Coffee Break 18.12.2017

Central bankers of the two most powerful institutions delivered their presents in advance: the ECB upgraded its growth forecasts aggressively to 2.3% in 2018 (above the expectations of the EU Commission and the OECD) and the Federal Reserve increased its median projection for growth in 2018 to 2.5%, taking the fiscal stimulus into account. The icing of the cake consisted in the fact that the FOMC did not raise its rate path for 2018 whereas the ECB increased its inflation forecast for next year only by two tenths.

Nevertheless Mario Draghi went a step further in its assessment of the price environment as he was confident that “deflation risks have disappeared” after declaring end-June that “reflationary forces have replaced deflationary forces”. We can safely say that the ECB shares our bullish outlook on euro zone growth as Mario Draghi mentioned a ”strong pace of economic expansion” and a “significant improvement in the growth outlook”.

The upcoming week will likely see the potential settlement of the tax reform story in the US, the regional elections in Catalonia and the BoJ meeting. Outside of these events, the worthwhile 2017 news flow will have run dry.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

While we remain positive on equities and still positive on both EMU and Japan, we approach the end of the year and want to lock in our gains while using cautiousness.

• Global economic momentum is accelerating further however, geopolitical risks remain an obstacle.
  • We concentrate our portfolio’s regional positioning on the euro zone and Japan. Emerging markets could face some headwinds if the USD strengthens.
• Central bank divergence becomes more obvious:
  • The Fed has started its balance sheet reduction and has just voted a rate hike at its last meeting of the year.
  • The ECB has announced that it will pursue its quantitative easing but will cut the amount to EUR 30bn starting this January. Asset purchases will continue for at least 9 months in 2018 and interest rate increases should not happen before 2019.
• Equities have an attractive relative valuation compared to credit.

REGIONAL EQUITY STRATEGY

• We remain positive on euro zone equities which are supported by a strong economic and earnings momentum and relatively attractive valuations. We have increased our exposure to European small caps on the basis of good visibility on the domestic European profit cycle.
• We have kept a neutral tactical stance on emerging markets equities, as a result of the current USD level and technical indicators.
• We have become less negative on UK equities. We have reduced our underweight by 1% vs euro zone ones. The hawkish BoE monetary policy stance has put a barrier to GBP depreciation, challenging overseas profit growth and “Brexit” negotiations are progressing, but slowly.
• We remain neutral on US equities. We see progress on the upcoming tax bill. The transition from Janet Yellen to Jerome Powell should be smooth as he presents himself as “a pragmatic moderate”, who would - largely - continue the Fed’s current policies.
• We are positive on Japanese equities. A strengthening growth and a supportive domestic policy mix are among the main performance drivers and we have gained more conviction that the BoJ will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY. Furthermore, Japanese earnings have been progressing so far without depreciation of the JPY.

BOND STRATEGY

• We are negative on bonds and have a low duration.
• With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to continue their uptrend from September’s low.
• We continue to diversify out of low-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 diversification to emerging market debt, as the on-going monetary easing represents an important support.
  • We are more or less neutral on high yield. The correction on US High Yield observed recently is not expected to continue. 

• In the US, industrial output increased by 0.2% in November, less than expected due to a drop in utilities. The percentage of industrial capacity in use also rose slightly to 77.1%, 2.8% below the long-term average from 1972-2016.
• Also in the US, inflation rate YoY rose by 2.2% from 2% the previous month as healthcare and apparel costs fell while gasoline prices increased at a faster pace.
• In the euro zone, economic activity continues to advance. The preliminary composite PMI came in at 58, exceeding expectations and higher than the prior reading of 57.5.
• In Germany, business confidence grew with the ZEW current situation index increasing to 89.3, beating expectations.

EUROPE

European indices ended the week lower.

• Basic Resources significantly outperformed supported by higher commodity prices as aluminium and iron ore gained over the week.
• Utilities slumped on profit warning and downgrades (Innogy, RWE…).
• Retail underperformed on negative performances by Metro and H&M. The Swedish retailer reported its biggest drop in quarterly sales in at least a decade.
• Euro zone banks also underperformed, dragged by Italians ones.

US

US large caps managed new highs last week.

• Consumer discretionary and consumer staples shares led the gains last week with media stocks boosted by the purchase of much of 21st Century Fox by Disney.
• Materials and Utilities lagged as well as Energy stocks, despite oil prices climbing above $65 during the week.
• Uncertainties over the progress of House and Senate Republicans in finalising the tax reform bill sparked some volatility late in the week.

EMERGING MARKETS

Positive week for Emerging equities.

• In China, equities underperformed on fears that US corporate tax cuts could result in massive outflow for the market.
• Asian tech shares continued their persistent fall after a strong YTD performance.
• Financials benefited from a rotation out of tech and into value, particularly in Korea.
• Peru had a difficult week after a scandal-plagued Brazilian builder reported having paid $4.8 million to companies linked to the Peruvian President.
• Chili saw its highest rise in two years due to higher copper prices, the country’s main export.

RATES

Dovish messages from the Fed and the ECB last week.

• As expected the Federal Reserve raised its key rate by 25bps and 3 rate hikes are anticipated next year, in line with market forecast.
• The ECB left its rates unchanged, but positives signs came from upward revisions of the growth outlook.
• The inflation outlook, is not yet responding to the brightening economic outlook, which should lead to a very gradual adjustment of the ECB monetary policy.
• 10Y US, UK, Japan and German yields stood at respectively 2.37%, 1.15%, 0.03% and 0.30%.

CREDIT

Quiet week on credit markets, only marked by some selling flows.

• Italians credit bonds (financials and corporate) were in selling mode last week as a return of the political risk in Q1 2018 is a possibility?
• On the M&A front, an acquisition of Westfield by Unibail is on the cards.
• Flat spreads on both Investment Grade and High Yield over the week while on synthetic markets the Xover widened by 7bps.
• Low volumes on the primary markets due to the end of year period. 

FOREX

Slightly weakening USD following the dovish Fed announcement.

• In the euro zone, the impact on FX markets of the upgrade by the ECB of its forecast on GDP and inflation for the coming years was broadly muted by Mario Draghi’s cautious speech.
• The GBP took a small leg lower as European leaders emphasised the complexity of the upcoming “Brexit” talks.
• The AUD and NZD were boosted last week by the better-than-expected employment data in Australia and by the RBNZ’s comment about a more flexible approach regarding inflation. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES