Coffee Break 02.10.2017

Last week saw the re-election of Angela Merkel as German chancellor for a 4th term. The political landscape has changed though and her authority will be diminished as the CDU and SPD suffered their worst post-war results losing respectively 8.6% and 5.2% since the last elections, 4 years ago.
The chancellor will have to form a new coalition with the centre-right liberals, FDP, and the Greens and navigate through uncharted water. The elections also saw the surge of the populist right party, AfD, which resulted in 94 Bundestag seats (out of 709).

Political risk has switched from Europe to the US as the German elections should not alter the global outlook on the old continent.

In the US, Donald Trump and Republican leaders have published a framework to amend the tax code. It is now up to the tax-writing committees in both the House and the Senate to settle some of the divisive issues while avoiding another failure similar to the repeal of Obamacare. Tax rate for top-earners and how to limit corporate interest deductions are two of the issues. In addition to these fiscal uncertainties, the government is about to reshuffle the Board of Governors of the Federal Reserve.

This week, we will keep an eye on the US economy as both the non-farm payrolls and the confidence index on corporates (ISM) figures will be published.

Our current investment strategy on traditional funds:

Legend
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.
  • We concentrate our portfolio’s regional positioning on the euro zone, Japan and the Emerging markets. While we are still positive on Japan, we suspect that Emerging Markets could face some headwinds given the strengthening of the USD.
• Central bank are expected to adapt their monetary policies in the coming months:
  • The Fed will start its balance sheet reduction in October.
  • 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. Q2 GDP data have confirmed the on-going, more robust and geographically broadening economic expansion while the ECB remains accommodative and corporate earnings keep their strong momentum. The pause in the recent increase of the EUR acts as a support after a more challenging summer for EMU equities.
• As a result of the strengthening USD and technical indicators, we are reducing our exposure to Emerging markets equities down to “neutral”.
• As we are gearing towards a soft “Brexit”, we are adopting a neutral view on GBP.
• We keep our neutral stance on US equities. There is an execution risk in the announced fiscal stimulus and pro-growth policies. Nevertheless, we note that there are timid movements towards a bi-partisan approach in Washington.
• 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. Despite the coming elections, political risk should be limited.

BOND STRATEGY

• 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 exposure as the EUR/USD exchange rate broke key resistance levels. 

• During Q2 2017, the US economy expanded at an annualised 3.1% QoQ whereas market expectations were at 3%. It is the strongest growth rate since Q1 2015
• In September, the University of Michigan's consumer sentiment for the US came out at 95.1 down from 96.8 and despite a forecast at 95.3. The outlook on the national economy was downgraded following the recent hurricanes in the region.
• In the euro zone, several economic data are coming out stronger than expected for the previous month: business confidence at 1.34 up from 1.08; industrial sentiment at 6.6 up from 5; services sentiment at 15.3 up from 15.1 and economic sentiment at 113 up from 111.9. 

EUROPE

Strong week for European equities.

• Higher US bond yields and steepening curves boosted insurance and banking stocks and weighed on utilities and healthcare.
• Basic resources were down due to falling commodity prices, especially Iron ore (-4%).
• Chemicals was the best sector led by Linde (+6%) following the merger with Praxair.
• The DAX was the best performer due to the lower EUR while the IBEX underperformed on rising concerns over this weekend’s referendum in Catalonia.

US

Outperforming small caps on US markets last week.

• Large caps closed modestly higher last week while small caps scored more substantial gains.
• The unveiling of the Republican tax reform plan last Wednesday fostered, at least temporarily, a revival in the “reflation trade” of late last year, and saw small caps and value stocks lead the market higher.
• On a sector basis, technology stocks were especially strong, helped by a rebound of Apple and strengthening semiconductor names. Consumer Staples and Utilities segments lagged.

EMERGING MARKETS

Emerging market equities traded near three-week lows due to the rising dollar and higher US yields.

• Brazilian stocks fell the most among the emerging markets as the optimism over President Michel Temer’s reform agenda faded. Support for the Brazilian president is fading in the lower house, as he is facing corruption accusations.
• Chinese stocks also had a difficult week after local authorities’ action on the real estate sector and the cooling sentiment over Apple supply chain stocks.
• Indeed, Apple-related stocks continued their weakness in Asia, as investor enthusiasm decreased following the unveiling of the latest iPhones two weeks ago.
• Markets also witnessed a rotation out of HK/China financials names towards Japanese companies. 

R
ATES

European government bonds experienced some volatility over the week.

• After having rallied early in the week following the outcome of the German elections, Bund yields jumped driven by the selloff in treasuries.
• US treasuries climbed after Janet Yellen’s hawkish speech over the increasing probability of a rate hike in December and the unveiling of Donald Trump’s tax plans.
• The US 2Y note reached its highest level since November 2008.
• 10Y US, UK, Japan and German yields stood at respectively 2.29%, 1.35%, 0.05% and 0.45%. 

CREDIT

Credit market were mainly driven by the Fed’s statement and the unveiling of Donald Trump’s tax plan.

• Cash credit spreads tightened by 1bp for Investment Grade and 2 bps for High Yield, outperforming iTraxx indices (+1bp and +2bp respectively).
• The week saw over EUR10.3bn of Investment Grade supply, i.e. 40% less than on previous weeks. 

FOREX

Outperforming USD of the week.

• The USD outperformed all its peers after the Fed’s statement over the increasing probability of a rate hike in December and the unveiling of Donald Trump’s tax plans.
• The underperformers of the week were the emerging currencies, the EUR and the SEK.
• Emerging Markets suffered from the Fed’s hawkish comments, Angela Merkel’s unconvincing victory in the German elections weighed on EUR and the SEK went down after the new 5Y term for Riksbank governor Stefan Ingves. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES