Coffee Break 11.06.2018

INVESTMENT CONVICTIONS

• Core scenario
  • The global expansion is synchronised, self-sustained and not easy to derail.
  • US growth accelerates towards 3%, the euro zone growth cycle may have peaked.
  • Gradual rise in inflation in the US, but no inflation fear.
  • US Fed monetary normalisation is progressive, other central banks are in no hurry to tighten.
• Market views
  • Global equities are supported by solid earnings growth, in particular in the US.
  • Valuations have become less stretched after the correction earlier this year and solid earnings reports.
  • Credit is expensive, in particular in the US, leaving little room for improving fundamentals.
  • US equities are supported by the tax reform, buybacks and still attractive valuation vs. bonds.
• Risks
  • Risks to our core scenario show that markets are switching between two “opposite” risks: inflation fear and recession fear;
  • Outside the US, the macro momentum is peaking, concerns about protectionism are intensifying, European political risk makes a comeback and geopolitical risks have increased.
  • On the other hand, strong demand and tensions in the Middle East could lead to a spike in the price of oil or tight US labour markets could lead to an overshoot in wages while the Fed’s monetary tightening is making progress.
  • Drifting too cold (a shock on growth or fear of recession in one key region) or too hot (an unexpected acceleration in inflation) will trigger higher volatility.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY 

We are overweight equities vs. bonds via US and EM equities. We keep a short duration, and expect the 1.15-1.25 range on the EURUSD to hold.

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

• We have gained more conviction and have moved our equity exposure to overweight as we expect the underlying favourable background to prevail.
  • US growth re-accelerates and global growth momentum outside the US is expected to continue.
  • We are overweight on US equities. The improving earnings growth and the positive impact of Donald Trump’s tax reform and deregulation are a support for the asset class. In addition, valuations are no longer too expensive. “America first” policy is likely to impact other countries negatively.
  • We are neutral on the euro zone. The region still displays a robust economic expansion but uncertainties have risen recently (new Italian coalition, potential trade conflict with US, weaker activity indicators). Ending its QE by the end of this year, the ECB remains accommodative and is not in a hurry to hike rates. We prefer small and mid-caps to large caps.
  • We are underweight Europe ex-EMU equities. The region has a lower expected earnings growth and thus lower expected returns than the continent, justifying our negative stance. “Brexit” negotiations remain a risk, while negotiations on new trade relations are stalling.
  • We are underweight Japanese equities. Japanese stocks show a weakening earnings momentum as corporates can no longer rely on JPY weakness. In addition, the leadership vote of the LDP party by September represents a risk for PM Abe. On the positives, the accommodative policy mix remains good news for Japan.
  • We are overweight emerging market equities. Emerging equities benefit from strong global growth and attractive relative valuation. Our preference goes to EM Asia, the cornerstone of the high weighting of the tech sector (28%). We do not foresee a global trade conflict.

• We are underweight bonds and keep a short duration
  • We expect a gradual rise in inflation, but no inflation fear.
  • Global monetary tightening is progressive. Outside of the US, other developed market central banks are in no hurry to tighten.
  • With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to resume their uptrend. In addition to rising producer prices, rising wages, fiscal stimulus and trade tariffs could push inflation higher.
  • The overall improvement in the European economy could also lead EMU yields higher over the medium term. The ECB remains dovish in its QE plans and is opposed to a strong euro. Political uncertainties in Italy could delay the ECB tightening, but not derail the end of QE.
  • We have a neutral view on credit overall but prefer EU to US in both Investment Grade and High Yield. Spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
  • The emerging market debt faces headwinds with a strengthening USD and rising Treasury yields but we believe spreads can tighten from current levels. The carry is among the highest in the fixed income universe. It is an attractive diversification vs other asset classes.