Coffee Break 6/12/2017

Last week, investors focused on both the speech of ECB President Mario Draghi after its latest policy session and the outcome of the parliamentary election in the UK, in which British voters punished Theresa May for the snap election and denied her the stronger mandate she sought to conduct the “Brexit” talks with the European Union. In an immediate reaction, the GBP dropped to an eight-week low against the USD, as the start of the negotiations with the EU next week seems at risk.

Meanwhile Mario Draghi’s ECB remained highly accommodative, despite taking its very first little step towards exiting its massive stimulus by omitting the lower interest rate levels in its forward guidance.

Moreover, in France, Emmanuel Macron’s party is on track to win a majority of seats in the national assembly, leading well ahead of all opponents with more than 32% in Sunday’s first round of parliamentary elections. Despite the record-low turnout with less than 50% of participants, the newly elected president will be in a strong position to enact his pro-business agenda although nothing is certain until the second round on Sunday.

This week, we will closely follow the developments of the UK and France’s political situations and especially the Fed’s interest rate decision this Wednesday.

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 positive economic news flow has reversed in the US and economic surprises are negative. US equities are unimpressed, marking new record highs. The 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 dovishness to recede very gradually:
  • Mario Draghi’s ECB left its monetary policy unchanged, though stating that it “considers risks to the growth outlook as broadly balanced”. Even though, Mario Draghi denied that there was any discussion regarding an eventual tapering, the ECB has taken its very first little step towards exiting its massive stimulus by omitting the lower interest rate levels in its forward guidance. QE tapering should become a central theme after the summer.
  • The probability of a Fed hike in June is priced by markets, with probably another hike expected later this year. The next step in the Fed tightening will be through balance sheet reduction, timing and size are however uncertain.
  • Tightening in developed markets is at odds with monetary policy easing in emerging markets, including Brazil.
• 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 has switched from Europe to the US:
  • The Italian risk on the horizon looks manageable.
  • The “Brexit” risk has regained interest with Theresa May’s surprising defeat during the general elections.
  • The geopolitical tensions in Syria and North Korea can cause uncertainty
  • 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. An on-going, more robust and geographically broadening economic expansion, an accommodative central bank (for now) and a strong corporate earnings momentum underpin the attractiveness of the region’s risky assets. Furthermore, relative valuations are attractive and non-resident flows are picking up gradually.
• We maintain an underweight on Europe ex-EMU. 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. Donald Trump’s unpredictability adds to the uncertainties. Reflation trade positioning has reversed back to early-November levels. Deflation dynamics no longer at work but we see a gradual rise. We identified an execution risk (at least a delay into 2018) in the expected fiscal stimulus.
• 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. They benefit from attractive valuations in a robust global growth context. China should not trigger a systemic risk this year, but we keep an eye on the impact of regulatory tightening, which, has accelerated.

BOND STRATEGY

• We maintain our underweight on bonds and a short duration. With a hawkish Fed and continuing inflationary pressures, we expect rates and bond yields to maintain 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 to the second semester.
• 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 initial relative value strategy: long German Bund / short French OAT as a hedge against the European political risk ahead of the June elections.
  • We have a slight overweight in emerging market debt. Emerging market bonds benefit from strong fundamentals as risks in China and the commodity rout have declined, and the benefit from an attractive carry.
  • 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 held a lower underweight on GBP before the British elections. 

• In the US, the number of Americans filing for unemployment benefits dropped to 245.000, according to the Labor Department. Claims have now been below 300,000, a threshold associated with a healthy labour market, for 118 straight weeks, the longest such stretch since 1970.
• New orders for US manufactured goods in April declined by 0.2% after four consecutive monthly increases. New orders for durable goods slipped by 0.8%.
• In the euro zone, annualised Q1 growth was revised upwardly to 1.9 % from 1.7% compared to the first quarter of 2016.
• In addition, growth is set to continue, as the Markit PMI Composite came in at 56.8 in May, in line with expectations.

EUROPE

Slightly negative week for European equities.

• European equity markets opened higher on Friday following the UK’s general election, as the outcome may have improved prospects for a so-called soft “Brexit”.
• The FTSE 100 equity index rose by 1% to end just 20 points short of its record close, reflecting the potential benefit of the weakness of the GBP. The fall of the GBP was positive for UK exporters, but domestic shares plummeted.
• Basic resources stocks provided the biggest lift to European markets as copper prices rose, helped by supply concerns in Chile and recent data pointing to robust import demand from China.

US

Slightly negative week for US equities.

• Market dynamics changed abruptly last Friday as market-leading stocks such as Amazon, Facebook, and Apple sold off.
• The turnaround in the technology sector came after a research report from Goldman Sachs said that the huge increase for several stocks this year needed “a pause”.
• Trading activity was also light for much of the week, on the back of some notable domestic political developments (i.e. the Senate testimony of former FBI Director James Comey) and this failed to drive significant market moves.

EMERGING MARKETS

New two-year highs for emerging market equities.

• The decision by several Arab states to cut diplomatic ties with Qatar, accusing it of supporting terrorism, made markets uneasy.
• South Africa also had a difficult week after data showed on Tuesday that Africa’s most industrialised nation slipped into recession for the first time in eight years.
• But Asian market remained strong despite weaker Chinese factory gate prices.
• China was one of the best performing market thanks to a rising Alibaba (+13%).
• South Korea hit a fresh record high, taking gains this year to more than 17% as investors snapped up shares of technology and brokerage firms on expectations of stronger earnings. 

RATES

Peripheral spreads tightened against core bonds over the week.

• Italian Bond yields rallied the most after parliament rejected the electoral reform proposal reducing the probability of an early election this autumn.
• The ECB removed reference to lowering rates further and kept a dovish tone as Mario Draghi indicated that a tapering was not discussed.
• In the UK, Gilt remained stable despite the result of the general elections.
• In the US, Treasury bonds yields ticked higher while the testimony of the former FBI Director increased speculation about a possible Trump impeachment.
• 10Y US, UK, Japan and German yields stood at respectively 2.21%, 1.21%, 0.04% and 0.26%. 

CREDIT

Another resilient week for corporate credit indices.

• Peripheral subordinated debt was under pressure on the back of the resolution of Banco Popular. After the bail-on of its AT1 and Tier 2 issues, the bank was sold to Banco Santander for 1EUR.
• Decent primary market with a total of 13.7bn EUR issued with notably the five-transaction of AT&T and the launch of a corporate hybrid by Volkswagen.

FOREX

The dollar index continued to pull away from a seven-month low.

• The MXN consolidated its gains as interest in the currency picked up steam with economists updating forecasts to reflect a more positive outlook.
• Other outperformers were the AUD and the NZD thanks to the better outlook for these two antipodean economies as Australia released better than expected GDP figures.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES