Coffee Break 2/6/2017

Over the past week, investors have closely monitored the Central Banks’ meetings.

• The Bank of Japan has upgraded its GDP outlook, but kept its rates and inflation forecasts unchanged.
• Although the Fed has mentioned improving consumer and business sentiment, it has kept interest rates unchanged. Furthermore, Janet Yellen gave no indication on the timing of the next interest rate hikes this year. However, the reinvestment of maturing bonds will likely be questioned in the coming quarters as Janet Yellen has started to address it. The USD has stopped appreciating and lost some ground against the EUR and JPY. Positioning remains high, but any hawkish words from the Fed would intensify the divergence of central bank policies.
• The Bank of England left its inflation forecasts unchanged, whilst raising its growth projections for 2017 to 2%. As an immediate reaction on Governor Carney’s warning on “Brexit”, the GBP tumbled sharply.

In this context with accelerating economic growth, increasing inflation and divergent central bank policies, we maintain our positive view on US, euro zone and Japanese equities, whilst keeping a low duration and an important exposure to inflation-linked bonds.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are overweight in equities versus bonds:

• The macro news flow is still well-oriented as shown by various sentiment and supported by a strongly positive market sentiment both in US and Europe.
• Central banks are decoupling but they mostly keep a dovish stance:
  • The ECB will keep a steady hand given political uncertainties as it decided to extend its quantitative easing at least until December 2017.
  • The Fed tightening cycle is at odds with accommodative policies in Japan, the euro zone and the UK. Markets are pricing two Fed hikes in 2017 and another two in 2018, below the median Fed projection.
• Equities have an attractive relative valuation compared to credit, and their expected return should be boosted by the end of earnings recession in the US and Europe.
• Oil markets continue their rebalancing after the last OPEC agreement. However, US rigs have been re-opening, implying a greater production which could likely weigh on oil prices. Moreover, the panoply of executive actions from Donald Trump on energy issues could also put some pressure on oil.
• Important political risks nevertheless remain: upcoming elections in Europe (The Netherlands, France and Germany) and “Brexit” negotiations. Moreover, the wide range of possible outcomes of the Donald Trump’s presidency accentuate the risk of policy errors. Misallocation of resources, potential protectionist measures or an interest rate shock would significantly tighten monetary and financial conditions, which would be detrimental to stock market performance.

REGIONAL EQUITY STRATEGY

The Merrill Lynch Fund Manager survey confirmed investors’ preferences for the US, Japan and more recently for the euro zone.

• We have maintained our overweight on euro zone equities, as we expect a gradual improvement from the high discount due to political uncertainties. Recent surveys point to some acceleration in activity. Moreover, Q4 earnings growth in Europe now prints at 11% YoY (around 10% of Stoxx 600 companies have reported earnings so far).
  • We took our profits and exited the relative value strategy in favour of the DAX against the FTSE250.
• We have maintained our underweight in UK equities. A deterioration in domestic UK macro indicators should hit the FTSE250 with significant domestic exposure.
• We are overweight on US equities. Sound consumer expenditures while consumer confidence hits a 13Y high, consolidating oil prices and a post-election stimulus should support an improving US earnings outlook. The earnings season is positive in the US with Q4 earnings growth at 5% YoY (around 35% of S&P 500 companies have already reported).
• We are positive on Japan. The country benefits from an aggressive domestic policy mix, stronger US growth and a weaker currency. Furthermore, the Bank of Japan has kept its stimulus unchanged on last Tuesday, leaving its target on 10Y Japanese government bond yields around zero and upwardly revised its growth forecasts to 1.4% for this current fiscal year, and to 1.5% for fiscal 2017.
• We have maintained a neutral positioning in emerging markets.

BOND STRATEGY

• We have maintained a significant duration underweight as we expect stronger inflation figures and US fiscal policy easing to push bond yields higher.
• We continue to diversify out of low/negative yielding government bonds:
  • We implemented a new relative value strategy: long German Bund / short French OAT due to increasing uncertainties surrounding the French election. We also see the strategy as a hedge against the European political risk.
  • We took profit on our relative value strategy: long Italian BTP / short Spanish bonds.
  • We remain positive on inflation-linked bonds.
  • We have a slight overweight in emerging market debt, both in local and in hard currency terms.
  • We are slightly positive on high yield, even as the significant spread tightening has reduced the potential, the carry remains attractive. 
    
    

• In the US, the job market added 227.000 jobs in January, more than the expected 175.000, and the largest gain in four months. Revisions to November and December showed the economy created 39,000 fewer jobs than previously reported.
• The ISM manufacturing index came in at 56, better than December’s downwardly revised 54.5 level and consensus for 55. This represents the 92nd consecutive month in expansionary territory.
• In the euro zone, the preliminary Q4 economic growth estimation came in slightly higher than expected. In the last quarter of the year, the economy grew at a 1.8% pace.
• Inflation is also on the rise in the region as the consumer prices index jumped by 1.8% YoY. The increase was nevertheless mainly due to energy prices, with inflation remaining at 0.9%. 

EUROPE

Slightly negative week for European equities with the Stoxx Europe 600 down by 0.63%

• Political news flows took again the floor with the French presidential candidate François Fillon being involved in a fake jobs scandal and “Brexit” talks speeding up.
• Some major European players issued disappointing earnings reports.
• European markets seem to track the current US caution.

US

Flat week for US markets with the S&P 500 ending the week up by 0.12%

• Health Care finally rallied after Donald Trump met several executives of the pharmaceutical sector.
• Apple issued a very positive earnings report and the stock went up by 6% on the news.
• The S&P gained almost nothing over the week as investors were more focused on the political environment than on the ongoing flow of Q4 earnings reports.

EMERGING MARKETS

Emerging Markets equities up by only 0.33% last week.

• South Korea exports rose at the fastest pace in nearly five years.
• Factory activity in Russia grew at the fastest rate in almost six years while Poland and Czech activity expanded at the fastest pace in one year.
• India continued its rally after confirming a return to growth in January, bouncing back from December’s contraction which was triggered by the government’s demonization plan.
• An unexpected Chinese interest rate raise on Friday hit emerging stocks already pushed down by weakness across Asia. 

RATES

Core sovereign markets delivered positive performances despite strong economic and inflation data out of Europe.

• Political risk however remains important in Europe while Friday's US employment data were mixed with lower than expected average hourly earnings data.
• Europe's inflation data point to further reflation with upward surprises in Spain and France. Headline came out at 1.8% YoY and should rise somewhat further in coming months but core inflation is likely to remain subdued.
• 10Y US, UK, Japan and German yields stood at respectively 2.43%,
  1.35%, 0.09% and 0.41%. 
  
  

CREDIT

Investment grade spread widened last week.

• Investment grade credit market were up by 3bps for cash and synthetic indices last week despite a sharp drop in primary issues (around EUR10bn).
• Political risks especially in France and Italy were under the spotlight and led to a slight spread widening in the banking sector (+2 bps for both senior and subordinated debts). 
  
  

FOREX

The USD has stopped appreciating and lost some ground against the EUR and JPY.

• The Trump Trade movement is running out of energy and geopolitical issues are weighting on the USD.
• In the same time, the MXN, which suffered from the Trump election, is now getting back on track. 
  
  

COMMODITIES

Positive week for commodities with the GSCI Light Energy up by 0.65% (+2.29% YTD).

• Energy prices rose and are at 3 week highs on a weaker USD and rising geopolitical tensions.
• Base metals were mixed on the LME, but opened sharply lower in Shanghai.
• Precious metals on the other hand were able to post gains, on haven flows given rising geopolitical risks.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES