Coffee Break 23.10.2017

Stock markets are trading at all-time highs and we are on the lookout for any possible source of interference of the optimistic stance.
Donald Trump’s list for the next Fed chair is down to 5 names – including Janet Yellen’s, the current Chair - and a decision is expected within the next 2 weeks.
In Catalonia, following the referendum and the tensions with the Spanish government, Madrid launched the process to seize power from Barcelona on Saturday, escalating tensions. In the short-term however, we think it is premature to commit any risk budget to Spain.
In Germany, Angela Merkel began discussions, last Wednesday, to establishing a new coalition with the pro-business Free Democrats and the Green Party. All three parties met again on Friday.

The growth is strengthening and inflation is coming back very slowly. Recent fund managers surveys revealed that 45% of investors were now overweighed on equities vs. bonds and had put money to work. Cash holdings have shrunken to their lowest level in 2½ years. Simultaneously, 85% think that the bond market is overvalued.

This week, the 19th Congress of the Communist Party in China ends, the Governing Council of the ECB will hold a monetary policy meeting and the Q3 earnings season will gather further steam.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

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

• Global economic momentum is accelerating further with economic news-flows surprising on the upside.
  • o We concentrate our portfolio’s regional positioning on the euro zone, Japan and the Emerging markets. While we are positive on Japan, we suspect that Emerging Markets could face some headwinds if the USD strengthens.
• Central bank stimulus will fade gradually:
  • The Fed is starting its balance sheet reduction this month.
  • The ECB will likely announce its tapering this week.
  • Overall, central banks are confident on the synchronised global growth context and are prudently adopting a tightening bias.
• Equities have an attractive relative valuation compared to credit.
• The main risks for equity markets remain (geo)political, with different degrees (i.e. Catalonia and North Korea). We add the US to the list, where the monetary policy uncertainties due to the upcoming reshuffle of the Board of Governors of the Federal Reserve adds to the fiscal policy uncertainties but should be clarified in the coming weeks.

REGIONAL EQUITY STRATEGY

• We have tactically reduced our exposure to euro zone equities which have performed well since early September when we increased our position. We remain positive on euro zone equities nonetheless.
• Earnings momentum remains strong. As a result, expected price/earnings for the coming twelve months will probably remain around their long-term mean next year. Sentiment has improved and flows have been returning. The pause in the recent increase of the EUR acts as a support after a more challenging summer for euro zone equities.
• As a result of the USD stabilisation and technical indicators, we keep our exposure to Emerging markets equities to “neutral”.
• 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 GBP depreciation, weakening the repatriation of overseas profits realised by UK corporates.
• We keep our neutral stance on US equities. There is an execution risk in the announced fiscal stimulus and pro-growth policies. Nevertheless, on the policy mix, we see progress on fiscal stimulus along with a tightening Fed. We note that the House and the Senate Budget Committees both approved versions of the FY 2018 budget that included general directions to act on tax reform.
• 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 BoJ will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY.

BOND STRATEGY

• We are negative on bonds and have a low duration. We expect rates and bond yields to resume their uptrend, driven by a tightening Fed, and potential upcoming inflation pressures. The improvement in the European economy could also lead EMU yields higher.
• 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.
• On the currency side, we expect the EUR/USD exchange rate to strengthen over a 12 month horizon after a temporary weakness. 

• In the US, the Industrial Production rebounded in September and increased by 0.3% MoM. It had been downwardly revised after a 0.7% drop in August due to the hurricanes.
• The US housing market has taken a hit following the hurricanes in the region. Housing starts fell sharply by 4.7% from the previous month whereas a decline by 0.5% was expected. It was the lowest level since September 2016.
• Euro zone September inflation rate is confirmed at 1.5%, the same pace as in the previous month and in line with preliminary estimates.
• The ZEW Indicator of Economic Sentiment for the Eurozone fell to 26.7 in October from 31.7 in September. It is the lowest reading since March. 

EUROPE

European equities ended the week broadly flat.

• The main winner last week was the OMX, led by Volvo and Ericsson.
• The SMI was at the bottom of the ranking due to its defensive nature on a risk-on week with cyclicals outperforming defensives.
• Euro zone Banks significantly outperformed on stronger bond yields and steepening curves.
• Household & Personal Goods was the worst performer as the sector was dragged down by lower-than-expected sales from Unilever and a guidance cut by Reckitt.

US

US stocks recorded solid gains last week.

• Stronger-than-expected results from IBM helped the stock surge last week and provided a strong boost to the Dow Jones Industrial Average index.
• Johnson & Johnson also beat expectations, giving another lift to the index as well as to the health care sector.
• Consumer staples gave back some of their previous week’s gains, while energy companies fell alongside oil prices as data showed an increase in US inventories.
• Housing permits declined more than expected last month, but existing home sales rose and surprised on the upside.

EMERGING MARKETS

Emerging markets equities went down last week as Chinese growth crimped investor appetite.

• Chinese stock exchanges led the fall last week, with Hong Kong down by almost 2% last Thursday, its biggest one-day loss since August, on the back of tumbling property shares.
• China’s central bank chief issued a stark warning about asset bubbles in the country.

South Africa’s rand weakened by 3% over the week as messy politics added to the woes of Africa’s most industrialised economy after embattled President Jacob Zuma announced his second cabinet reshuffle in seven months. 

RATES

Euro zone bond yields rose over the week while curves were slightly steeper.

• Despite increasing political risk in Spain, peripheral spreads have remained stable.
• In the UK, inflation accelerated further to 3%, pressuring the Bank of England to hike rates.
• 10Y US, UK, Japan and German yields stood at respectively 2.38%, 1.32%, 0.065% and 0.44%. 

CREDIT

Tension between Madrid and Barcelona did not weigh on credit markets last week.

• Investors seemed to expect dovish outcomes from this week’s ECB announcement on QE and CSPP.
• Cash spreads performed on all segments on a weekly basis (Investment Grade -2 bps and High Yield -5 bps vs swaps rates). Cash outperformed synthetic indices which remained rather flattish during the week.
• In the US, Q3 earnings are starting on a positive note with more than 75% of companies beating estimates on both top and bottom line growth.

FOREX

Both EUR and USD had a positive week and outperformed all other currencies.

• In Europe, the political risk in Spain faded slightly as the Catalan government did not make a formal declaration of independence and in the US, expectations of a tax reform boosted the outlook for the USD.
• The worst performers in the major currencies universe were the JPY and the NZD.
• Coming elections in Japan and a higher yields environment made the JPY weaker and in New Zealand, local currency depreciated by more than 2.5% due to a coalition agreement between the Labour Party and New Zealand First. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES