Coffee Break 5/28/2018

INVESTMENT CONVICTIONS

• Core scenario
  • We expect an underlying favourable background and look for an entry point to increase risk exposure
  • Growth cycle may have peaked, but the growth momentum is expected to continue
  • Gradual rise in inflation in the US, but no inflation fear
  • US Fed monetary tightening is progressive, other central banks are in no hurry to tighten
• Market views
  • Global equities face temporary headwinds but solid earnings growth is a support for the asset class
  • Valuations have become less stretched after solid earnings reports
  • Credit is expensive, leaving little room for improving fundamentals going forward
  • US equities are supported by the tax reform, buybacks and still attractive valuation vs. bonds
• Risks
  • We note an increase in downside risks since the start of the year
  • The macro momentum is peaking, concerns about protectionism are intensifying, geopolitical risks have increased and US monetary tightening is making progress
  • An overshooting in the price of oil cannot be excluded after the US decision to back out of the Iran nuclear agreement
  • Moving towards a higher volatility regime would require a shock on growth and the fear of recession in one key region, or an unexpected acceleration in inflation

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are neutral on equities and keep a short duration

CROSS ASSET VIEWS AND PORTFOLIO POSITIONING

• We have kept our neutral exposure to equities, underlying fundamentals remain solid but new political uncertainties have come back to the forefront.
  • Global growth momentum outside the US is likely to have peaked but the growth momentum is expected to continue.
  • We are neutral on the euro zone. The region still displays a robust economic expansion and should rebound from Q1 soft patch, but uncertainties have risen recently (Italian coalition, potential trade conflict with the US, weaker activity indicators). The ECB remains accommodative, and is not in a hurry to become hawkish. Corporate earnings momentum has weakened and euro zone equities currently lack new catalysts, not only a weaker currency.
  • We are underweight Europe ex-EMU equities. The region has a lower expected earnings growth and thus lower expected returns than the continent, justifying our negative stance. “Brexit” negotiations remain a risk, while negotiations on new trade relations are stalling.
  • We have a neutral stance on US equities. We acknowledge the improving earnings growth and the positive impact of Donald Trump’s tax reform and deregulation. Nevertheless, the US trade policy is a major policy unknown as risks start to materialise.
  • We keep our neutral exposure to Japanese equities. An accommodative policy mix and an above-potential expansion remain good news for Japan. The recent currency weakness is a support for the stock market which remains highly correlated with the performance of the JPY. The leadership vote within the LDP party by September represents a risk for PM Abe.
  • We are neutral on emerging markets equities. Emerging equities benefit from the strong global growth. The region is nevertheless vulnerable in case of a global trade conflict. In addition, the high weighting of the tech sector (28%), rising bond yields and USD strength are adding volatility.
• We are underweight bonds and keep a short duration
  • We expect a gradual rise in inflation, but no inflation fear.
  • Global monetary tightening is progressive. Outside of the US, other developed markets central banks are in no hurry to tighten.
  • With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to continue their uptrend, albeit at a slower pace than in recent weeks. In addition to rising producer prices, rising wages, fiscal stimulus and trade tariffs could push inflation higher.
  • The overall improvement in the European economy could also lead EMU yields higher over the medium term. The ECB remains dovish in its Quantitative Easing plans and is opposed to a strong EUR. However, Italian political uncertainties have resulted in widening spreads and put core yields under downward pressure.
  • We have a neutral view on credit as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
  • The emerging market debt faces headwinds with a strengthening USD and rising Treasury yields. But we believe spreads can tighten from current levels. The carry is among the highest in the fixed income universe. It is an attractive diversification vs other asset classes.