Coffee Break 09.05.2017

Over the past week, investors closely monitored the FOMC meeting and the second round of the French presidential elections.

In France, the pro-European candidate Emmanuel Macron won the French presidential election as predicted by polls. His victory was widely anticipated by markets as the political risk premium on euro zone equities has started to decline after the first round of the election. However, a further decline of the risk premium will now depend on the publication of the first polls on the Parliamentary elections scheduled for 11/18 June. Meanwhile, euro zone equities still benefit from a supportive macroeconomic cycle, a higher expected earnings growth compared to the US and attractive valuations. These are good reasons to maintain an important conviction to euro equities.

As widely expected, the Federal Reserve decided last Wednesday not to raise its key interest rate but remains on track for the next rate hike on 14 June. The central bank did not alter its “dot plot” as it expects the economic growth to speed up in the coming months. As an immediate reaction, bank stocks rose broadly as the probability for another rate hike in June jumped to 90%. The US job report headline number was stronger than expected (211k) and the unemployment rate fell to 4.4%.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are neutral on equities, but still maintain important convictions within our regional equity exposure (positive on EMU and emerging markets, negative on UK)

• The US cyclical expansion, the economic recovery in Europe, the global inflation momentum and decent growth in China are all supportive for equities leading to a rising rates context. Data released so far this year confirm our view of a synchronised global expansion. We think that the euro zone and Emerging economies are best placed to leverage on these dynamics.
• Central banks’ actions are decoupling but their tone has turned less dovish:
  • The ECB left its monetary policy unchanged, making no changes to its key interest rates or bond buying programme. ECB President Mario Draghi has put emphasis on the importance of wage growth - which is likely to turn very slowly – confirming a dovish posture relative to the data for the long run. However, QE tapering should become a central theme after the summer.
  • After the Fed interest rate hike in March, two additional moves are expected this year, starting in June.
• 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.
• There is a risk of policy error in the medium term. The geopolitical tensions in Syria and North Korea, the slippage in the timing of the fiscal stimulus, and “Brexit” negotiations are all implying high dispersion of possible outcomes, including a misallocation of resources.

REGIONAL EQUITY STRATEGY

• We remain overweight on euro zone equities. A more robust and geographically broadening economic expansion throughout the region and an accommodative central bank underpin the attractiveness of the region’s risky assets. Furthermore, profits are revised upwards while relative valuations are attractive and non-resident flows are picking up gradually.
• In the UK, with the official notification that the country would leave the European Union, we maintain an underweight position on equities. Although the upcoming elections announced by Theresa May present little risk, the uncertainty surrounding the “Brexit” negotiations can potentially weigh on the British economy. While the bulk of the exchange rate adjustment might be behind us, we expect the earnings growth expectations to soften somewhat once the negotiation talks start in earnest and keep an underweight stance.
• We keep our neutral stance on US equities. We are waiting for more clarity on fiscal stimulus and see the gap between survey optimism and actual activity as a tactical warning on US equities.
• We have a neutral exposure to Japanese equities. Stronger global 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.

BOND STRATEGY

• We maintain our underweight on bonds and keep a short duration. With a hawkish Fed and continuing inflationary pressures, we expect interest rates to maintain their uptrend. The improvement in the European economy could also lead euro zone yields higher especially as political risks continue to recede.
• We continue to diversify out of low/negative 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 remain positive on inflation-linked bonds as we expect a rise in core inflation by fiscal easing, higher wages, less deflationary pressure in China. Potential US protectionist measures are a wild card.
  • We took some profit on our relative value strategy: long German Bund / short French OAT but keep a small position as a hedge against the European political risk ahead of the June Parliamentary elections.
  • 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, but the carry remains attractive.
  • On the currency side, we hold a slight lower underweight in GBP ahead of the upcoming British elections.

• In the US, the Markit Manufacturing PMI fell to 52.8 in April, from 53.3 in March, matching the flash estimate. It was the lowest reading since September 2016, due to a slowdown in output and new business growth.
• Nonfarm payrolls increased by 211,000 in April following a downwardly revised 79,000 increase in March and are higher than the Reuters consensus estimate of 185,000. Meanwhile, the unemployment rate fell to 4.4%, its lowest since May 2007.
• In the euro zone, the Markit Composite PMI rose to a 6Y high of 56.8 in April from March’s 56.4. Both services and manufacturing rose at a faster pace, signalling a strong start of the second quarter.
• In Germany, the Markit Manufacturing PMI came in at 58.2 in April, from 58.3 in March. German manufacturing activity held near a 6Y high suggesting factories will continue to support economic growth in Europe's biggest economy. 

EUROPE

Positive week for European equities.

• The fading of French political risk meant high beta indices, such as IBEX and FTSEMIB, outperformed last week on a part-return of the risk on/reflation rally.
• The Automobiles sector was dragged down by its US peers following lower than expected April car sales.
• Oil & Gas and Basic Materials stocks underperformed after crude and industrial metals were hit hard on supply and China growth.
• The FTSE100 underperformed on a relative basis again.

US

Mixed week for US markets.

• The major benchmarks ended the week mixed with the technology-heavy Nasdaq Composite Index performing best for the third consecutive week.
• US stocks saw only modest swings during the week despite an active political backdrop and a continuing flood of Q1 earnings reports.
• Even as the House of Representatives voted narrowly for the Republican health care legislation to replace Obamacare, investors appeared to take a wait-and-see approach, with future budget battles still to come and health care reform facing an even steeper hurdle in the Senate.

EMERGING MARKETS

Emerging markets equities ended the week lower following a sharp sell-off in commodity prices.

• Russian stocks matched up with the falling oil price led by Sistema collapsing after oil major Rosneft filed a 1.9 billion lawsuit against the business conglomerate.
• Stocks in China closed at a three month low after a survey showed activity in services sector grew at its slowest pace in almost a year in April, raising concerns over economic risks.
• South Korean stocks hit a record high on robust exports, upbeat earnings and rising hopes for economic stimulus as the presidential election approaches.
• Greece also rallied by around 10% as the country signed a deal to release the next tranche of its bailout aid. 

RATES

The Fed remains on course to raise rates.

• In the United States, the Fed indicated that it remained on course to raise its rates as the recent slow pace of growth was “likely to be transitory”. The US10Y yield rose by 6bps on the news.
• In Europe, the market priced in Emmanuel Macron’s victory as the reaction following the outcome was quite limited. Positive sentiment led the OAT-Bund and peripheral spreads to compress further over the week.
• 10Y US, UK, Japan and German yields now stand at respectively 2.38%, 1.15%, 0.01% and 0.42%. 

CREDIT

Risk-on sentiment continued to dominate the market last week with strong Q1 earnings.

• 60% of Investment Grade companies beat the consensus in Europe and~75% in the US.
• Cash remained extremely well bid with -6bp over the week. The same path on the synthetic market was observed where Xover and Subfin closed respectively 10bp and 16bp tighter.
• The primary market side was quiet on the contrary.
• But some weaknesses observed on the oil price could lead to potential spread dislocation on oil-linked names. 

FOREX

Positive EUR versus all major peers.

• Despite a quite dovish ECB stance the EUR kept jumping versus all major peers thanks to good economic data in the euro zone and Emmanuel Macron’s victory in the French Election.
• With increasing tightening expectations by the RBNZ (rise in inflation expectations, fiscal impulse, capacity constraints), the NZD improved. 

COMMODITIES

Energy ended the week much lower on growing concerns over rising US output and scepticism over OPEC’ capability to restrain production.

• Brent started to rise on Monday after having ended the week down by more than 5%. The WTI gained 0.6% at the opening on Monday after a loss of 6% last week.
• Base metals ended the week much lower, with copper and nickel leading declines.
• Precious metals continued to weaken significantly as yields and USD strengthened.
• Base metals slumped on further growth and deleveraging in China exerting downwards pressure. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES