Coffee Break 8/8/2016

Last Monday, oil prices have fallen below 40$/barrel, on the back of OPEC production at record highs. The increase in output has resulted in a 20% price decrease since last June when prices were above 50$. Besides production, oil inventories are very high. Those combinations reduce the demand for crude just as the peak driving season in the United States comes to a close and refiners prepare to shut facilities for their yearly maintenance. Speculations on crude oil futures are also a contributing factor. High Yield bonds, some Emerging markets currencies and the reflation theme will be impacted.

In Europe, the European Banking Authority and the ECB coordinated another stress test on banks. These assessments help to make sure that the banks are sufficiently capitalised and can weather potential financial shocks. Nonetheless bank shares across Europe dropped following the publication of the results. The worst performers were the Italian banks Banca Monte Dei Paschi di Siena and Unicredit. These banks drag non-performing loans since the 2008 crisis. Those loans weigh on the balance sheet, prevent banks from performing their standard duties and sap investors’ confidence. In short, they are growth detractors. Banca Monte Dei Paschi di Siena presented a plan to unload its bad loans and raise capital before the stress test results were known. Whether the plan to move the debt from their balance sheet to another entity’s is approved by the ECB remains to be seen.

In the US, nonfarm payroll were published and came in at 255K vs. a market expectation of 180K. The services, health care and financial sectors generated most of the job gains. Employment in mining is on a decreasing trend. Employment in other major sectors stayed stable.

Our current investment strategy:

Legend
grey : no change
blue : new change

EQUITIES VERSUS BONDS

Visibility has been reduced by the outcome of the EU referendum in the UK. A nimble approach in our investment scenario will be warranted in the coming months as "Brexit" raises more questions than gives answers. We are reassured by the hands-on approach by central banks. The ECB is according to Mario Draghi “ready, willing and able to act”. Meanwhile, the Fed left its rates unchanged at its last FOMC meeting. Following the Brexit and its initial consequences including a fall of the GBP and a weakened outlook for growth in the short and medium term, the BoE is introducing new fiscal and monetary measures, including:

• A 25 basis point cut in Bank rate to 0.25%,
• A new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate,
• The purchase of up to £10 billion of UK corporate bonds and
• An expansion of £60 billion of the asset purchase scheme for UK government bonds, taking the total stock of these asset purchases to £435 billion.

The last three elements will be financed by the issuance of central bank reserves.

Outside Europe,

• The macroeconomic news flow is in line with sluggish but positive growth.
• Stabilising macro indicators and commodity prices still above USD 40 have led to easing financial conditions compared to the start of the year.
• The PBoC is set to continue its easing policy at a later stage.
• Emerging markets remain historically cheap and have been resilient in the Brexit aftermath. A combination of improving fundamentals and a still dovish Fed has further improved the region’s attractiveness.
• Emerging markets are seeing investor inflows as "Brexit" has less impact on distant regions. In light of the latest economic news, we have increased our emerging markets exposure.

REGIONAL EQUITY STRATEGY

We have an underweight on equities mainly on European and UK ones.

• We have a neutral stance on US equities, as the US market is less impacted and thus more resilient in the current market environment.
• We have a slight overweight on emerging markets equities: the short-term evolution will depend on the evolution of the USD, a more dovish Fed and the global context. The solid momentum into H2 in China reassures us.
• We have a neutral view on Japan but implemented tactical derivative strategies to benefit from any upcoming announcement of fiscal and monetary policies.
• We are overweight Emerging Markets equities

BOND STRATEGY

• In the light of "Brexit" uncertainties, we had recently increased our duration, as investors are looking for safe havens and policymakers keep an accommodative stance.
• We continue to diversify out of low/negative yielding government bonds:
  • We are positive on credit. In the current context, we see more potential in credit than in equities.
  • We are positive on inflation-linked bonds. We view the subdued inflation expectations as a temporary phenomenon and expect wages and consumer price inflation data to rise gradually. This implies a re-rating of inflation-protected bonds over the course of the coming quarters.
  • Our constructive view on commodity prices is reflected in our exposure on emerging markets debt, both in local and in hard currency terms. 

• In the US, total nonfarm payrolls was published at 255K vs a market expectation of 180K.
• In the UK, the Bank of England cut bank rate to 0.25% and announces an additional monetary stimulus package.
• In the Euro zone, inflation rate YoY is negative at -0.1% vs. -0.2% forecasted.
• The final Markit Eurozone PMI Composite output index came in at 53.2, a 6-month high. Germany was the main contributor thanks to an accelerated rate of output expansion.

EUROPE

Flattish performance for European equities with the Stoxx 600 closing at 341 down by only 0.15% for the week.

• European equities ended the week slightly lower, despite a late-week rebound following the announcement of a large stimulus package by the Bank of England (BoE) and strong jobs figures in the USA.
• The Stoxx 600 and Germany’s DAX were both dragged lower early in the week, following weak earnings reports and poor economic sentiment. The DAX nonetheless finished the week slightly up.
• Peripheral euro zone’s outperformed as their banks continue to enjoy some short squeeze relief following a brutal sell off at the start of the week.
• UK equities enjoyed a positive week with the FTSE100 adding over 1% following the larger than expected BoE easing package.
• At a sector level, Basic resources, Insurance et Automobiles outperformed the benchmark (1.27%, 0.80% and 0.60% respectively) while Health Care (-0.91%), Telecoms (-1.02%) and Utilities (-1.65%) underperformed.

US

Positive performance for US equities with the S&P 500 closing at 2183 last Friday.

• The release of the latest Non farm payrolls figures boosted US stocks on Friday.
• The strong rally helped the Nasdaq Composite Index join the DJIA and the S&P 500 and S&P MidCap 400 Index to reach record territory.
• Falling oil prices weighted on energy stocks and overall sentiment. But the slight rebound mid-week helped stocks recover some of their momentum.
• At a sector level, IT, Financials and Industrials outperformed the S&P 500 (1.63%, 1.42% and 0.40% respectively) while Consumer Staples (-0.11%), Telecoms (-1.82%) and Utilities (-2.68%) were underperforming. 

EMERGING MARKETS

Emerging market stocks were on track for a fourth week of gains.

• Hungarian equities surged after Russia’s Vnesheconombank was said to be considering the sale of its Ukrainian unit to the largest lending in Hungary.
• Egyptian stocks rallied to their highest levels in more than a year as local funds increased their holdings to protect against a devaluation of the local currency, which is expected to be a condition of a loan agreement with the IMF.
• Chinese shares also advanced after the People’s Bank of China said Wednesday it would keep a prudent monetary policy in the second half of the year.
• At a sector level, Materials, IT and Financials outperformed the index (+2.24%, +2.05% and +1.96% respectively) while Energy (0.36%), Consumer Staples (0.23%) and Telecoms (0.02%) were all below the benchmark.

RATES

Core sovereign rates sold off over the week triggered by the BoJ and a strong US payroll.

• Japanese yields have pulled of record lows in the wake of the Bank of Japan meeting and increasing worries that monetary easing has reached its limits
• On Thursday, European rate rallied sharply following the Bank of England’s decision to cut rates, increase government bond and corporate purchases.
• The rally in US and euro zone yields proved short lived as NFP employment increased by a solid 255k (vs. 180k expected).
• Government bond rates experienced large swings climbing to -0.75%, 1.54% in Germany and the USA while rates in UK declined to 0.65%

CREDIT

Credit spreads did not move materially last week as the stress test results were not considered as a high market driver for the European banking sector.

• Investors focused on the more satisfying stress tests results for most of the European banking sector. Under the adverse scenario, the fully loaded CET1 of the 51 banks involved reached 9.2%. These results didn’t have a material impact on markets and will be used as an input for the Supervisory Review and Evaluation Process (SREP).
• Banca Monte dei Paschi di Siena announced a set of measures in order to offload its NPL portfolio through a transfer to a securisation vehicle.
• In addition, the Italian bank expects to launch a capital increase by the end of the year. This plan, which seems complex and risky, would avoid any state intervention or the bail-in of bondholders.
• The primary market was notably dynamic on financials: UBS issued an AT1 bond in USD (more than 5 times oversubscribed) while BNP Paribas launched a Tier 2 bullet in EUR in order to meet its TLAC requirements. 

FOREX

The GBP plunged after the BoE delivered a massive package to boost the economy.

•  The GBP vs USD dipped to 1.304 and the GBP could continue to depreciate further as the BoE sent an aggressive signal on future rate cuts.
• By contrast, the USD vs EUR rebounded to 0.904 after strong NFPs figures signalling that a rate hike could be on the horizon.
• Similarly, the JPY promptly appreciated versus the EUR and USD while the EUR vs SEK detracted to 9.48 from multi-year highs near 9.60.

COMMODITIES

Over the past week, commodities rebounded slightly, as the GSCI Light Energy rose by 0.4% and posted a positive return for the year (+1.6%).

• Both crude oil and Brent prices rose by 3.4% and 4.5% respectively, as the US Energy Information Administration reported an unexpected draw of 3.3 million barrels in gasoline inventories.
• Silver lost over 3% last week, after reaching a new two-year high last Tuesday amid a broad precious metals rally and as the USD stabilised after another sharp selloff.
• On the soft commodity side, sugar and cotton prices gained over 6% and 3.9% respectively last week amid weaker global supply.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES