Coffee Break 8/7/2017

Last Thursday, as expected, the BoE left its policy on hold. GDP forecasts were revised down with 2017 and 2018 growth cut respectively to 1.7% and 1.6% amid persistent uncertainty over “Brexit” negotiations outcome which could weigh on both demand and supply. Inflation was also seen peaking at 3% in October and gradually moving towards 2.2% by 2019. As an immediate reaction, the GBP fell sharply against the USD and the EUR. The central bank however warned that rates may need to rise faster than at the levels the markets were currently pricing them.

Earnings and sales publications continued to surprise positively in the US while earnings revisions remained broadly positive except for the energy sector. Prospects for the coming months were also encouraging as multinational companies benefited from the weak USD. In Europe, the picture looked less optimistic despite earnings publications broadly in line so far. Earnings revision ratio has fallen to a 1Y low level amid recent EUR appreciation, leading 2017 growth expectations to be revised down to around 11%.

Although we expect the EUR/USD appreciation to come to an end, we see that a major resistance has been broken on the short run and we have therefore decided to sell half of our USD overweight exposure.

In the coming weeks, we will closely follow UK and US political developments as well as the Central banks meeting in Jackson Hole.

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, including the July Bank Lending Survey confirmed that the European recovery is well on track and is leading to above-trend growth in 2017-18.
  • 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.
• Monetary policy divergence between both sides of the Atlantic should remain:
  • We consider that investors are too complacent about Fed policy adjustments while they are much more cautious on the impact of ECB decisions. Despite a possible tapering announcement, the ECB will continue to expand its balance sheet next year. At the same time, the Fed could start reducing its own balance sheet by October 2017 and accelerate the pace of its balance sheet’s reduction in 2018. The symposium in Jackson Hole in August should give more clarity.
• 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, Russia and potentially Iran add to uncertainties.
  • In the US, after the collapse of the healthcare reform, the 2018 budget and the tax reform will be key for the credibility of Donald Trump’s presidency. Slippage in the timing of the fiscal stimulus 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, the accommodative and prudent central bank and the strong corporate earnings momentum underpin the attractiveness of the region’s risky assets. We are still positive on Italian equities, especially as they remain relatively immune to the EUR appreciation. We also keep our exposure to banks. The sharp decline in the political risk premium and recent bank rescues are restoring confidence. However, we remain vigilant as the recent EUR appreciation has been a headwind to EMU equities’ performance.
• 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. However, we remain vigilant as Abe’s approval rating is decreasing.
• 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 have revised our spread targets downwards, the duration effect is less negative and the carry remains attractive.
  • On the currency side, we sold half of our USD overweight exposure as the EUR/USD exchange rate broke key resistance levels.

• In the US, The ISM manufacturing index fell slightly to 56.3 last month after reaching a 3-year high of 57.8 in June. Although new orders, production and plans for employment all declined, they remained at very high levels typically seen during a period of stable economic growth.
• Non-farm payrolls increased by 209,000 in July, against consensus estimate of 180,000 and following an upwardly revised 231,000 gain in June. Meanwhile, unemployment rate fell to a 16-year low of 4.3%.
• In the euro zone, the Markit Eurozone Composite PMI reached 55.7 in July, down from 56.3 in June and from a flash estimate of 55.8. The reading has been above the 50 mark that divides growth from contraction since mid-2013.
• In Germany, the Markit Germany Manufacturing PMI fell to a 5-month low at 58.1 in July, from a preliminary reading of 58.3 and 59.6 in June. The slowdown was largely due to softer increases in output, new orders and jobs. 

EUROPE

Positive week for European equities.

• Single stock performances after Q2 earnings reports was the main driver last week.
• Italy and the FTSEMIB performed best after excellent results from Intesa and UniCredit.
• The FTSE100 also outperformed for similar reasons with positive results from Next and BP among others.
• The declines in the GBP and the EUR after the publication of the US non-farm payrolls on Friday boosted the FTSE 100, DAX and CAC 40.

US

US equities boosted by a strong US jobs report.

• All main indexes finished the week in positive territory.
• Financials were the best performing S&P sector last week.
• But gains on the S&P 500 were curbed by a decline in Healthcare and a severe drop by the Consumer Discretionary giant Viacom.

EMERGING MARKETS

Fourth week of gains for Emerging equities.

• The weakness of the USD is keeping emerging markets aloft, shrugging off geopolitical risks.
• But fresh falls for US technology giants filtered through some Asian names such as Samsung and put Korean stocks on track for a second downwards week.
• As markets are monitoring the potential trade war between the US and China, Chinese mainland shares ended the week down, although Shanghai-listed stocks eked out a small weekly gain.
• Russia stayed under pressure after a fresh set of sanctions were slapped on Russia by the United States.

RATES

European sovereign bond yields marginally lower last week while curves flattened.

• UK government bond yields have fallen after the release of the BoE’s inflation reports (more dovish than expected).
• In the US, yields dropped early in the week following mixed data (ISM) before rebounding after the strong labour market reports.
• 10Y US, UK, Japan and German yields stood at respectively 2.28%, 1.17%, 0.05% and 0.48%. 

CREDIT

Credit markets continued to perform last week with spreads narrowing by 1 to 11 for Investment Grades and High Yields respectively.

• Teva suffered from bad earnings and analysts warned investors that it may breach debt covenants. As a result, Moody’s downgraded the firm to Baa3.
• Still low volumes on the primary markets due to the holiday period. 

FOREX

EUR is still rallying…

• The EUR rose to a more than 2.5 year high against the USD on the back of robust economic data.
• The rally against all other major currencies comes also from speculation of a less accommodative European Central Bank facing the euro zone’s improving economic outlook.
• The AUD, NZD and CAD all struggled against the EUR.
• Markets were heavily short USD for weeks on, but on Friday, good economic data helped the USD to offer some resistance to the euro zone currency, loosing less than 1% on the week. 

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES