Coffee Break 24.07.2017

Last week, investors closely monitored the ECB meeting on Thursday. As expected, the ECB kept its policy settings and accompanying guidance unchanged. The central bank reiterating its pledge to increase or lengthen its quantitative easing programme if the outlook should worsen was a little dovish surprise. The ECB’s chairman Mario Draghi emphasised that current level of policy was necessary to bring inflation back to target (close to 2%) over the medium term. However, he also stated that a potential discussion on policy changes would take place “in the autumn” and did not talk down the EUR. As an immediate reaction, the EUR soared to a near 14-month high of 1.16 against the USD. Also, the Bank of Japan left its monetary policy unchanged, remaining highly accommodative and in line with our scenario.

The second round of the “Brexit” negotiations has failed to produce a breakthrough on key disputes between the UK and the European Union, namely the “Brexit” bill, the future rights of European citizens, and the common travel area in Ireland. Meanwhile, the UK government has announced that Parliament is set to debate as of 7th September, the Great repeal bill - a key piece of “Brexit” legislation that would transform EU laws into British laws.

In the coming weeks, we will closely follow Central Banks’ communication, as well as political developments in the UK and the US.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We hold a slight overweight on equities and remain negative on bonds, maintaining a short duration:

• Global expansion dynamics are well underway.
  • Most recent 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:
  • We expect another hike later this year (which is not priced by the market). Even though Janet Yellen recently stated that the Fed may not need to hike rates much more, interest rate pressures are likely to remain. The next step in the Fed tightening process will be through balance sheet reduction, likely in September. The symposium in Jackson Hole in August should give more clarity.
  • The ECB left its accommodative monetary policy unchanged following last Thursday’s meeting, and talks on reducing quantitative easing should start this fall.
• 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.
  • In the UK, the “Brexit” negotiations are making little progress.
  • Protectionism fears have decreased, but have not completely disappeared. The geopolitical tensions in Syria, North Korea and potentially Iran may cause uncertainties.
  • In the US, the Senate is unlikely to vote on a bill to simply repeal the Affordable Care Act after efforts to repeal and replace Obamacare collapsed. The US House of Representatives took a new step towards tax reform legislation last Wednesday by approving a fiscal 2018 budget resolution that would allow the Senate to pass a sweeping tax code overhaul without support from the Democrats. 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. European equities continue to see inflows as shown by the latest BofAML Fund Manager Survey.
• 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 soft patch could now be behind us. 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.
• We hold an overweight exposure to Japanese equities. A strengthening global growth and a supportive domestic policy mix are among the main performance drivers. Furthermore, the BoJ confirmed its highly accommodative monetary policy - leading to a weaker JPY - anytime soon. Furthermore, the latest BofAML Fund Manager survey also confirmed the positive change in investor positioning towards Japanese equities.
• 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 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 increased and should continue their uptrend, driven by a tightening Fed, 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 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, the Philadelphia Fed Manufacturing index fell to 19.5 from 27.6 in June, reporting solid but slowing growth in July. The new-orders index in particular plummeted, to a reading of 2.1 from 25.9 in June.
• Weekly jobless claims also dropped by 15,000 to a seasonally adjusted 233,000 for the week ending July 15th. This level was the lowest since February, when claims fell to 227,000, which was the best reading since March 1973.
• In the euro zone, consumer prices increased by 1.3% YoY in June, matching the flash estimate and eased from a 1.4% rise in May. It was the lowest inflation rate since December 2016, as energy prices and unprocessed food rose at a slower pace.
• In Germany, the ZEW economic sentiment dropped to 17.5 in July from 18.6 the previous month, which was below the indicator’s long-term average of 23.8. 

EUROPE

Slightly negative week for European equities.

• The higher EUR weighted on European markets, mainly on exporting sectors, such as Automobiles.
• Corporate earnings were mixed and did not provide support for the main sectors.
• Only the FTSE performed well, boosted by good corporate earnings results and by the weakness of the GBP.

US

Modest gains for US stocks

• The technology-heavy Nasdaq Composite Index performed best among the large indexes, boosted by Internet-related stocks.
• A midweek rally in oil prices helped energy stocks.
• Economic data news flows improved compared with the previous week, especially from the Construction sector.
• Politics might generate some noise again as investigations on links between the Trump administration and Russia are still under progress.

EMERGING MARKETS

China ahead of expectations.

• The Chinese GDP growth was slightly better than expected in Q2, at 6,9%, supported by solid exports and some analysts are revising slightly upwards their growth figures for the whole year.
• South Korean stocks are reaching new highs, boosted by the dovish tone from central banks in the US and Europe, and a very solid world growth.
• The South African Central Bank cut its rates on Thursday, trying to prevent the economy to fall in a recession, but this had little impact on the markets so far. 

RATES

Global sovereign yields dropped as the ECB reiterated that inflation levels were not yet to the anticipated figures.

• Against this backdrop, peripheral countries rallied relative to core countries.
• In the UK, yields were down by 10bp after soft inflation data (2.6% vs. 2.9% expected) while US treasuries yields dipped following the apparent failure of the Senate Republicans to agree on the President’s health care reform.
• 10Y US, UK, Japan and German yields stood at respectively 2.24%, 1.19%, 0.07% and 0.52%. 

CREDIT

Solid Q2 results for US banks but weakness in FICC division (low volatile trading environment).

• US companies are delivering better sales results than consensus (+/- 75% positive surprise).
• ECB meeting: As there are no sign of inflation picking up, the last ECB meeting did not discussed tapering scenarios.
• In this favourable context, Credit spreads continued to tighten (-2bp to 95bp). 

FOREX

Further decline for the USD following the latest Trump investigation news.

• The EUR remained strong against most of its peers, due to tapering expectation from the ECB and growth expectations.
• The BRL recovered strongly against the EUR as political risk diminished over the period. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES