Coffee Break 8/28/2017

Along with equity market volatility, volumes have fallen considerably in recent days. The global economic momentum appears well anchored, leading to consensus upward revisions, while inflationary pressures remain subdued. In our understanding, this could lead central banks to remain extremely prudent in adjusting their balance sheets, and –even more so- their key interest rate levels. Central bankers are well aware that markets fear a monetary policy error, which would provoke a tightening in financial conditions. In the context of elevated (geo)political risk premiums, not least in the US, central banks should avoid adding to uncertainties.
The annual gathering of central bankers in Jackson Hole, Wyoming has confirmed our view, as Janet Yellen did not warn about asset market excesses nor gave any suggestion that financial stability concerns would weigh on the future Fed policy path.

In the coming weeks, we will closely follow central banks’ meetings and political developments from both sides of the Atlantic.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We hold an overweight on equities and remain negative on bonds, maintaining a short duration:

• Global expansion dynamics are well underway. The growth outlook for the world economy appears solidly anchored above 3% for both this year and the next, while inflationary pressures remain subdued.
  • Most recent data confirmed that both the euro zone and Japan are expanding above potential while the US is exiting its soft patch experienced earlier this year.
  • Emerging markets benefit from tailwinds like stabilising commodity prices, a weakening in the USD and a decline in inflationary pressures, such as in Brazil, India and Russia.
  • In this context, we concentrate our portfolio’s regional positioning on euro zone, Japan and Emerging markets.
• Central bank dovishness to recede only gradually:
  • Most recent central bank accounts of their monetary policy meetings reveal unease facing the inflation conundrum. The meeting in Jackson Hole has confirmed that removing policy accommodation will be gradual.
  • ECB tapering announcements should occur after the summer, in line with economic robustness in the region – but the ECB will take into account the recent rise in the EUR exchange rate.
• Equities have an attractive relative valuation compared to credit.
• The main risks for equity markets remain political and have switched from Europe to the US:
  • The Italian risk on a medium-term horizon appears manageable and is already priced in by the markets.
  • The German elections should not materially alter the outlook for the continent.
  • In the UK, the “Brexit” negotiations are making little progress.
  • In the US, the risk of legislative delay in pro-growth policies has increased further. The mediatised drop in CEO backing, the collapse on healthcare reform in Congress and the escalating tensions between Donald Trump and his own party reveal chaos surrounding the White House, further undermining Republicans’ image. Furthermore, we see that expectations for more clarity on both domestic and international issues in the foreseeable future have fallen significantly.

REGIONAL EQUITY STRATEGY

• We remain positive on euro zone equities. Q2 GDP data confirmed the on-going, more robust and geographically broadening economic expansion. the accommodative and prudent central bank and the strong corporate earnings momentum underpin the attractiveness of the region’s risky assets. The recent increase of the EUR has been a headwind to EMU equities’ outperformance and confirm that the region is no longer subject to a major political risk premium.
• 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. Renewed weakness in the exchange rate might constitute a temporary support for earnings growth expectations.
• We keep our neutral stance on US equities. US stock markets have benefitted from post-election optimism among consumers and businesses but there is a considerable execution risk in the announced fiscal stimulus and pro-growth policies. Collapse on healthcare reform, Republicans distancing themselves from president Trump’s recent remarks and declines in CEO backing constitute warning signs.
• We hold an overweight exposure to Japanese equities. A strengthening global growth and a supportive domestic policy mix are among the main performance drivers and we have gained more conviction that the BoJ will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY.
• 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 recent data are rather supportive, leading the IMF to revise upward its medium term growth expectations (on average from 6.0 to 6.4% for the years 2017 to 2021). Furthermore, its relative economic and political stability, added to its long-term systematic approach, partly justifies our overweight stance on emerging markets. We continue to monitor the importance of IT/Tech, contributing more than 50% to H1 returns.

BOND STRATEGY

• We maintain our underweight on bonds and a short duration. We expect rates and bond yields to resume their uptrend over the medium-term, driven by a tightening Fed, and potential upcoming inflation pressures. We expect rising wages and potential stimulus to push inflation higher, although it takes longer than expected to materialise. Potential US protectionist measures are a wild card (NAFTA renegotiation, China).
• We continue to diversify out of low 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.
• We keep our overweight on emerging market debt, as the on-going monetary easing represents an important support.
• We are close to a neutral high yield exposure.
• On the currency side, we maintain a lower USD overweight exposure as the EUR/USD exchange rate broke key resistance levels. 

• In the US, durable goods orders posted the biggest drop since 2014, falling by 6.8% in July after a 6.4% increase in June. This preliminary figure was largely dragged down by a decline in the volatile category of civilian aircraft.
• Initial jobless claims increased less than expected (by 2,000) to a seasonally adjusted figure of 234,000, suggesting a further tightening in labour markets conditions.
• In the euro zone, the flash Composite PMI rose in August to 55.8 from 55.7 in July. Manufacturing activity grew at the fastest pace since April 2011 to 57.4, while services activity dipped to 54.9, the weakest reading in seven months.
• In Germany, the Ifo business climate index slightly edged down to 115.9 from 116 in July due to firms taking a slightly less positive assessment of the current business situation and the managers' business outlook for the next six months improved against the trend.

EUROPE

Flattish week for European equities.

• The FTSE 100 Index was the best performing country sector, thanks to the weakening GBP, which helps boost shares of multinational companies with earnings in other currencies.
• Strong earnings in Energy stocks and a rally in base metals helped mining companies.
• Automobiles was the second best performer helped by the positive return of FCA (Fiat Chrysler, +16%) following the news of a potential spin-off of the Maserati and Alfa Romeo brands.
• Media was the worst performer after the world’s largest advertising company, WPP, cut its full-year revenue forecast.

US

Positive week for US equities.

• US markets recorded gains for the week, mostly due to a solid rally on Tuesday.
• Trading volumes were light, however, with the lowest traded level for the year reached on Wednesday.
• Energy stocks rebounded from the previous week losses.
• Amazon’s announcement that it would lower prices at its recently acquired Whole Foods Market stores dragged Consumer staples down.
• Advertising stocks fell sharply after UK-based industry leader WPP lowered its growth forecasts.

EMERGING MARKETS

Emerging markets were boosted by solid gains in Poland and Brazil last week.

• Poland was up by 4.7% (2Y high) after the local consumer confidence index hit an all-time high in August.
• Brazil also touched a 6Y high as the government unveiled plans to privatize power utility company Centrais Eletricas Brasileiras. This spurred demand for state-run firms.
• The Hong Kong stock market (H-Shares) continued its positive momentum following improving fundamentals. Resilient Q2 results from energy, banks, and insurance companies boosted the local market. 

RATES

Positive macro-economic data from both sides of the Atlantic.

• European peripherals saw spreads widening, following Silvio Berlusconi’s (who earlier gained ground in local elections) talk about a parallel currency.
• Markets were poised for the Jackson Hole speeches, where some hints on the possibility of tapering of the ECB QE and reduction of the Fed Balance sheet were expected.
• President Trump’s threats regarding a possible shutdown of the US government are likely to add to political risk in the coming weeks.
• Developed government yields did not change much with 10Y US, UK, Japan and German yields have at respectively 2.18%, 1.05%, 0.07% and 0.38%. 

CREDIT

Expectations over central banks meeting in Jackson Hole drove markets last week.

• Cash spreads moved a little wider, with the Investment Grade index extending the bearish trend of the past three weeks (standing at 99 bps).
• Widening was also seen in Financials (+4 bps to 101) while Cocos were relatively limited (+12 bps to 376).
• The synthetic market on the other hand tightened over the course of the week (Itraxx Main down by 2 bps at 56 bps) and Itrax Xover narrowing by 7 bps to 242).
• Unlike the Italian sovereign CDS market, the synthetic market (both EUR Investment Grade and EUR High Yield) has not reacted to the deterioration in the political situation in Italy and hence a catch-up is possible (as Italian risk does not look attractive). 

FOREX

Strengthening EUR vs the USD.

• In spite of a small respite at the beginning of the week, the USD continued move lower vs. the EUR.
• The GBP also saw a sharp drop, to its lowest level vs. the EUR as a result of persisting uncertainties over the “Brexit” negotiations.
• Political uncertainties and geopolitical tensions resulted in the appreciation of the JPY, which continues to benefit from its safe haven status. 

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES