Coffee Break 1/23/2017

Over the past week, investors got some clarification regarding current political risks. As expected, Theresa May confirmed a “Brexit” with no compromise on a “half-in”, “half-out” solution. The Parliament will have to vote on the final deal, once agreed between the UK and the European Union. Her speech offered some relief, triggering a limited market reaction and a GBP rebound. We have maintained our underweight in UK equities at this stage as the uncertainties surrounding the conditions of the “Brexit” and its impact on the economy are nowhere near resolved.
Moreover, Donald Trump unveiled his vision of his presidency during his inauguration speech as the 45th President of the United States. He plans to revise trade deals as well as renegotiate the NAFTA agreement. He also have plans on immigration and border security. Donald Trump also reaffirmed his commitment to dismantle the health reform law by signing an executive order on "Obamacare".

This week, the UK Supreme Court will hand down its “Brexit” judgment on 24 January.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We maintain an overweight in equities versus bonds:

• The macro news flow is still well-oriented as shown by various sentiment surveys and supported by a strongly positive market sentiment both in US and Europe. Investors’ positioning is shifting from bonds to equities according to the Merrill Lynch Fund Manager Survey.
• Central banks are decoupling but they mostly keep a dovish stance:
  • ECB President Mario Draghi maintained a dovish tone during his press conference held on Thursday and reiterated the option of stepping up the quantitative easing strategy if financial conditions tightened or the outlook worsened.
  • 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.
• 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. The upcoming Q4 earnings season will give important information.
• 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.
• Important political risks nevertheless remain: upcoming elections in Europe (The Netherlands, France and Germany) and “Brexit” negotiations. The unpredictability of the new US president could lead to up or downside risks, as demonstrated by the recent impact of Donald Trump’s remarks on the healthcare sector and on the US dollar. The US policy mix could lead to misallocation of resources or an interest rate shock.

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 slight 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. Furthermore, the recent depreciation of the euro is in favour of exports and overall GDP growth, while pushing inflation somewhat higher. The Q4 2016 consensus earnings growth estimates are in line with the end of earnings recession expected in the US and Europe.
  • We still have a relative value strategy in favour of the DAX against the FTSE 250.
• We have maintained our underweight in UK equities. A deterioration in domestic UK macro indicators should hit the FTSE250 with significant domestic exposure. We avoid domestically-oriented small and mid-caps and still have a relative value strategy long FTSE 100 against a short FTSE 250.
• We are slightly overweight on US equities. Markets are anticipating a stronger growth and a higher inflation. This has pushed rates and USD higher and led to a tightening in financial conditions. Furthermore, the Q4 2016 earnings season has started with positive surprises for US financials.
• We are positive on Japan. The country benefits from an aggressive domestic policy mix, stronger US growth and a weaker currency.
• We have maintained a neutral positioning in emerging markets.

BOND STRATEGY

• We have maintained a significant underweight in duration.
• We continue to diversify out of low/negative yielding government bonds:
  • We have maintained an overall below-benchmark duration as we expect stronger inflation figures and US fiscal policy easing to push bond yields higher.
  • We have maintained our relative value trade, long Italian yields / short Spanish yields, as Italian rates continue to tighten as too much pessimism was priced in.
  • We remain positive on inflation-linked bonds. Inflation expectations have reached new highs since 2014 and should keep growing, supported by oil price increases, wage growth, possible fiscal easing and protectionism measures.
  • 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, initial jobless claims declined by 15,000 and were down to 1970s levels at 234,000 for the week ending on 14 January.
• The US Consumer Price index increased by 2.1% YoY in December, led by rising costs of gas, housing and medical care.
• The US industrial production rose by 0.8% in December, the fastest pace in more than two years,
• In Germany, the economic sentiment index rose to 16.6 in January from 13.8 the previous month. 

EUROPE

European Equity markets ended the week lower.

• Volumes remained low, investors seem to become more defensive, going to precious metals.
• The "Brexit" issue continues to generate uncertainties as the Prime Minister Theresa May announced that the final deal could be submitted to a vote in Parliament. As a consequence, the GBP was again volatile.
• The best sectors last week were Basic Resources, HPC and Chemicals while the worst ones were Healthcare, Real Estate and Insurance.

US

Low volume on US Equities due to the wait-and-see mode before the inauguration of Donald Trump on Friday.

• Several stocks and sectors that have done well since the US Presidential elections underperformed, while sectors that have lagged did better.
• Financial stocks, which have benefited from hopes of deregulation, pulled back as investors appeared to doubt whether Donal Trump would response to his promises.
• Defensive stocks, like Consumer Staples and Utilities, have had a good performance.
• Several major companies reported good earnings, but it did not help.

EMERGING MARKETS

Slightly negative week for Emerging Markets stocks.

• The tough talk from Donald Trump's inauguration speech has set the stage for a showdown on everything from security to trade.
• The MXN sank to record low level after Trump's commerce pick said renegotiating the NAFTA agreement would be a priority.
• India continued to show a recovery from the sharp fall post demonetisation with rising expectation of tax cuts and pro-growth policies in the coming budget.
• China confirmed its official 6.7% growth target was met in Q4 2016, but also stated that it relied more and more on stimulus and credit. The IMF warned about the risks of potential sharper slowdown. 

RATES

Generally speaking, markets were calm as investors were in a wait and see mode in search of some clarity on Donald Trump's fiscal stimulus and its trade policy.

• Theresa May's speech on "Brexit" confirmed the government's intention to leave the single market while restoring control of borders. This hard "Brexit" was well anticipated by markets which didn't over-react to the announcement.
• The ECB press conference underlined the commitment to maintain a very accommodative stance. Indeed, Mario Draghi stressed the lack in improvement in underlying inflation trends and confirmed that a tapering was not on the agenda. He also reminded that risks were still present for the European economy.
• 10Y US, UK, Japan and German yields stood respectively at 2.48%, 1.41%, 0.05% and 0.40%.

CREDIT

Limited M&A activity last week.

• Mario Draghi announced that the inflation target was far from being realised and the ECB would maintain its support for an extended period.
• The results of US banks were positive thanks to some fixed income trading activities.
• Limited M&A activity last week with the BAT/Reynolds, Safran/Zodiac and Essilor/Luxottica mega deals in the headlines. 

FOREX

GBP and CAD in the headlines last week.

• Higher GBP following Theresa May's speech on a clean and full "Brexit". Markets appreciated the fact that the Parliament would get to vote on the terms of the deal with the European Union.
• The CAD was the worst performer on dovish stance by the Bank of Canada and poor CPI data. 

COMMODITIES

Positive week for commodities with the GSCI Light Energy up by 1.3% (+2.1% YTD).

• Oil rose following news that OPEC and other nations were on their way to achieve the promised output cuts. Russian supply also dropped in January.
• Higher prices are likely to revive production in the US while Libya is also bringing back fields.
• Gold advanced (+0.5%) as investors hedged against the prospect of political and inflation risks during Donald Trump’s presidency and speculated that the United kingdom would leave Europe’s single market. Silver gained 1.5%. 

WEEKLY MARKET OVERVIEW



UPCOMING FACTS AND FIGURES