Global macroeconomic newsflow remains positive

United States: growth should continue

Despite some volatility among US leading indicators, economic activity indices are now in line with our economic growth scenario of just under 2%. Growth continues to be driven by consumption, while exports should become more dynamic and business spending should no longer hold back economic activity. In this context, we still believe the Federal Reserve will hike its interest rate in December. Of course, as the major short-term risk, US presidential elections could shape a different scenario.

Euro zone: growth is resilient

For the time being, there is no sign of the recovery being derailed by Brexit uncertainty. Accommodating monetary policy continues to support easier credit conditions for both firms and households. Sources of political uncertainty are manifold however:

• governments must submit their Stability and Convergence Programs to the European Commission by October 15: some of them may be at risk of being non-compliant or only partially compliant;
• still no government in Spain;
• constitutional referendum in Italy on December 4^th;
• elections in the Netherlands, France and Germany in 2017.

All in all, we believe GDP growth should be around 1.5% in 2016 and 2017. However, Brexit-related uncertainty could resurface when negotiations start and the road ahead is paved with many political risks.Economic policy uncertainty has abated recently, but nevertheless remains historically high.

Emerging markets: heading in the right direction

Economic momentum continues to improve in emerging markets. Manufacturing PMIs are now increasing in almost all emerging regions. Brazil’s manufacturning PMI remains strongly below 50, the threshold that divides growth from contraction, but has improved significantly, while Russia’s manufacturing PMI has passed the 50 mark. Growth expectations are now positive once again in these two commodity-dependant emerging markets. As a result consensus forecast revisions have been bottoming-out.

Central bank expansionary policies remain in place

While the global economy continues to grow at a moderate pace, the balance sheets of the major central banks continue to provide support, while their expansionary policies remain in place:

• The Fed currently has a neutral stance that is justified by the latest economic figures. However, economic data could also clear the way for an interest rate hike before the end of the year.
• The Bank of England remains extremely supportive. It is nevertheless taking inflation risks into account and has now evoked fiscal stimulus.
• The Bank of Japan is innovating through yield-curve targeting, while the ECB is expected to clarify its intentions.

Tail risk n°1: US presidential elections

Merrill Lynch’s latest fund manager survey shows that the US presidential election is the greatest source of uncertainty in the coming weeks. After the recent (second) debate, Clinton has clearly taken a step closer to being elected, but the race is not over yet.

• If Clinton should become president, a probably split Congress will prevent any fundamental change, implying continuity after Barack Obama. We expect in this case:
  • A broadly unchanged economic base scenario;
  • A (moderate) rise in oil prices and a moderate Fed;
  • A gradual rise in US bond yields due to fiscal easing;
  • A rise in the MXN;
  • A sustained rise in Emerging market equities.

• However, if Trump should be elected, we identify the following risks:
  • Short-term risk-off: mid-term uncertain due to Trump’s unpredictable personality;
  • A rise in Fed rates and US bond yields, due to expected widening in the fiscal deficit;
  • A decline in the MXN and the AUD;
  • A decline in oil prices;
  • A decline in Emerging market equities;

Furthermore, investors are also ‘worried’ about a ‘hard’ Brexit, that could undermine confidence in the UK and the EMU, and the forthcoming political events in the euro zone over the next few months, including the constitutional referendum in Italy, Dutch general elections and the French parliamentary elections.

Cross-asset: slight overweight on equities

Macro news flow remains positively oriented, while central banks have maintained a dovish stance, providing ample liquidity to the markets. However, various political events (Brexit, US presidential elections, Italian constitutional referendum, probable fresh election in Spain), have increased the uncertainties over forthcoming months, translating into just a slight overweight in equities vs bonds.

REGIONAL EQUITY STRATEGY

Neutral on US equities

Economic growth is gaining momentum in the US and earnings growth should improve over the coming months and turn positive on a year-on-year basis. We are at the end of the earnings recession and revisions are now positive. However, we believe fourth-quarter and full-year 2017 growth expectations are too high. Given this factor and the relatively more expensive valuations, a neutral stance is justified in the current market context.

Neutral on euro zone equities and negative on the UK

We are less bullish on the possible re-rating of euro zone equities since Brexit. Given the greater downside risks, we do no expect a significant decrease in the risk premium over the short term, and therefore no major re-rating of the market. Despite positive economic growth, expected earnings growth for the coming twelve months seems too high and should be revised downwards.

Meanwhile, we remain negative on UK equities:

• The performance of the market mainly relies on the potential depreciation of the GBP.
• The relative valuation is rather expensive, as earnings have dropped over recent years.
• Earnings growth should benefit from a weaker GBP and more stable commodity prices. As a result, earnings revisions are now clearly positive, reflecting a positive forex effect.
• Implementing the Brexit remains an important risk.

Strongest conviction: emerging markets

Emerging markets are currently our strongest conviction for five reasons:

1. Attractive relative valuation: the relative valuation is still highly attractive vs other markets.
2. Stabilising economic growth
3. Reduced fear of a USD rally and bottoming-out of commodity prices
4. Highest expected return: emerging markets have an attractive medium term expected return thanks to higher expected growth.  
5. Attractive technical picture 

FIXED INCOME STRATEGY

Broad diversification out of low-yielding bond segments

• Although we still have an overweight in high yield bonds, we have slightly reduced our exposure to the bond segment. Spreads have reached our first target, while default rates have recently increased, especially in the US.
• We remain positive on emerging debt, both in local and hard currency. Emerging debt spreads still have some room to tighten and still offer an attractive yield pick-up against US treasuries.
• We are positive on inflation-linked bonds. We expect an increase in headline inflation numbers at the turn of the year. The oil price comparison-base effect represents the main driver. US headline CPI should come in at above 2% in December for the first time since mid-2014 and should peak at levels close to 3% during Q1 2017. Euro zone headline CPI should rise towards 1% early next year, a level not seen in the region since late 2013
• We are positive on the Norwegian krona (NOK).After years of negotiations, OPEC members have finally reached an agreement. If the deal is implemented, it could lead to a global balance between supply and demand by mid-2017. This agreement should support oil prices as the temptation to sell could fade. The NOK is highly correlated to the price of oil and is particularly attractive compared to the Swiss franc (CHF).

COMMODITIES STRATEGY

Topic on oil

After years of negotiations, OPEC members have finally reached an agreement. It has still to be signed on November 30th but is already a new step towards more supportive oil prices. The deal consists of reducing OPEC oil production to 32.5-33 million barrels per day (mb/d) from its current level of 33.3 mb/d.

The deal could lead to a global balance between supply and demand by mid-2017. As US production has stopped decreasing and should remain stable, based on the most recent EIA forecast, the OPEC freeze should allow rising demand to converge faster towards global supply.

This agreement should support oil prices as the temptation to sell could fade, and therefore stabilise above USD50/b, having remained between USD40 and 50 for some months.

However, risks persist regarding the effective implementation of the deal. The formal agreement has yet to be signed at the November 30th meeting.