Coffee Break 7/3/2017

Last week, investors positively reacted to the Italian government’s decision, initially approved by the European commission, to rescue two small regional banks for up to $17 billion euros. The Single Resolution Board judged that Veneto Banca and BP Vicenza were not systematically important, sidestepping the Bank Recovery and Resolution Directive. Undoubtedly, a fresh political wind in Europe is changing the established landscape and has helped swiftly resolve this Italian issue. Whereas Italy’s structural problems in the banking sector are well known, there is now a political will among various authorities to move forward and lengthen the (investment) horizon. In addition, the ECB looks ready to introduce a very gradual tapering, hence supporting Italian public debt for the foreseeable future and, last but not least, the European economic cycle is supportive and the upward revisions for Italy’s GDP growth easily absorb the expenses linked to this state intervention.

Meanwhile, in the UK, the DUP agreed to support Theresa May’s government on all Brexit and security legislation in exchange for an extra £1 billion spent for Northern Ireland over the next two years.

In the coming weeks, we will continue to monitor political developments from both sides of the Atlantic and central banks’ talks and meetings as last week’s speeches from Janet Yellen, Mario Draghi and Marc Carney surprised by perceived hawkishness.

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. The economic news flow is less supportive in the US and we lack a catalyst or a market setback to become more constructive. The European recovery is well on track and should lead to above-potential growth in 2017-18, leading us to raise earnings expectations. We think that the euro zone and emerging economies are best placed to leverage on these dynamics.
• Central banks’ tone remains dovish, but policies diverge:
  • Following the June Fed hike, we expect another hike later this year (which is not priced by the market). The next step in the Fed tightening process will be through balance sheet reduction, where timing is uncertain, but likely in the second half of this year.
  • The ECB adopted a dovish tone during its last meeting, as inflation still needs time to increase. Tapering should however become a central theme after the summer.
• 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.
• The main risks for equity markets remain political and have switched from Europe to the US:
  • Italian elections are unlikely to be held in 2017. The Italian risk
  • The UK elections outcome has led to more uncertainties on the tone of the “Brexit” negotiations.
  • The geopolitical tensions in Syria, North Korea and potentially Iran may cause uncertainty.
  • In the US, progress on healthcare reform in Congress could put the tax reform on the agenda, a welcome issue to improve the credibility of the Trump presidency. Slippage in the timing of the fiscal stimulus nevertheless continues to be a source of uncertainty.

REGIONAL EQUITY STRATEGY

• We remain positive on euro zone equities. The on-going, more robust and geographically broadening economic expansion, an accommodative central bank and a strong corporate earnings momentum underpin the attractiveness of the region’s risky assets. Furthermore, relative valuations are attractive and non-resident flows should continue to pick up.
• We maintain an underweight on Europe ex-EMU, especially the UK. The uncertainties surrounding the UK’s political situation, the “Brexit” negotiations and the impact on the economy lead us to avoid the region.
• 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. Negative surprises are approaching extreme levels. We identify an execution risk in the expected fiscal stimulus and will follow upcoming updates from lawmakers. Progress on healthcare reform would be a first step in regaining confidence.
• We remain neutral on Japanese equities and decided to maintain our neutral stance. The Japanese economy is supported by favourable conditions, such as a supportive policy mix, solid domestic consumption, a tight labour market and an improving earnings growth. Valuation is also not expensive, but the technical short-term upside looks limited. Furthermore, the JPY-evolution will remain an important market driver, in particular for non-resident flows.
• We maintain an overweight on emerging market equities. They benefit from attractive valuations in a robust global growth context. China should not trigger a systemic risk this year and most recent data (foreign reserves, retail sales, industrial production, loans) are rather supportive.

BOND STRATEGY

• We maintain our underweight on bonds and a short duration. With a relatively hawkish Fed and labour market conditions in place to increase inflationary pressures, we expect rates and bond yields to resume their uptrend. The improvement in the European economy could also lead euro zone yields higher as political risks recede and the ECB should start detailing its tapering in the second half.
• 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 have a diversification in inflation-linked bonds. Although expected and observed inflation have decreased, we believe it is mainly due to oil price evolution, which should stabilise.
  • We have a slight overweight in emerging market debt as it benefits from strong fundamentals and an attractive carry. Contagion from Brazil 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 have increased our NOK exposure, as we expect the oil price decline to come to an end. We remain cautious on the GBP in the light of the on-going “Brexit” negotiations.

• In the US, the economy slowed less sharply than expected in the first quarter than initially estimated. Q1 GDP increased at a 1.4% rate instead of a 1.2% pace reported last month.
• Separately, the Michigan Consumer Sentiment index fell less than initially feared to 95.1 in June, from 97.1 the previous month. It was the lowest level since Donald Trump’s election.
• In the Eurozone, the year-on-year flash inflation rate fell for the second straight month in June to 1.3%, from 1.4% in May but was better than the consensus estimate of 1.2%. The figure reached its lowest level since December 2016, dragged down by lower energy prices.
• In Germany, the Ifo Business Climate index rose more than expected to 115.1 in June from 114.6 in May, hitting an all-time high. Companies are significantly more satisfied with their current business situation and also expect business to improve, indicating the strong momentum of the Eurozone’s biggest economy.

EUROPE

Markets went down almost everywhere in Europe, underperforming other regions, after a good first semester. The Eurostoxx lost 2,87% over the week, the Dax lost 3,21% and CAC 40 lost 2,76%.

• The week was rather volatile, and was the worst one year-to-date. More hawkish ECB comments made investors take some profit on European equities at the second half of the week.
• Economic sentiment in the Euro area remains nevertheless strong and should support the markets in the coming weeks.
• Banks stabilised on Friday, after a four-day rise, boosted by the yield curve steepening.
• Automotives and Chemicals suffered from the rise of the Euro against the Dollar.

US

US markets ended mixed after a volatile week and unusually high trading volumes, and seem to search their way after a great first semester. The S&P closed the week slightly negative.

• Some economic indicators are showing mixed signs. Investors are starting to become nervous about the economy’s ability to withstand a tightening cycle.
• Technology stocks have been under pressure during the week, after news that the European Union was fining Google parent Alphabet $2.7 billion for antitrust violations.
• Banks were boosted by the prospect for higher rates and almost compensated the drop technology stocks in the benchmarks.

EMERGING MARKETS

Emerging markets equities remained on track for a weekly gain as the dollar fell to a near nine-month low.

• Gains were nevertheless capped due to weak (preliminary) U.S. durable goods orders, raising concerns about tepid growth and slowing inflation.
• Chinese mainland stocks rose to an 18-month high, as industrial earnings surged by almost 17% year-on-year in May.
• The Brazilian market showed its strength, as the oil price rebounded.
• The diplomatic crisis between Qatar and its Arab neighbours rumbled on, with Bahrain accusing Qatar of military escalation. 

RATES

Draghi’s speech at the ECB central bank forum on Tuesday set the debate, about possible changes in monetary policy in 2018, back to the forefront.

• The speech was seen as hawkish while at the same time economic data remain strong, beating expectations (IFO, PMI,…).
• Key to monitor for the ECB will be the evolution in inflation and the dynamics of the Euro.
• In this context Euro sovereign yields moved sharply higher while curve steepened.
• 10Y US, UK, Japan and German yields now stand at respectively 2.30%, 1.25%, 0.07% and 0.46%.

CREDIT

The week started on a positive tone following the rescue of failing Veneto Banca and Banca Popolare di Vicenza which will be acquired by Intesa.

• Senior debtholders have not been hit by the liquidation but the deal wiped out the subordinated bonds of both Veneto banks.
• US banks have largely succeeded in the stress test. The outcome is supportive for WFC, as it was considered one of the most likely candidates to fail, but passed comfortably on both quantitative/ qualitative tests. The US stress test were supportive for spreads in general.
• Sharp increase in rates following Mario Draghi’s comments didn’t weigh on credit with IG spreads tightening during the week (-2bps for cash index).

FOREX

Except from the Mexican Peso and the Cseck Coruna, all currencies depreciate against the euro last week.

• The Draghi speech at the ECB Forum on Central Banking in Sintra was considered pretty hawkish by market participants as tapering discussions seem on the table. As a consequences the Euro rallied strongly and ended the week at 1.1426 against the dollar.

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES