Coffee Break 10.07.2017

We note that there is no weakening of growth in the world economy at the start of the second half. In the Euro zone, most recent indicators (PMI, Consumer confidence, Retail Sales, Industrial Production) confirm that activity is broadening among economic agents throughout the region. Speakers of the European Central Bank, including its President, are starting to acknowledge the “growth shock” underway – strong and self-sustaining growth could ultimately no longer be dependent on sizeable monetary stimulus. In this context, we expect the ECB to announce less monetary accommodation later this year. We note further that the pragmatic approach (including bail-ins) to resolve the legacy issues of non-performing exposures of small Italian banks in the northern part of the country has continued last week. We think that bending the rules now to allow some bank clean-up in Italy might well remove an obstacle for a closer banking union in the EU later. Overall, confidence towards risk assets in general and the banking space is being restored, at the expense of government bonds. Ultimately, rising bond yields could well represent a risk for equities at some point in the second half of 2017. This is good reason to tactically maintain our neutral stance on equities.

In the coming weeks, we will continue to monitor (geo)political developments and central banks’ statements, in particular Chair Yellen’s testimony to Congress after a solid US job report for the month of June.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are tactically neutral on equities and remain negative on bonds, maintaining a short duration:

• Global expansion dynamics are well underway. Most recent PMI data confirmed that the European recovery is well on track and is leading to above-trend growth in 2017-18. This has led us to increase our profit earnings expectations for Euro zone equities. The economic news flow is starting to become more supportive again in the US. We lack a catalyst or a market setback to become more constructive. We think that the euro zone and emerging economies are best placed to leverage on these dynamics
• Central bank dovishness to recede gradually:
  • Following the June Fed hike and recent hawkish tone of Fed members, we expect another hike later this year (which is not priced by the market). The next step in the Fed tightening process will be through balance sheet reduction, where timing is uncertain, but likely in the second half of this year.
  • The minutes of the ECB’s meeting published on Thursday showed that officials discussed whether to end the central bank “easing bias”. They decided against it for now, but did not exclude it, stating "If confidence in the inflation outlook improved further, the case of retaining this bias could be reviewed". Tapering has already become a central theme.
• 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.
• The main risks for equity markets remain political and have switched from Europe to the US:
  • Italian elections are unlikely to be held in 2017. The Italian risk on a medium-term horizon appears manageable and already priced in by the markets.
  • The UK elections outcome has led to more uncertainties on the tone of the “Brexit” negotiations.
  • Protectionism fears have decreased (China, NAFTA), but have not completely disappeared. The geopolitical tensions in Syria, North Korea and potentially Iran may cause uncertainty.
  • In the US, progress on healthcare reform in Congress could put the tax reform on the agenda, a welcome issue to improve the credibility of the Trump presidency. Slippage in the timing of the fiscal stimulus nevertheless continues to be a source of uncertainty.

REGIONAL EQUITY STRATEGY

• We remain positive on Euro zone equities. The on-going, more robust and geographically broadening economic expansion, an accommodative central bank and a strong corporate earnings momentum underpin the attractiveness of the region’s risky assets. We have increased our exposure to Italian equities and banks within our Euro zone exposure, as we expect the recent bank rescues to restore confidence.
• We maintain an underweight on Europe ex-EMU, especially the UK. The uncertainties surrounding the UK’s political situation, the “Brexit” negotiations and the impact on the economy lead us to avoid the region.
• We keep our neutral stance on US equities. The US cyclical recovery stalled in Q1 and activity data has yet to catch up with survey optimism. However, economic surprises have started to recover from extreme negative levels. We continue to identify an execution risk in the expected fiscal stimulus and will follow upcoming updates from lawmakers. Progress on healthcare reform would be a first step in regaining confidence.
• We remain neutral on Japanese equities. The Japanese economy is supported by favourable conditions, such as a supportive policy mix, solid domestic consumption, a tight labour market and an improving earnings growth. Valuation is also not expensive, but the technical short-term upside looks limited. Furthermore, the JPY-evolution will remain an important market driver, in particular for non-resident flows.
• We maintain an overweight on emerging market equities. They benefit from attractive valuations in a robust global growth context. China should not trigger a systemic risk this year and most recent data (foreign reserves, retail sales, industrial production, loans) are rather supportive. Nevertheless, we monitor the importance of the technology sector, contributing more than 50% to H1 returns.

BOND STRATEGY

• We maintain our underweight on bonds and a short duration. We have further reduced our duration during the recent rise in bond yields. With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to resume an uptrend from June’s low. We expect rising wages and potential stimulus to push inflation higher, although it takes longer than expected to materialise. The improvement in the European economy could also lead euro zone yields higher as political risks recede and the ECB should start detailing its tapering in the second half.
• 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 have a diversification in inflation-linked bonds.
  • We keep our overweight on emerging market debt, as the on-going monetary easing represents an important support.
  • 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 maintain our positive stance on our NOK exposure, as we expect the oil price decline to come to an end. We remain cautious on the GBP in the light of the on-going “Brexit” negotiations.

• In the US, nonfarm payrolls increased by 222.000 in June, above consensus expectations for a 178.000 gain. Meanwhile, the unemployment rate unexpectedly ticked up to 4.4% from the 16-year low of 4.3% in May.
• Separately, the ISM PMI manufacturing came in above market expectations. The June reading rose to 57.8 from 54.9 in May, the strongest rate of expansion since August 2014, as output, new orders and employment grew faster than anticipated.
• In the Euro zone, the Markit Composite PMI reached 56.3 in June, below May’s reading but above earlier estimates. The expansion was again led by the manufacturing sector, where production rose to the greatest extent since April 2011.
• In Germany, the Markit Manufacturing PMI continued to grow at the strongest rate in over six years, posting 59.6 in June from 59.5 in May. This was largely due by a faster rise in new orders and a greater lengthening in supplier delivery times. 

EUROPE

Markets lacked direction over the past week.

• With interest rates are going up, upon the ECB’s more hawkish tone, defensive companies went down.
• Automotives and commodity sectors saved the global picture, upon the publication of a strong industrial production.
• Financials outperformed, as market were relieved by the EU’s approval of the state bailout of Italy’s fourth-largest lender, Banca Monte dei Paschi, for EUR5.4 billion.
• Fundamentals improved with economic positive surprises and better than expected Payroll figures.

US

Independence Day and lighter volumes in a mixed week.

• Due to the 4th of July holiday, trading volumes were light over the past week, while economic activity indictors (ISM, PMI) surprised positively.
• US markets ended the week with modest gains, except for technology that bounced back mid-week.
• Treasury yields are going up, which of course does not help equity markets. The latest Fed minutes reinforced expectations for a third rate hike this year.
• Decent labour market figures on Friday supported the markets on Friday.

EMERGING MARKETS

Emerging market stocks ended the week slightly lower.

• Markets experienced their biggest fall in nearly three weeks, as the market felt pressure ahead of the publication of the Fed minutes, while investors awaited the latest development on the Qatar crisis.
• North Korea’s latest missile test also heighted the tensions on Asian markets.
• Commodity exporting countries such as Brazil and Russia edged lower, as new data showed U.S. production rose last week just. OPEC exports hit a 2017 high, casting doubt on efforts by producers to curb oversupply.
• South Africa’s rand racked up 3% weekly loss, as worries continued about its central bank’s independence, plans for land redistribution without compensation as well a lack of drive for much needed economic reforms. However, the preliminary earnings release from Samsung electronics gave a positive impact on the investors sentiment. 

RATES

European government bonds suffered another sell off, as large supply from France and Spain hit the market. Hawkish ECB minutes added some pressure highlighting that the central bank has begun to discuss whether to change QE easing bias.

• In the US, Fed minutes revealed that most members view the recent softness in inflation as temporary. US rates failed to rise significantly further despite solid NFP report (222k vs. 179k expected) but still subdued wage growth (2.5%).
• The 10Y German yield breached the 0.50% level. 10Y US, UK, Japan and German yields now stand at respectively 2.38%, 1.29%, 0.07% and 0.57%. 

CREDIT

Interest rates influence credit.

• Synthetic market was under pressure in the context of the bund sell-off: X-over index widened by 12bps on a weekly basis while financial indexes (senior and subordinated) slightly widened by 2 bps.
• Cash market appeared more resilient: IG spreads tightened by 5 bps vs. govies and HY index was flat.
• Spanish banks were active on the primary market: Caixabank issued a Tier 2 debt while Bankia (recently considered as an IG name by all rating agencies) launched its first AT1. 

FOREX

Hawkish shifts in major Central Banks’ communication have supported FX appreciation of related currencies.

• USD, EUR, SEK and CAD benefited from this (perceived) change in rhetoric.
• This shift proved detrimental for carry trades, as ZAR, AUD and NZD posted worst weekly performances amongst major currencies

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES