Coffee Break 8/21/2017

The first half of August was marked by one spike of volatility but recovery has been rapid since then. North Korea has provided the catalyst for the sell-off in risky assets but in the absence of imminent military actions, markets have quickly recovered some of the losses. In the US, the risk of legislative delay in pro-growth policies has increased further as some Republican Congressmen distanced themselves from president Trump’s recent remarks. In our thinking, recent developments clearly show that politics and geopolitics are the biggest investment risks we are facing. As global growth appears solidly anchored above 3% while inflation remains subdued, corporate profit growth should be able to rise while the risk of an overshooting in bond yields has declined. Japan is a case in point. In annualised terms, economic growth in Japan is outpacing the US and the euro zone in Q2. At 2.1% YoY, growth is significantly above its potential rate (0.75%), supporting exiting deflation, an effort led by the BoJ and its on-going asset purchases. In addition to a strong economic backdrop – both on domestic and international fronts – leading to decent earnings growth, exposure to Japanese equities is not a crowded trade yet. The key risks for Japanese equities are PM Abe’s political trouble (he therefore reshuffled its cabinet aiming at increasing its approval ratings) and geopolitical risks which could result in a strengthening of the JPY.

This week, we will closely follow the central bankers’ meeting in Jackson Hole.

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 outlook for the world economy appears solidly anchored above 3% growth for this year and 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. Upcoming focus is likely to be on balance sheet management / reduction rather than on interest rates.
  • 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 and the collapse on healthcare reform in Congress reveal chaos surrounding the White House, further undermining Republicans’ image. A de-escalation of geopolitical tensions would be a welcome development. We see, however, 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 bank 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). We continue monitoring 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, consumer sentiment rose to a seven-month high in the first half of August as the Michigan consumer sentiment index rose to 97.6 from 93.4 the month before, exceeding expectations for a 94 reading.
• Industrial production increased by 0.2% in July, coming short of a 0.3% expected increase according to a Reuters poll.
• In the euro zone, economic growth continued to improve with a 0.6% QoQ growth. Compared to a year ago, the economy grew by 2.2%, slightly better than anticipated by the markets.
• Inflation remained stable at 1.3% in July, in line with the flash estimate. The reading was still below the ECB's target of just below 2% per year. 

EUROPE

European equities ended the week slightly higher.

• Reduced fears of conflict on the Korean peninsula contributed to broad risk-on moves at the start of the week. However, equities pulled back on Friday following the S&P selloff in the US and due to the terrorist attack in Barcelona.
• The FTSE MIB was the best performer as Italian GDP expanded by 0.4% during the second quarter, in line with expectations.
• The DAX also outperformed, helped by E.ON, Bayer and Linde.
• Spanish stocks, obviously, fell at the end of the week with airlines, hotels, and other tourism-related stocks supporting the brunt of losses.

US

Negative week for US equities.

• Stocks ended lower after a volatile week that often seemed dominated by concerns over domestic and global conflicts.
• Waning tensions with North Korea deserved much of the credit for the stock market’s strong start to the week.
• Falling oil prices led energy stocks to suffer the worst declines during the week, while the small utilities segment managed a modest gain.
• At the end of the week, the terrorist attack in Barcelona, Donald Trump’s response to the violence in Charlottesville and the dissolution of two CEO advisory councils weighed on most indexes.

EMERGING MARKETS

Positive week for Emerging market stocks.

• Malaysia reported that the economy grew by 5.8% in the second quarter, expanding at a faster pace than expected, due to domestic demand and robust exports.
• Brazil seesawed as credit ratings agency Standard Poor’s spared the country from a downgrade after the government loosened budget targets for years to come.
• Argentina rallied after President Mauricio Macri’s Cambiemos coalition did better than expected in last Sunday’s primary election. 

RATES

Government bonds rallied over the week amid the resurging political tension.

• Against this backdrop, peripheral spreads widened while core curves flattened, especially in the front end.
• In the US, inflation figures were muted, with core CPI modestly up by 0.1% MoM (vs. 0.2% expected).
• 10Y US, UK, Japan and German yields stood at respectively 2.22%, 1.10%, 0.05% and 0.42%. 

CREDIT

Risk-off mode last week in a context of very low liquidity and geopolitical turmoil.

• The pressure was more important on Cash than on Synthetic indexes, and more specifically on financials.
• Spreads widened by 5bp for the Investment Grade segment, by 47 bps for Cocos and by 30 bps for Sub-insurance. 

FOREX

The geopolitical tensions boosted safe haven currencies.

• The JPY and CHF got stronger and outperformed all the major currencies.
• On the opposite, the KRW weakened by almost 2%.
• The NZD had a tough week due to the central banker’s comments on strong currency and the negative impact on inflation expectation.

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES