Over the past week, our conviction on higher bonds yields and a continuation of the equity market rise, has increased. There is a plenty of possible catalysts to end the months-long range bound market evolution. Beyond (geo)political events, this week’s FOMC is likely to shape the balance sheet management for the quarters to come, and provides a case study for Mario Draghi. Also, the recent easing in financial conditions, will certainly relieve the pressure on the Fed’s shoulders to pursue removing monetary accommodation. In addition, House speaker Paul Ryan announced that the tax plan outline backed by tax writing committees will be released on 25 September. Although execution risk remains, tentative movements towards a bipartisan approach in Washington could end-up prolonging the current expansion cycle further.
In this context, we are well positioned to benefit from the bond yield increase and equity market rebound, and we added further to our exposure to euro zone equities as our fundamental assessment and our technical indicators are sending converging signals.
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:
- The robustness of the global economic news flow is supportive. The outlook for the world economy appears solidly anchored above 3% for both this year and the next, while inflationary pressures remain subdued.
- The euro zone and Japan are expanding above potential.
- Emerging markets benefit from the bottoming-out of commodities, the USD weakness and the decline in inflationary pressures.
- In this context, we concentrate our portfolio’s regional positioning on the euro zone, Japan and the Emerging markets.
- Central bank are expected to adapt their monetary policies in the coming months:
- The Fed is poised to announce a balance sheet reduction this week.
- The ECB will likely announce its tapering in October.
- Overall, central banks are confident on the synchronised global growth context and are prudently adopting a tightening bias.
- Equities have an attractive relative valuation compared to credit.
- The main risks for equity markets remain political and mainly concern the US, where the risk of legislative delay in pro-growth policies has increased. Although the temporary agreement to lift the debt ceiling was a relief, expectations for more clarity on both domestic and international issues in the foreseeable future have fallen.
REGIONAL EQUITY STRATEGY
- We continue to favour euro zone equities, and further increase our exposure to the region based on technical indicators and the supportive fundamental backdrop. Q2 GDP data have confirmed the on-going, more robust and geographically broadening economic expansion and the ECB remains accommodative and corporate earnings keep their strong momentum.
- We remain negative on Europe ex-EMU, especially the UK. The deterioration in the “Brexit” negotiations, the difficulties to setup new trade relations (e.g. with Japan) and their impact on the economy pushes us to avoid the region. Relative valuation is rather expensive as earnings have dropped and a political risk premium should be priced.
- We keep our neutral stance on US equities. There is an execution risk in the announced fiscal stimulus and pro-growth policies.
- 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 BoJ will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY.
- Emerging market equities remain one of our main regional convictions. They benefit from attractive valuations in a robust global growth context. China should not trigger a systemic risk this year and recent data are overall supportive, leading the IMF to revise upward its medium term growth expectations (on average from 6 to 6.4% for the years 2017 to 2021).
- We are negative on bonds and have a low duration. We expect rates and bond yields to resume their uptrend from this month’s low, driven by a tightening Fed, and potential upcoming inflation pressures. The improvement in the European economy could also lead EMU yields higher.
- 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.
- On the currency side, we maintain a lower USD overweight exposure as the EUR/USD exchange rate broke key resistance levels.