Coffee Break 27.03.2017

The synchronised cyclical uptick on a global scale has been among the drivers of the equity market outperformance vs. bonds during this first quarter. Risky assets have risen along with the marked improvement in the economic news flow. We note, however, that most of the upside surprises in US data has come from “soft” survey data rather than “hard” activity data. Our reading of the current gap between survey optimism and actual activity is as follows: we would not be surprised to see risky markets making a pause allowing activity to catch-up. Clearly, if reality does not catch up with current hope, equities would become vulnerable. Looking forward, it will therefore be key to assess if the current optimism is translating into stronger activity. The cliff-hanger in Washington on the health care bill implies that the upcoming tax overhaul and infrastructure package are no plain sailing.

The latest BofA Merrill Lynch Fund Manager Survey has confirmed an increase in equity overweight as fears that continental Europe would suffer an anti-EU, populist wave have receded somewhat after the Dutch general election. It has to be seen if the next hurdle, the French presidential elections next month, confirms this behaviour, which would clearly be a positive sign for European assets.

In this context, we keep our overweight on equities while taking partially profit on our US equity exposure as we interpret the gap between survey optimism and actual activity as a tactical warning on US equities.

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 extended 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”.
  • After the Fed interest rate hike in March, the central bank 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, while OPEC members are bringing back oil production to more durable levels, US rigs have been re-opening, implying a greater production.
• 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.

REGIONAL EQUITY STRATEGY

• We have maintained our overweight on euro zone equities. A more robust and geographically broadening economic expansion, as witnessed by the most recent PMI indicators, an accommodative central bank and a high valuation discount linked to political uncertainties underpin the attractiveness of the region’s risky assets.
• In the UK, Theresa May will notify the EU on 29 March, under the Article 50 process, that the UK is leaving the European 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 took partially profit on our US equity overweight as the gap between “soft” survey data and “hard” activity data has widened to unprecedented levels. US stock markets have benefitted from post-election optimism among consumers and businesses but activity has yet to follow sentiment. We nevertheless maintain a small overweight in the region.
• We have a slight overweight on Japanese equities. Stronger global 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 recently 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 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 are close to a neutral high yield exposure. The spread compression has exceeded our targets on both sides of the Atlantic.

• In the US, initial jobless claims unexpectedly rose by 15,000 to 258,000. Nonetheless these figures still show the ongoing strength of the labour market.
• The Markit flash composite PMI index came in at 53.2 in March, down from 54.1 the previous month and signalled the slowest expansion of private sector output since September 2016.
• In the euro zone, the flash consumer confidence indicator rose by 1.2 to -5 in March, beating market expectations of a more modest rise to -5.7.
• The Markit flash composite PMI increased to 56.7 in March, up from February’s 56. This is the highest reading since April 2011 and above the Reuters consensus of 55.8. 

EUROPE

Negative week for European equities with the Stoxx Europe 600 down by 0.48%.

• The first part of the week was marked by low volumes and low volatility as investors were in a wait & see mode.
• On Thursday, the index rallied after three days of consecutive losses, with bank, travel, and retail stocks boosted by stronger economic data reports.
• The positive result of the Dutch election and strong PMI numbers from France and Germany seemed to have calmed investors.

US

Negative week for US equities with the S&P 500 down by 1.44%.

• US stock markets showed their first real decline of the year, with a drop of 1% on Tuesday.
• Debates around health care reforms and tensions between Donald Trump and the Congress over a new bill to repeal the Obamacare brought uncertainties.
• On Friday, after the closing of the markets, the House of Representatives withdrew the legislation. This might be perceived as a sign of difficulty for the Trump administration for further negociations around other important spending programmes such as infrastructure.

EMERGING MARKETS

Positive week for Emerging equities with the main index up by 0.41%.

• Emerging market stocks steadied last week, helped by modest gains in Asia as investors waited to see if US President Donald Trump could push through a health bill to replace “Obamacare”.
• Emerging stocks have rallied hard this year on the back of Donald Trump’s promised fiscal splurge but stumbled after his health care bill stalled in Congress, raising doubts about his ability to implement the pledges.
• The rally in China stalled as the domestic’s money market rates were at their highest level since April 2015, resulting in tighter liquidity for over-leveraged banks.
• Brazil was lower last week as investors feared widening corruption investigations could hamper government efforts to balance the budget.
• On the other hand, Mexico showed some strength after the latest rate hike by the US Federal reserve.

RATES

Political debates and PMI publications supported markets.

• Less stress on French spreads last week after the first televised presidential debate that showed that Emanuel Macron taking the lead in the run for presidency.
• In the euro zone, PMI publications came above expectations with the PMI flash composite at 56.7 (vs 55.8), the PMI Flash Manufacturing reaching 56.2 (vs 55.3) and the PMI Flash Services at 56.5 (vs 55.3).
• For the new TLTRO, the ECB allotted EUR 233.5bn, which is twice the anticipated amount and the (net) largest since the beginning of the programme.
• 10Y US, UK, Japan and German yields stood at respectively 2.40%, 1.20%, 0.06% and 0.41%.

CREDIT

Positive performance for euro credit markets.

• Euro credit markets managed to perform on a weekly basis (-2bps for Investment Grade and -3bps for High Yield), while investors are in a wait & see mode due to Donald Trump administration’s difficulties to pass the promised health care bill.
• Firm flow of issuance on the primary market last week, notably with Volkswagen’s first multi-tranche issuance since the emission scandal in late 2015. 

FOREX

The JPY was the winner of the major currencies last week

• The JPY benefited from lower yields globally and its steady appreciation against the USD over the past two weeks is partly the result of the USD weakness in response to concerns relating to the Trump administration's ability to enact domestic spending and tax programmes.
• The worst performer last week was the AUD due to weakness on both iron ore and gold markets.

COMMODITIES

Negative week for commodities with the GSCI Light Energy down by 1.09%. The index remains also negative for the year (-1.92%).

• The release of mid-March figures of rising US crude inventories triggered an immediate bout of selling that pushed Brent below $50 during the week, for the first time since last November.
• The price of iron ore fell during the week as global stock markets slipped and traders anticipated a moderation of Chinese steel demand. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES