Coffee Break 7/31/2017

Earnings season gained momentum last week with nearly one third of S&P 500 companies and half of Eurostoxx companies releasing their results. US figures have positively surprised so far with more than 70% of US companies beating their sales estimates, largely exceeding the historical average of around 50%. Therefore, US Q2 earnings growth is now expected to be around 7% YoY while sales growth should reach 5% YoY. However, we continue to closely monitor earnings publications as earnings misses are more severely sanctioned than before and could lead to forecast revisions.

The Fed kept its policy unchanged following the FOMC meeting last Wednesday. Despite some tweaks to inflation language, the central bank still expects inflation to stabilise around 2% over the medium term and should starts its balance sheet normalisation “soon”. As an immediate reaction, both USD and US yields lost some ground.

Currencies will nevertheless remain the key driver of equities’ relative performance over the short-term. We expect the current USD weakening trend to come to an end thanks to better US economic news flow, continuing central banks’ divergence and a potential easing in US political tensions. This induces us to maintain our overweight on euro zone equities in the prospect of a stronger USD.

In the coming weeks, we will closely follow central banks’ communication, as well as political developments in the UK and the US.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

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

• Global expansion dynamics are well underway.
  • Most recent data, including the July Bank Lending Survey confirmed that the European recovery is well on track and is leading to above-trend growth in 2017-18. This has led us to increase our profit earnings expectations for euro zone equities.
  • The economic news flow is starting to become more supportive in the US, while emerging markets are benefiting from a good economic momentum.
  • In this context, we concentrate our portfolio’s regional positioning on euro zone, Japan and Emerging markets.
• Central bank dovishness to recede gradually:
  • The Fed kept its rates unchanged following last Wednesday’s FOMC meeting and should begin its balance sheet normalisation “relatively soon” as long as the economy evolves broadly as anticipated. The balanced sheet reduction is likely to begin in September. The symposium in Jackson Hole in August should give more clarity.
  • The ECB left its accommodative monetary policy unchanged following its latest meeting, and talks on reducing quantitative easing should start this fall. Nevertheless, 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:
  • Italian elections are unlikely to be held in 2017. The Italian risk on a medium-term horizon appears manageable and is already priced in by the markets.
  • In the UK, the “Brexit” negotiations are making little progress.
  • Protectionism fears have decreased, but have not completely disappeared. The geopolitical tensions in Syria, North Korea and potentially Iran may cause uncertainties.
  • In the US, after the collapse of the healthcare reform, the 2018 budget and the tax reform will be key for the credibility of Donald Trump’s presidency. Slippage in the timing of the fiscal stimulus continues to be a source of uncertainty.

REGIONAL EQUITY STRATEGY

• We remain positive on euro zone equities. 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. We are still positive on Italian equities, especially as they remain relatively immune to the EUR appreciation. We also keep our exposure to banks. The sharp decline in the political risk premium and recent bank rescues are restoring confidence. European equities continue to see inflows as shown by the latest BofAML Fund Manager Survey.
• 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.
• We keep our neutral stance on US equities. The US soft patch could now be behind us. Economic surprises have started to recover from extreme negative levels. We however continue to identify an execution risk in the expected fiscal stimulus and will follow upcoming updates from lawmakers.
• We hold an overweight exposure to Japanese equities. A strengthening global growth and a supportive domestic policy mix are among the main performance drivers. Furthermore, the BoJ confirmed its highly accommodative monetary policy leading to a weaker JPY. However, we remain vigilant as Abe’s approval rating is decreasing and a reshuffle of its government is foreseen in early August.
• We maintain an overweight on emerging market equities. They benefit from attractive valuations in a robust global growth context. Fed balance sheet adjustments could create more uncertainties on Emerging markets, but global cycle and accommodative domestic monetary policies should support them.

BOND STRATEGY

• We maintain our underweight on bonds and a short duration. EU and US sovereign yields have increased and should continue their uptrend, 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.
• 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: we have revised our spread targets downwards, the duration effect is less negative and the carry remains attractive.
  • On the currency side, we maintain our positive stance on our NOK exposure, as the current level of oil prices remains supportive. We remain cautious on the GBP in the light of the on-going “Brexit” negotiations.

• In the US, orders for durable goods climbed by 6.5% in June, reversing two straight monthly drops. This increase was the biggest since July 2014 and was pulled up by a surge in orders for civilian aircraft.
• The Michigan Consumer Sentiment index fell to 93.4 in July, up from a preliminary reading of 93.1 but below June’s 95.1. Less enthusiasm over the U.S. economy and personal finances sent consumer sentiment to a nine-month low.
• In the euro zone, the Markit preliminary Eurozone Composite PMI fell to 55.8 in July, down from 56.3 in June. Despite coming off recent highs, the index signalled one of the strongest expansions seen over the past six years.
• In Germany, the Ifo business climate index reached a record high since Germany’s reunification at 116 in July up from 115.2 in June and above consensus estimate of 114.9. Improvement was recorded in all sectors beside retail. 

EUROPE

Corporate earnings weighted on European indexes last week.

• Telecommunication companies and utilities led the markets higher midweek.
• But investors were disappointed that Q2 earnings results fared poorly compared with figures published over the last few quarters.
• By the end of the week, basic resources, banks and oil & gas were the best performing sectors. On the contrary healthcare, automobiles and HPC dragged indexes’ performance lower.
• The FTSE 100 also underperformed and was dragged down by the poor performance of GSK and Astrazeneca (-14% due to a setback on its next generation of cancer therapy).

US

US equities modestly lower for the week.

• Major benchmarks were boosted by the rebound of energy stocks, as oil prices advanced following the promise of production cutbacks by Saudi Arabia.
• Real estate-related shares performed well and Health care stocks fared poorly, weighed down by persisting uncertainties over the sector regulation.
• Last week’s economic data were mixed and had minimal impact on stock prices.

EMERGING MARKETS

Emerging equities were hit by the technology selloff.

• Wall Street’s drop in technology and transportation shares filtered throughout Asia, pushing down South Korean, Taiwanese, Hong Kong and Indian stocks.
• Pakistan shares slid as a top court ordered Prime Minister Nawaz Sharif be removed from office after a corruption investigation.
• Russian shares were down last week following the new economic sanctions ordered by the US Senate

RATES

European Government bonds yields rose last week following strong economic data.

• Peripherals spreads widened marginally while on the cash curve, 2Y–10Y European Bonds steepened by 10bp.
• In the primary market, Greece tapped markets with 5-year bond (EUR3bn) for the first time since 2014.
• In the US, treasuries yields grinded higher despite mixed data (softer Q2 GDP) while the FOMC statement hinted at a balance sheet reduction “relatively soon”.
• 10Y US, UK, Japan and German yields stood at respectively 2.32%, 1.23%, 0.07% and 0.56%. 

CREDIT

Strong results for the Q2 earnings season.

• In the oil & gas sector, Repsol hybrids performed well following good results and an upgrade to BBB by S&P is more than likely.
• French and Italian Tier 2 outperformed due to the decree approved by Italian senate to save Venetian Banks.
• Due to the holiday period, we saw low volumes on the primary markets. 

FOREX

Rallying EUR.

• Last week saw a rebound of the EUR and this was particularly noticeable with the SNB's ever-dovish stance on the currency and the Swiss economic stagnation versus the euro area's improved economic outlook.
• Better than expected GDP in Sweden boosted the SEK and the currency is performing well vs the EUR on a year-to-date basis. 

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES