Coffee Break 10.04.2017

Over the past weeks, investors’ attention has shifted to France ahead of the first round of the presidential elections on 23 April. Emmanuel Macron remains the favourite to become France’s next president, despite the slight decline in voting intentions after the second French presidential debate last Tuesday. Actual voting intentions based on first round movers and bookmaker odds point to a 60-40 victory for Emmanuel Macron against Marine Le Pen. This justifies our central scenario, which would be supportive for riskier assets, in particular euro zone equities, and can possibly trigger a strong rally in European equities. Though quite unlikely, we cannot exclude a Le Pen victory, therefore we continue to closely monitor the recent developments that can impact on central scenario.

In this context, we remain overweight on euro zone equities while maintaining our relative value strategy long German Bnd / short French OAT to protect our portfolios against the tail risk scenario.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are overweight in equities versus bonds:

• The US cyclical expansion, the economic recovery in Europe, the global inflation momentum and a soft landing in China are all supportive for equities in a rising rates context.
• Central banks’ actions are decoupling but their tone has turned less dovish:
  • The ECB has started the new downsized 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's interest rate hike in March, the central bank still expects two additional moves this year.
• 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 are close to neutral in US equities 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 are close to neutral in 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 have a neutral view on credit, as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
• 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 ISM manufacturing fell to 57.2 in March, from 57.7 in February, but better than estimate of 57. New orders and production grew less, while employment and export orders indices jumped.
• Separately, nonfarm payrolls came in at 98,000, well below the expected 180,000 and down from February’s revised 219,000. The unemployment rate, however, plunged to 4.5%, a new post-crisis low and the lowest since May 2007.
• In the Euro zone, the final market composite PMI index rose to a near-six year high of 56.4 in March from February’s 56. Soaring demand allowed businesses to raise prices at the fastest rate since mid-2011.
• In Germany, the PMI manufacturing came in at 58.3 in March, up from 56.8 in February and matching preliminary estimates. Output increased at the fastest pace in over three years, driven by the strongest gains in new orders in nearly six years. 

EUROPE

Optimism remains despite upcoming elections and geopolitical events.

• European markets were flat this week, impacted by the poor performance of the sectors banks and materials’, but rebounded on Friday, upon nice US employment figures.
• Inflows to European equities are falling against US funds, but keep the pace from European funds.
• Manufacturing economic data remains supportive.
• Oil prices lifted energy stocks, especially at the end of the week.
• Real estate reached its highest level in six months, due to the slower rise of the interest rates.

US

Attack on Syria.

• Most US markets ended the week slightly lower.
• Energy stocks were boosted by the refinery demand, and later in the week by oil prices after the attack on Syria.
• As usual in case of geopolitical tensions, gold went up dramatically, reaching its highest level year-to-date.
• The nonfarm payrolls report disappointed the markets, but unemployment reached its lowest level in 10 years.

EMERGING MARKETS

Fears of massive outflows after South Africa’s downgrade to junk.

• South African Minister of Finance, Pravin Gordhan has been dismissed, while he was considered as a key actor of the anti-corruption trend in South Africa.
• This lead to a massive political turmoil in the country, the population asking for presidential dismissal.
• S&P and Fitch downgraded the South African debt to ‘Junk’, which might generate massive outflows from the local markets. 

RATES

Sovereign rates continued to fall over the past week.

• In the euro zone, yields dropped following comments by Mario Draghi, saying he did “not see cause to deviate from the indications we have been consistently providing”.
• In the US, despite “hawkish” FOMC minutes including discussion around balance sheet reduction, yields declined on well below consensus payrolls.
• 10Y US, UK, Japan and German yields now stand at respectively 2.29%, 1.05%, 0.05% and 0.22%. 

CREDIT

• Credit markets have not been impacted by the recalibration of the QE program. In the cash market, the corporate and financial index widened slightly by 1 bp on a weekly basis. This trend is similar for the synthetic market.
• Calm week in terms of new issues. The primary was a bit active in dollar (with the issuance of senior debt by Airbus and Unicredit). 

FOREX

Risk-off currencies perform well.

• The Japanese Yen gained from a risk-off mode this week on the market.
• The worst performer was the Australian Dollar due to more dovish central bank, while the British Pound dropped due to weak economic data (Industrial Production and retail sales). 

COMMODITIES

Commodities were slightly up over the past week (GSCI Light Energy up by 0.43)%. The index remains nonetheless negative for the year (-0.61%).

• Oil prices surged last week, after Donald Trump’s ordered US air strikes on an airbase in Syria. In one week, Brent crude oil jumped almost 5% to around 55 USD/barrel.
• Gold rose to a five-year high after the US jobs data report, giving up most of the gains as the USD rose and safe haven demand ebbed. It ended the week at 1254 USD/ozt. 

UPCOMING FACTS AND FIGURES