Coffee Break 20.03.2017

Over the past week, investors’ attention shifted to the FOMC meeting. As widely anticipated, the Fed decided to raise its rates by 25bps, into a range of 0.75%-1%, amid rising confidence that the economy is poised for more robust growth. As an immediate reaction, the USD slipped back vs the EUR and the JPY, as three rate hikes were already priced into the markets and the Fed did not indicate any increase to their expectations for further rate hikes. Meanwhile, government bonds yields stepped back as the markets’ fears of a more hawkish Fed with a faster pace of rate hikes were averted.

The result of the Dutch election gave insights into French polls: the anti-EU PVV was not able to win the expected 25-30 seats forecasted, confirming that opinion polls have correctly judged the limited rise of euro-scepticism and populism. This led markets to reevaluate somewhat expectations of a Le Pen victory in France. Despite the political uncertainties, the economic news flow remains robust, allowing European equity markets to recover some of the ground lost since 2015.

In this context, we keep our overweight on equities and still favour the US, the euro zone, Japan and the emerging markets.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are overweight in equities versus bonds:

• The macro news flow is still well-oriented. Data released in the first months of the year continue to surprise on the upside, confirming our view of a synchronised global expansion. In particular, upside surprises on growth and inflation confirm the improvement in nominal growth rates, fuelling corporate earnings growth.
• Central banks’ actions are decoupling but their tone has turned less dovish:
  • The ECB has confirmed, during its last press conference, that it would extend its 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”. The ECB President Mario Draghi’s emphasis on the importance of wage growth (which is likely to turn only very slowly) confirms a dovish posture for the long run.
  • The Fed has increased its benchmark interest rates on Wednesday and still expects two additional moves this year. The acceleration in the Fed tightening pace is at odds with accommodative policies in Japan, the euro zone and, to a lesser extent, the United Kingdom.
• 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, OPEC members have only slightly cut production in February, which remains above the agreed 32.5 mbd. Meanwhile, US rigs have been re-opening, implying a greater production which weighs on oil prices.
• 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. And a stronger than expected rise in bond yields (higher inflation, significant fiscal easing) could be detrimental to equity performance.

REGIONAL EQUITY STRATEGY

• We have maintained our overweight on euro zone equities. A more robust and geographically broadening economic expansion, an accommodative central bank and a high valuation discount linked to political uncertainties underpin the attractiveness of the region’s risk assets.
• The UK is expected to trigger article 50 of the Lisbon treaty by the end of March, which gives the departing country up to two years to negotiate “its future relationship with the Union”. In this context, we keep 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 keep our overweight stance on US equities. US stock markets have benefitted from solid household expenditures and post-election optimism among consumers and businesses. The expected fiscal stimulus should support the earnings outlook further. Nevertheless, slippage in the expected timing of the fiscal stimulus represents a risk.
• We have a slight overweight on Japanese equities. Stronger US 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. Indian stocks hit a record high as the victory by Narendra Modi’s Bharatiya Janata Party in the key state of Uttar Pradesh should bolster his economic reform agenda and strengthen his claim to a second term in national elections in 2019.

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 also 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 have adjusted towards a close to neutral exposure on high yield bonds. We took profit on our global high yield exposure, as the spread compression has exceeded our targets on both sides of the Atlantic.

• In the US, initial jobless claims dropped by 2,000 to a seasonally adjusted 241,000. It was the 106th straight week that claims remained below 300,000, a threshold associated with a healthy labour market.
• The preliminary Michigan’s Consumer Sentiment index hit 97.6 in March, up from 96.3 in the previous month and above the consensus estimate of 97, largely due to improved household finances.
• In the euro zone, headline inflation accelerated to 2% in February, from 1.8% in January and in line with consensus and flash estimate.
• In Germany, the ZEW economic sentiment improved by 2.4 to 12.8 in March, slightly less than the consensus, due to pending political uncertainties. 

EUROPE

Positive week for European equities with the Stoxx Europe 600 up by 1.36%.

• European equities were boosted last week by two positive news: a more dovish than expected Fed hike and a decisive liberal VVD party election win in the Netherlands at the expense of the euro sceptic PVV party.
• The week started on the right foot for mining stocks as commodity prices and demand were strong.
• Bank stocks were shaky early in the week as investors seemingly were in a risk reduction mode.
• Nevertheless, European banks, oil stocks, and mining stocks outperformed their US peers at the end of the week.

US

Slightly Positive week for US equities with the S&P 500 up by 0.24%

• US markets after the Fed raised its short-term interest rate target range on Wednesday and Fed Chair Janet Yellen expressed confidence in the domestic economy.
• The S&P500 made new highs and traded above 2400 on the FOMC news.
• Bond proxies (Telecom, Real Estate for instance) outperformed on the flatter yield curve following the dovish Fed hike.

EMERGING MARKETS

Excellent week for Emerging equities with the main index up by 4.29%.

• Emerging Markets equities were helped last week by the dovish Fed hike, the lower USD and rising commodity prices.
• Economic data are pointing to solid growth in China in the first two months of the year, reflecting the impact of stimulus measures as the government strives to maintain stability before a key leadership transition this fall.
• Brazil’s economy added jobs for the first time since March 2015, a sign that the economy may be emerging from its worst-ever recession. This boosted the Brazilian market until mid-week, but the index lost more than 2% on Friday. 

RATES

Positive results in the Dutch elections and the rate hike in the US supported rate markets.

• The victory of prime minister Mark Rutte in the Netherlands was seen as an important test for populism in Europe after last year “Brexit” results and the election of Donald Trump in the USA.
• As expected, the FOMC decided to hike the Fed Funds rates by 25 bps. However, forecast were less hawkish than expected as dot plot remained unchanged at 3 hikes for 2017.
• European core rates (Bund & OAT) were moving upwards following this announcement.
• 10Y US, UK, Japan and German yields stood at respectively 2.49%, 1.24%, 0.065% and 0.43% last week.

CREDIT

The Dutch elections had a positive impact on high yield and the financial subordinated debt.

• The effect of the Dutch election was particularly visible on the synthetic market with the cross-over index decreasing by 11bps on a weekly basis (standing at 275) while the subfin index reached the low level of 191.
• On the cash markets, spreads on corporate bonds did not move significantly (at 288).
• On the primary market, the week was relatively quiet. 

FOREX

Negative week for EUR and USD.

• The dovish rate hike in the USA pushed yields lower and reinforced the JPY. EUR and USD fell vs their major peers.
• The MXN reinforced after a few nice words from US officials on mutual benefits of a trade agreement between the two countries.

COMMODITIES

Positive week for commodities with the GSCI Light Energy up by 1.13%. The index remains nonetheless negative for the year (-0.85%).

• Improving risk sentiment boosted energy and added to the gains on the weaker USD post FOMC.
• Base metals traded higher all week following the release of Chinese activity data.
• Precious metals performed even more strongly, after having declined strongly into the FOMC decision

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES