Liquidity will remain more than ever a KEY driver

Cross asset strategy

Even if the Fed’s challenge of a first rate hike could increase arbitrage between asset classes, the Bank of Japan and the European Central Bank continue to flood the financial markets with huge amounts of liquidity. In fact, on the one hand, after announcing its Quantitative Easing programme more than one month ago, the ECB has now officially started to buy EUR 60 billion of sovereign bonds and agency debt each month. On the other hand, investors anticipate an acceleration of Japanese QE by mid-year (currently JPY 80 trillion per year). The purpose of these combined actions, aiming at a price reflation, will continue to support equities, especially in a context of gradual global economic growth recovery.

Although equities have a less attractive absolute valuation, they remain more attractive than bonds.

On the valuation side, the recent equity market rally has made valuations less attractive. The MSCI World median PE ratio has increased to 16.66 (from 13.9 in October), meaning that equities have become less appealing than in previous weeks, particularly in the US. However, the attractiveness of equities remains important on a relative basis, with bond yields at all-time lows and the MSCI World dividend yield around 2.3%.

Earnings, too, continue to support equities: the solidity of the US’s last earnings season and the strongly improving momentum observed on European earnings are positive for equities. The expected earnings growth over the next 3 years (see chart 2) could also take equity markets to a higher level.

Valuation is far from excessive

From a valuation perspective, equities are still attractive, especially when compared to bonds, whose yields are still near their all-time lows. Consequently, the dividend yield from equities is, in many cases, more attractive than bond yields, giving even bond investors a fundamental reason to increase their equity exposure.

Positive medium-term scenario

After having performed well in recent months, equities could now face a more challenging short-term period, but our medium-term, cross-asset scenario of somewhat better growth, supportive global financial conditions and a moderate increase in interest rates remains intact, and is clearly favourable to risky assets.

 

REGIONAL EQUITY STRATEGY

Euro zone equities will continue to outperform

We continue to prefer euro zone equities to their US counterparts

There are still many arguments in favour of European equities:

• In the euro zone, equities are still more attractively valued than bonds. The current ECB actions are pushing European yields to all-time lows, with returns near zero or negative. In this context, even if the European stock markets have performed well (more than 15% since the beginning of the year), they still have a relatively attractive valuation.
• Euro zone equities are benefiting from better momentum. Earnings growth has been positive YoY since H2 2014 and should continue to deliver in 2015, while US earnings are being penalised by a strong USD and the energy sector.
• The euro and oil price depreciation will be favourable to euro zone equities.

Neutral on emerging markets

In terms of valuation, emerging market equities seem to be quite cheap (PE at 11.66, below the median); however, relative to their earnings growth, the cheapness is less obvious. Furthermore, emerging countries are not equal in the current economic situation. Not all of them are benefiting in the same way from the current drop in commodity prices and the increase of the USD. There is a lot of dispersion among the different emerging countries, sectors and individual stocks. As dispersion is here to stay, an active stock-picking strategy is the best way to play some of the emerging countries. We have a preference for Asian markets.

Positive on Japan

FIXED INCOME STRATEGY

We have maintained our overexposure to high yield and emerging debt

The combined actions of the ECB and BoJ have vindicated our choice to favour riskier, higher-yielding bonds. Investors will be very attentive to Janet Yellen’s upcoming announcements, as the Fed’s rate strategy will be key for the bond markets.

As high yield and emerging debt still offer the best carry-to-risk ratio (risk-return measure: yield-to-maturity divided by 1-year volatility,) we have maintained our overexposure to these asset classes.

COMMODITIES STRATEGY

Too early to be positive on commodities

Although probably much of the bad news on excess supply and lower global economic growth is already integrated, it is still too soon to become positive.

Oil: while oil prices seemed to have reached a bottom, the recent declaration of the Chinese government about China growth and the USD increase have put pressure on an oil price appreciation.

Base metals have also been affected by some bad Chinese economic data in the manufacturing sector. Nonetheless, the oversupply problem is going to be solved for some base metals such as copper, zinc and nickel, with supply deficits from 2016-2017. We consider it too early to invest in this asset class.

Finally, gold prices are negatively correlated with US real interest rates, which should increase in 2015.