Coffee Break 03.04.2017

Over the past week, the Prime Minister Theresa May officially notified the EU council of the UK’s intention to withdraw from the European Union. This will ignite a two-year process before the actual departure. The UK Prime Minister called for talks on a future trade deal with the EU to take place at the same time as the divorce negotiations. A request which has already been rejected by the German Chancellor Angela Merkel and the French President François Hollande, both claiming that talks must first focus on the terms of withdrawal. Market reaction was muted as the triggering of article 50 of the Lisbon Treaty was well anticipated and the serious talks would start only in May. On the equity markets, the official launch of the “Brexit” proceedings swung the FTSE 100 into the red but the index quickly recovered. As opposed to the FTSE 250 index, which closed 0.96% off its pre-“Brexit” levels.

Apart from the observed rise in inflation, we identify three cross-asset implications as negotiations start:

• On the fixed income side, the gilt market reliance on the BoE, overseas and financial institutions reveals some vulnerability.
• On the equity side, the FTSE 100, due to its high international and commodity exposure, and its value bias is likely to outperform the FTSE 250.
• On the currency side, the GBP is likely to remain under pressure.

In this context, we keep our underweight on UK equities and GBP.

Independently, the oil price momentum has reversed on the downside due to high level of inventories in the US. But this is mainly linked to seasonal factors which are coming to an end. Oil markets remain nevertheless supported by high OPEC compliance and the stronger global growth implying a higher demand.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are overweight in equities versus bonds:

• The macro news flow is still well-oriented. Data released in the first months of the year continue to surprise on the upside, confirming our view of a synchronised global expansion. In particular, upside surprises on growth and inflation confirm the improvement in nominal growth rates, fuelling corporate earnings growth.
• Central banks’ actions are decoupling but their tone has turned less dovish:
  • The ECB has extended its 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, the central bank still expects two additional moves this year. The acceleration in the Fed tightening pace is at odds with accommodative policies in Japan, the euro zone and, to a lesser extent, the United Kingdom.
• 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.
• Important political risks remain: “Brexit” negotiations, elections in France and the new US administration imply high dispersion of possible outcomes. The political risk premium 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, Theresa May has notified the EU on 29 March, under the Article 50 process, that the UK is leaving the European Union. In this context, we maintain an underweight position on UK equities. The uncertainties of the “Brexit” conditions and their impact on the economy lead us to avoid domestically-oriented small and mid-caps.
• We hold a small US equity overweight as the gap between “soft” survey data and “hard” activity data has widened to unprecedented levels which led us to take some profit on our overweight exposure. US stock markets have benefitted from post-election optimism among consumers and businesses but activity has yet to follow sentiment.
• We have a slight overweight on Japanese equities. Stronger global growth, a supportive domestic policy mix and a relatively weak currency are among the main performance drivers.
• We hold a slight overweight on emerging market equities. They still benefit from attractive valuations in a robust global growth context, but remain vulnerable to potential protectionist measures in the US. Earnings growth has been revised a little upward thanks to increasing commodity prices. Meanwhile, India remains our preferred emerging market.

BOND STRATEGY

• 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 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 continue to diversify out of low/negative yielding government bonds:
  • We remain positive on inflation-linked bonds as we expect rising wages, increasing price pressures in China and potential stimulus to push inflation higher. 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 election. 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. Carry remains attractive and negative financial implications of the US presidential election, 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.

• In the US, the Michigan consumer sentiment index unexpectedly fell to 96.9 in March versus a consensus estimate of 97.6. The index is however strong in a longer term view as respondents remain optimistic about higher incomes, and more favourable job prospects.
• Initial jobless claims unexpectedly slipped by 3,000 to a seasonally adjusted 258,000. The labour market is still near full employment.
• In the euro zone, at 0.82, the business climate indicator remained flat in March, compared to the previous month. This is below the Reuters consensus of 0.84.
• In Germany, the monthly Ifo Business Climate Index rose to 112.3 in March from an upwardly revised 111.1 last month and above market expectations of 111. The index hit its highest level since July 2011.

EUROPE

Positive week for European equities with the Stoxx Europe 600 up by 1.23%.

• European markets went up again last week, confirming the global inflows.
• The Dax reached 12300 points, its highest level since 2015, and pretty close to its all-time high.
• Inflows to European Equities were the largest in 12 months.
• European basic resources companies were boosted by higher metal prices.
• Despite the flows into European markets, trading volumes were notably low. Not even the official beginning of the “Brexit” process could boost movement in the markets.

US

Slightly positive week for US equities with the S&P 500 up by 0.80%.

• US stocks closed Q1 in positive territory with all the major indexes bouncing back after the previous week’s losses. The technology-heavy Nasdaq Composite Index was the only one to recoup all of its previous losses.
• Health care companies performed well after Donald Trump administration’s failure in reforming or closing the Obamacare programme the previous week.
• Investors are now focusing on potential tax reforms.
• Volumes are now getting lower, waiting for the upcoming earnings season.

EMERGING MARKETS

Negative week for Emerging equities with the main index down by 1.06%.

• South Africa stocks took a tumble after President Jacob Zuma fired Finance Minister Pravin Gordhan, replacing him with the relatively unknown head of home affairs Malusi Gigaba. The turmoil comes as south Africa is facing reviews by credit ratings agencies that could see it lose investment-grade status and make it more costly to borrow.
• Turkey was also in the spotlight with Halkbank’s shares set for their biggest one-day fall after the arrest of the company’s deputy CEO.
• Mexico on the other hand, saw all-time high levels since Donald Trump clinched the US presidency in November after one of Trump’s most protectionist trade advisers said last week that he wanted Mexico, US and Canada to form a regional manufacturing powerhouse.

RATES

Global rates have been driven by political events last week.

• First the Brexit has been triggered officially paving the way to two years of hard negotiations between the EU and the UK.
• Then the “Trumphoria” seems to be fading away since the bill to repeal and replace Obamacare failed to gain enough political support to pass.
• In this context the US 10Y yield continued its downward trend while Euro rates performance were fuelled by the release of good set of macroeconomic data.
• 10Y US, UK, Japan and German yields stood at respectively 2.30%, 1.17%, 0.00% and 0.32%. 

CREDIT

Constructive tone overall for euro credit market last week.

• Spread continued to tighten and is now reaching Govies +119bp.
• In financials, we saw some new papers across the capital structure and currencies before the non-issuance period: RABO USD 12NC7 T2, ABBEY GBP PNC7 AT1, BNP senior non- preferred FRN tap.
• Sterling financials drifted wider after the triggering of Article 50 by the UK government.
• In Non-financials, we also saw some new issuance notably on the utilities (Elia, Tennet…).

FOREX

Reinforcement of the USD against its peers.

• The EUR fell slightly last week vs the USD following news of a drop in inflation in Europe.
• The best performers of the week were the MXN and de the CAD due to better than expected GDP in Canada adding to the moderated stance on NAFTA and recent oil rally.
• The AUD took a tumble after the release of poor retail sales in the country.

COMMODITIES

Positive week for commodities with the GSCI Light Energy up by 0.91%. The index remains nonetheless negative for the year (-1.03%).

• Energy prices rose to a 3-week highs bouncing back on improving fundamentals (crude inventory and improving US economic data).
• Base metals mostly strengthened, led by steel and copper.
• Precious metals edged lower despite dovish central bank comments and flat bond yields. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES