While French politics remain centre stage at least until the first round of the presidential elections next Sunday, geopolitical developments and US military manoeuvres in Syria and North Korea have further added to markets uncertainties. Volatility indexes have risen from historically low levels to their highest levels registered since the aftermath of the US presidential elections last autumn. At the same time, the USD has fallen below 110 JPY, also a level not seen since mid-November. These are good reasons to slightly reduce the equity overweight, though maintaining a positive stance on them.
From a regional perspective, we are overweight on euro zone and emerging market equities. Clearly, we expect the French elections to become a catalyst for renewed outperformance of euro zone equities. But recent polls have injected some uncertainties in the run-up to the elections, compared to the previous weeks.
Regarding bonds, we remain confident that longer-term US bond yields will be higher in the coming months, despite the recent long-term yield set-back. We expect the global economic expansion to continue and a limited rise in core inflation by fiscal easing, higher wages, less deflationary pressure in China and the prospect of protectionist measures.
In the coming weeks, we will closely monitor the first round of the French presidential elections as well as both ECB and BoJ meetings on April 27th.
Our current investment strategy on traditional funds:
grey : no change
blue : change
EQUITIES VERSUS BONDS
We are overweight in equities versus bonds:
- The US cyclical expansion, the economic recovery in Europe, the global inflation momentum and a soft landing in China are all supportive for equities in a rising rates context. Both growth and inflation data have surprised on the upside, leading to higher nominal growth, which is ultimately supportive for corporate profits.
- Central banks’ actions are decoupling but their tone has turned less dovish:
- The ECB has started the new downsized stimulus programme until December 2017, standing ready to increase the programme in terms of size and/or duration “if the outlook becomes less favourable or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation”.
- After the Fed interest rate hike in March, two additional moves are expected this year by the central bank.
- Equities have an attractive relative valuation compared to credit, and their expected return should be boosted by the end of the earnings recession in the US and Europe.
- Oil markets continue their rebalancing. However, while OPEC members are bringing back oil production to more durable levels, US rigs have been re-opening, implying a greater production.
- Political events keep uncertainty levels high. The geopolitical tensions in Syria and North Korea, the US house’s failure to approve the healthcare reform, the UK officially triggering Art.50 of the Lisbon treaty and the first round of the French presidential elections, are all implying high dispersion of possible outcome. The political risk premium still weighs on European equities.
REGIONAL EQUITY STRATEGY
- We have maintained our overweight on euro zone equities. A more robust and geographically broadening economic expansion, as witnessed by the most recent PMI indicators, an accommodative central bank and a high valuation discount linked to political uncertainties underpin the attractiveness of the region’s risky assets.
- In the UK, with the official notification that the country would leave the European Union, we maintain an underweight position on equities. The uncertainties of the “Brexit” conditions and their impact on the economy lead us to avoid domestically-oriented small and mid-caps.
- We have taken partial profit on our overweight stance in US equities, bringing back our global positioning to neutral. US stock markets have benefitted from post-election optimism among consumers and businesses, but activity has yet to follow sentiment. The expected fiscal stimulus should support the earnings outlook further, but slippage in the expected timing represents a risk.
- We have a neutral view on Japanese equities. Stronger US growth and a supportive domestic policy mix are among the main performance drivers, but a weaker currency is warranted to gain more conviction.
- We hold an overweight on emerging market equities with India as our preferred market.
- We maintain our underweight on bonds and keep a short duration. With a more hawkish Fed and increasing inflationary pressures, we expect interest rates to maintain their uptrend. The improvement in the European economy could also lead euro zone yields higher, barring political risks.
- We have a neutral view on credit, as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
- We continue to diversify out of low/negative yielding government bonds:
- We remain positive on inflation-linked bonds as we expect a rise in core inflation by fiscal easing, higher wages, less deflationary pressure in China and the prospect of protectionist measures.. Potential US protectionist measures are a wild card.
- We have a relative value strategy: long German Bund / short French OAT due to increasing uncertainties surrounding the French elections. We see the strategy as a hedge against the European political risk.
- We have a slight overweight in emerging market debt, both in local and in hard currency terms. The carry remains attractive and negative financial implications of the US presidential elections, due to a stronger USD, are receding.
- We are close to a neutral high yield exposure. The spread compression has exceeded our targets on both sides of the Atlantic.