The breakdown of the preliminary talks to build a coalition in Germany will not alter the fact that Equity markets are currently experimenting some volatility. This correction seems somewhat severe for European markets, as they registered a second straight weekly loss. Many reasons have been brought up to explain this correction. As we are nearing the end of the year, some managers appear to lock in this year’s positive performances and create outflows by selling.
More fundamentally, the US - and then the European - high yield bond markets have been ruffled last week following the discussions between the US Senate and the House of Representatives on the proposed tax reform that includes a limit on the available tax deduction for net interest expense to 30% of Ebit. Additionally, a series of disappointing earnings publications for many issuers with decently large capital structures have also hurt the high yield performances.
More generally, it is becoming clear that the House and the Senate have yet to find an acceptable compromise on the tax reform, leading to uncertainty until the issue is resolved. As a result, the USD has sharply depreciated against the EUR at the start of last week, impacting euro zone companies.
Finally, the oil price decrease, based on stronger US production, lower demand expectations by the International Energy Agency and doubts about the extension of oil output cuts at the coming OPEC meeting at the end of the month are adding to the reasons to take some profits.
Looking forward, and if the context does not change materially (i.e. a supportive growth / inflation combination with higher visibility on monetary policies), the current setback could represent an opportunity to buy back some euro zone equities. Clearly, disappointing news out of Germany over the week-end will have to be digested first.
Our current investment strategy on traditional funds:
grey : no change
blue : change
EQUITIES VERSUS BONDS
We are positive on equities and remain negative on bonds, maintaining a short duration:
- Global economic momentum is accelerating further with economic news-flows surprising on the upside, adding to the ongoing good earnings season. However, geopolitical risks remain an obstacle with increasingly tense relations between North Korea and the US as well as in the Middle East, between Saudi Arabia and Iran.
- We concentrate our portfolio’s regional positioning on the euro zone and Japan. Emerging markets could face some headwinds if the USD strengthens.
- Central bank divergence becomes more obvious:
- The Fed has started its balance sheet reduction and forecasts another rate hike in December.
- The ECB has announced that it will pursue its quantitative easing but cut the amount to EUR 30bn in January 2018. Asset purchases will continue for at least 9 months in 2018 and interest rates increases should not happen before the second semester of 2019.
- Equities have an attractive relative valuation compared to credit.
REGIONAL EQUITY STRATEGY
- We remain positive on euro zone equities which are supported by a strong economic and earnings momentum and relatively attractive valuations. The current context offers a good mix of growth and inflation, coupled with a high visibility on monetary policies by central banks. We nevertheless tactically increased the partial hedge on our euro zone equities exposure.
- We have kept a neutral tactical stance on emerging markets equities, as a result of the USD stabilisation and technical indicators.
- We remain negative on UK equities. Beyond the difficult “Brexit” negotiations, the shift in the BoE’s monetary policy stance has put a halt to the GBP depreciation, weakening the repatriation of overseas profits realised by UK corporates.
- We remain neutral on US equities. Doubt on the timing of the Trump tax reform and on a possible compromise between the House and the Senate, create uncertainty.
- We are positive on Japanese equities. A strengthening growth and a supportive domestic policy mix are among the main performance drivers and we have gained more conviction that the Bank of Japan will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY. Furthermore, Japanese earnings remain positive so far without depreciation of the JPY.
- We are negative on bonds and have a low duration. The improvement in the European economy could also lead EMU yields higher.
- With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to continue their uptrend from September’s low.
- 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 diversification to emerging market debt, as the on-going monetary easing represents an important support.
- We are more or less neutral on high yield. The correction on US high yield observed last week could be attributed to the on-going negotiations surrounding the Trump tax reform which could include a limitation on the deductibility of interest payments.