Coffee Break 17.07.2017

Bond markets and economic news flows have given early signs of a broadening and converging activity cycle, which marks the second step in the global reflation. After a pause, following Inauguration Day, a synchronised expansion has resumed and is more evenly distributed than in any year since 2007, paving the way for a central bank tightening.

Equity markets are also following the bond markets’ trend, but we will monitor their resilience to the gradual tightening bias. However, the central bank divergence between a hawkish Fed and a highly accommodative Bank of Japan should support the weakness of the JPY and the Japanese earnings growth. We therefore decided to increase our Japanese equity exposure from neutral to overweight to benefit from this positive momentum.

This week, we will closely follow the BOJ and ECB meetings on Thursday, as well as the next round of “Brexit” talks between UK Secretary David Davis and EU negotiator Michel Barnier.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We have slightly increased our tactical equity exposure to overweight (via Japan) 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 in the US, while emerging markets are benefiting from a good economic momentum.
  • In this context, we concentrate our portfolio’s regional positioning on euro zone, Japan and Emerging markets.
• Central bank dovishness to recede gradually:
  • Following the June Fed hike, we expect another hike later this year (which is not priced by the market). Even though Janet Yellen stated last week that de Fed may not need to hike rates much more, upward interest rate pressures will remain. The next step in the Fed tightening process will be through balance sheet reduction, but the timing remains uncertain, but it will likely be in the second half of the year. The annual meeting in Jackson Hole in August should give more clarity.
  • The ECB tapering debate has already become a central theme after Mario Draghi’s latest speech.
• Equities have an attractive relative valuation compared to credit.
• 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 is 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 uncertainties.
  • 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 are positive on Italian equities and banks. The sharp decline in the political risk premium and recent bank rescues are restoring 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. Currently, the UK is having difficult political discussions on the “great repeal bill”, that will transpose EU legislation into UK law.
• We keep our neutral stance on US equities. The US soft patch could now be behind us, as economic surprises have started to recover from extreme negative levels. We however 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 have increased our Japanese exposure from neutral to overweight. Strengthening global growth and a supportive domestic policy mix are among the main performance drivers. Furthermore, we do not expect the BoJ to tighten its highly accommodative monetary policy anytime soon, leading to a weaker JPY.
• We maintain an overweight on emerging market equities. They benefit from attractive valuations in a robust global growth context. Fed balance sheet adjustments could create more uncertainties on Emerging markets, but the global cycle and accommodative domestic monetary policies should support them.

BOND STRATEGY

• We maintain our underweight on bonds and a short duration. EU and US sovereign yields have risen and should continue their uptrend, driven by a tightening Fed, a less dovish ECB and potential upcoming inflation pressures. We expect rising wages and potential stimulus to push inflation higher, although it takes longer than expected to materialise.
• 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: We revised our spread targets downwards, the duration effect is less negative and 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, industrial output rose for the fifth consecutive month, helped by gains in mining, while the manufacturing sector rebounded. Overall industrial production rise 0.4% in June. Capacity utilization, which measures how fully companies are deploying their resources, rose to 76.6%.
• Meanwhile, the consumer price index was unchanged in June after edging up by 0.1% a month earlier, pointing to benign inflation that could cast doubts on the Fed’s ability to increase interest rates for a third time this year.
• In the euro zone, industrial production rose more than expected in May. Compared to the previous month, industrial production in the euro area increased by 1.3% for a 4% annual increase.
• Separately, investor confidence has slightly worsened in July with The Sentix index dipping to 28.3 this month from a level of 28.4 registered the previous month. 

EUROPE

Positive week for European Equities.

• European stocks increased last week following signs that the major central banks would not move as quickly to tighten monetary policy as once thought.
• Positive economic data supported cyclicals, which, outperformed defensives.
• The automobiles sector rose upon good sales figures in China.
• Materials, Basic resources in particular rose as well, supported by the lower USD
• UK Retail was dragged down by domestic stocks.

US

Positive week for US stocks

• The DJIA and the S&P 500 Index were the only benchmarks to have new intraday highs last week.
• The technology-heavy Nasdaq Composite performed best within the large indexes.
• There were again some political turbulences perturbing the markets, upon rumours of contacts between Donald Trump Jr and Russian lawyers during the campaign.
• Last Wednesday, comments by Janet Yellen, stating that there was no rush for a monetary tightening, were welcome by the markets.
• Banks earnings, released on Friday, were mixed, which disappointed investors.

EMERGING MARKETS

Due to the lower USD, Emerging equities outperformed.

• Brazilian stocks rose after former president Lula was sentenced to 9 years in jail, for corruption, and after the adoption of a deep labour reform in the country.
• Chinese data supported the markets, in particular the solid pickup in exports led by Technology; on the other hand, imports of commodities were perceived as a positive signal of the good shape of the Chinese economy.
• Russia also showed its strength, led by Yandex as Uber decided to pull out of the local market, merging its business with rival Yandex. 

RATES

After the sharp sell-off in sovereign yields over the past weeks, global interest rates recovered.

• A less hawkish testimony from Janet Yellen and soft economic data in the US (CPI and retail sales) have both contributed to lower yields in developed markets.
• Against this backdrop, Spain and Italy performed well relative to core countries.
• 10Y US, UK, Japan and German yields stood at respectively 2.29%, 1.23%, 0.06% and 0.57%. 

CREDIT

After sharp upticks in the previous week, the Bund stabilised.

• Synthetic markets saw some improvement last week as credit spreads moved lower with the X-over index narrowing by 14 bps on a weekly basis while financial indices also compressed by 7 bps (subordinated) and 3 bps (senior).
• High Yield cash market also tightened slightly, by 6 bps.
• The ECB corporate bond buying program accelerated last week with inflows over EUR 2.3bn.
• Investment Grade markets experienced a summer lull as there was not much supply to be noted over the past week. 

FOREX

USD suffered following weaker than expected economic data

• High carry currencies (ZAR, MXN, BRL, AUD) appreciated against the USD as a result of less than expected monetary tightening in the US.
• The GBP strengthened across the week, rallying versus the USD on disappointing US data.
• The trade weighted EUR index managed to end slightly lower on the week despite the ECB’s recent hawkish shift, as risk-on currencies strengthened on the improvement in fundamentals. 

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES