017

The latest BofA Merril Lynch Fund Manager survey has confirmed the accelerating reallocation to euro zone equities with around 60% of investors saying they hold an overweight position. Flows are expected to rise further as they have not yet offset the outflows recorded in 2016. Meanwhile, emerging market flows are also gradually picking up. On the opposite, investors are more cautious on US equities with a relative negative positioning compared to the rest of the world, reaching the lowest level since November 2007. This is in line with our positive stance on euro zone and emerging equities, while remaining neutral on US equities. Last week revealed new confirmation of firming economic growth in the euro zone while US Q1 GDP was slightly revised upside.

Furthermore, as widely expected, the OPEC members decided to extend output cuts for 9 months following the early agreement between Saudi Arabia and non-OPEC Russia for the same period. As an immediate reaction oil prices gave back some of the performance registered in the previous two weeks as the meeting did not produce any new information.
In the coming weeks, we will closely monitor UK and French parliamentary elections and central banks’ meetings.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are tactically neutral on equities and remain negative on bonds, maintaining a short duration:

• Global expansion dynamics are less uniform than at the turn of the year. However, European recovery is well on track and should lead to above-trend growth in 2017-18, leading us to raise profit expectations. 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. 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. The next step in the Fed tightening will be a balance sheet reduction.
• 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 higher production and more time to absorb record inventories.
• Political risk has switched from Europe to the US. The geopolitical tensions in Syria and North Korea, the slippage in the timing of the fiscal stimulus due to the lack of political success in Congress and escalation of sensitive issues question the credibility of the Trump presidency.

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, 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. The US cyclical recovery stalled in Q1 and activity data has yet to catch up with survey optimism. Donald trump’s unpredictability adds to the uncertainty. Reflation trade positioning has reversed back to early-November levels. Deflation dynamics no longer at work but we see a gradual rise
• 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 hold half of our relative value strategy: long German Bund / short French OAT 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. Emerging market bonds benefit from strong fundamentals as risks in China and a commodity rout have declined. Although the recent Brazilian stress was unexpected, contagion to the rest of the emerging markets has been contained.
  • 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 keep an exposure to the NOK to benefit from oil prices evolution. We hold a lower underweight on GBP ahead of the upcoming British elections. 

• In the US, economic growth slowed less than expected as the Q1 2017 GDP increased at a 1.2% annual rate instead of the 0.7% pace reported last month, according the Commerce Department’s second GDP estimate.
• Also in the US, core capital goods remained unchanged. April’s non-defense durable goods orders remained flat after a 0.5% increase in March. Overall orders for durable goods fell by 0.7%.
• In the euro zone, business activity remains firm as the Markit’s preliminary PMI, a good guide to growth, matched April’s 56.8, the highest level since April 2011.
• In Germany, the economy picked up steam in Q1 2017 to a level of 0.6% QoQ. Growth accelerated thanks to strong exports, booming construction and government expenses. Business climate remains excellent in the meantime, with an Ifo business climate index at 114.6.

EUROPE

Slightly negative week for European equities.

• European stocks were pull down last week by the poor performance of energy, automobile and financial shares.
• The energy sector retreated following the fall in oil prices after the latest OPEC's meeting,
• Automobile stocks were under pressure from the ever-expanding emissions probes and following the argument by President Trump over Germany’s trade surplus with the US.
• In the UK, the FTSE 100 hit another all-time high but this was cut short on Friday by losses in oil and gas shares as well as financials.

US

Positive week for US markets.

• US stocks recorded good gains during the week as the S&P 500 and Nasdaq Composite Index showed record highs.
• Growth-oriented technology and consumer discretionary shares performed particularly well.
• Oil prices fell over the week and the energy sector took a sharp turn south.
• Neither the stock nor the bond market reacted strongly to Wednesday’s release of the Fed’s minutes as it didn’t changed investors’ minds over further interest rate hikes.

EMERGING MARKETS

Positive week for Emerging markets equities.

• Emerging stocks inched to new highs last week following a strong Wall Street close.
• Political problems in Brazil did not stop investors to pursue inflows into EM dedicated funds.
• Asian Pacific equities ended the week with solid gains, after a positive week for US markets, especially technology stocks. 

RATES

European sovereign yields moved higher last week on the back of firmer economic condition.

• Italian spread versus Germany tightened back to 170bps.
• In the US, yields moved slightly higher despite disappointing manufacturing PMI data.
• 10Y US, UK, Japan and German yields stood at respectively 2.27%, 1.07%, 0.04% and 0.38%. 

CREDIT

Stabilising Investment Grade spreads

• After the previous week's volatility, the cash market calmed down with the Investment Grade spread stable at 109bp (BoA ML € Credit).
• Derivatives outperformed the cash market with the iTraxx Main tightening by 2bp and the X-over by 5bp.
• A combination of holidays and primary calming down (only €8bn of European Investment Grade supply) helped to suppress much of the volumes and weakness seen the previous week.
• European Investment Grade retail funds saw inflow of around 800mio, with 4/5 going into short duration funds.

FOREX

Slightly negative USD trade weighted index last week.

• Due to macroeconomic data last week, the NZD was the best performer within major currencies and GBP the weakest.
• After the Brazilian politics scandal in the previous week, emerging currencies bounced back partly: BRL +0.74%, MXN +0.86% versus EUR.

COMMODITIES

Commodities were down over the past week (GSCI Light Energy down by 1.02%) and they remain negative for the year (-1.72%).

• Energy slumped 5% dramatically following the OPEC meeting last Thursday as the cartel decided to extend the production freeze by nine more months.
• Base metals suffered from a big decline in iron ore on news that Chinese steel makers have shifted to using scrap rather than ore. Copper however managed to post mild gains.
• Precious metals traded broadly sideways in a choppy week as bond yields and USD ended about flat.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES