Coffee Break 11/7/2016

Over the past week, investors' attention shifted to the upcoming US presidential elections on 8 November. Hillary Clinton's lead has been slipping since the controversy related to the warrant obtained by the FBI to examine her e-mails (although it was released this Monday morning that the FBI was unable to find any violations). October has been generally favourable to Hillary Clinton and she is likely to maintain her recent lead.

However, following Donald Trump's gain in the national polls we have decided to slightly adapt our portfolio against the Trump tail risk that could lead to a short-term risk-off scenario. As emerging markets are the most sensitive to a Trump election, we have decided to slightly reduce our exposure to emerging markets equities and emerging debt, both in hard and local currency. We nevertheless maintain a significant overweight, as emerging markets remain our most important conviction for the coming months.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : new change

EQUITIES VERSUS BONDS

We hold a slight overweight in equities vs. bonds:

• The macro news flow is in line with low but positive growth.
  • In the US, we expect accommodative monetary policy to prevail while Chinese authorities will continue to offer a supportive policy mix.
  • Europe is showing resilience following the "Brexit" referendum.
  • The stabilisation in commodity prices mitigates downside risks on a global scale.
• The medium to long-term economic risks have increased due to the various political events:
  • The two-year "Brexit" negotiations should start by the end of Q1 2017.
  • The US presidential elections have been perceived as the n°1 tail risk for investors over the past three months.
• Central banks keep a dovish stance, providing ample liquidity to the markets.
  • Following the FOMC and the release of supportive economic data, markets now price a probability of close to 80% of a 25bp December rate hike.
  • The Bank of Japan innovated by yield curve targeting, while the ECB is expected to clarify its intentions.
• Oil markets continue their rebalancing, and recent agreement expectations have led the way to higher prices. This is supportive for risky assets, particularly emerging debt, high yield and inflation-linked bonds. We expect a gradual increase in inflationary pressures and are confident in our inflation-linked exposure.
• Emerging markets face fewer headwinds, thanks to a stabilisation of commodity prices, a working Chinese stimulus and a cautious Fed that alleviates fears of USD strength.

REGIONAL EQUITY STRATEGY

• We are currently neutral in euro zone equities (since mid-August). The current risk premium of euro zone equities is attractive, but can be largely explained by the level of political risk.
  • We currently have a relative value strategy in favour of the DAX against the FTSE 250, while staying neutral. We anticipate a struggling domestic UK economy following "Brexit".
• We have maintained our underweight in UK equities. The government's perceived hard "Brexit" stance weighs on UK assets, pushing the GBP to new lows, bond yields significantly higher and leading to a substantial equity markets underperformance in common currency terms.
• We have a neutral stance on US equities and Japan.
• Although emerging markets have now become a consensus trade, investors' positioning keeps rising. Emerging markets remain our main conviction for the time being thanks to an improving economic and earnings momentum, the bottoming-out of oil and commodity markets, and attractive relative valuations. The region is more at risk should the USD appreciate too much or when US bond yields increase more than expected, which is not our base scenario. We nevertheless decided to slightly reduce our emerging markets exposure, as the latest polls showed an improvement for Donald Trump, that could lead to a short-term risk-off scenario.
  • We prefer India: economic fundamentals (expected economic growth at 7.8% with an inflation under control) are improving, both structurally and cyclically and the resilience of the Indian economy is supported by a domestic reform agenda, which makes the country less vulnerable to external influences.

BOND STRATEGY

• Anticipating an interest rate rise, we have reinforced our underweight in duration over the past weeks.
• We continue to diversify out of low/negative yielding government bonds:
  • We remain overall slightly short in duration.
  • We are particularly positive on emerging debt, both in local and hard currency. Emerging bonds are benefiting from inflows, as they provide an attractive yield compared to developed markets. We nevertheless decided to slightly reduce our emerging debt exposure, both hard and local currency, as the latest polls showed an improvement for Donald Trump, that could lead to a short-term risk-off scenario.
  • We are moderately positive on high yield. The significant spread tightening this summer has reduced the potential, but the carry remains attractive.
  • We are positive on inflation-linked bonds, as base effects (oil prices) have a positive effect. US headline CPI should come in 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 1.5% early next year, a level not seen in the region since end-2013. External prices pressures are starting to increase and inflation expectations are starting to bottom-out from extremely low levels.
• Regarding currencies, our main strategies are:
  • Emerging market currencies, based on our conviction that the USK peak and the low in commodity prices are behind us.
  • Commodity currencies, via NOK against CHF, to benefit from rising oil prices and an overvalued CHF that upsets the Swiss National Bank.

• In the US, employers maintained a strong pace of hiring in October, boosting wages for workers as nonfarm payrolls increased by 161.000 jobs last month. August and September data were revised to show 44.000 more jobs than previously reported.
• The US Labor Department issued that initial claims for state unemployment benefits increased to 265,000 for the week ending on 29 October, the highest level since early August. It was the 87th consecutive week that claims remained below 300,000.
• In the euro zone, growth stayed its course in the third quarter (+0.3%). Spain shrugged off a political impasse and continued to outperform its neighbours, with GDP increasing at a 0.7% pace.
• Economic momentum accelerated less than forecasted in October with the Markit's PMI composite rising to 53.3 (up from 52.6 in September, but below a preliminary reading of 53.7). France's services activity came in weaker than expected. 

EUROPE

Negative performance for European equities with the Stoxx 600 closing at 329, down by 3.52% for the week.

• European shares fell for the week to a level not seen since at least three months.
• The decline in European stocks came in tandem with a general global sell-off as recent polls showed a tightening US presidential race.
• At a sector level, Retail, Travel & Leisure and Real Estate outperformed the benchmark (-1.58%, -1.68% and -1.95% respectively) while Oil & Gas (-3.82%), Banks (-4.88%) and Automobiles (-5.04%) underperformed.

US

Negative week for US equities with the S&P 500 closing at 2085 last Friday.

• Heightening uncertainties surrounding the upcoming presidential election seemed to weigh on sentiment.
• The general “risk off” environment weighed especially on the Nasdaq Composite, home to many fast-growing and highly valued technology companies.
• But the recent economic data releases were generally positive with personal income and consumer spending both recording healthy gains.
• At a sector level, Materials, Utilities and Industrials outperformed the S&P 500 (-0.65%, -1.12% and -1.13% respectively) while Energy (-2.17%), Telecoms (-2.29%) and IT (-2.87%) underperformed.

EMERGING MARKETS

Second consecutive week of losses for Emerging markets stocks.

• Investors sought to hedge against the possibility of a Donald Trump victory in the US presidential election.
• In Turkey, the local stocks market plunged following the arrest of opposition leaders, which worsened political upheaval.
• In South Africa, stocks were set for their lowest level since February as a stand-off between President Jacob Zuma and Finance Minister Pravin Gordhan has increased the risk of a downgrade from ratings agencies.
• Commodity exporting countries such as Brazil and Russia declined due to the recent drop in oil prices.
• At a sector level, Materials, Finance and Telecoms outperformed the benchmark (-1.54%, -1.77% and -1.96% respectively) while Consumer Discretionary (-3.49%), Energy (-3.50%) and Health Care (-3.99%) underperformed. 

RATES

Decent US economic figures boosted markets last week

• The last FOMC statement maintained the macroeconomic perspectives unchanged and acknowledged that inflation has moved up.
• In the euro zone, the final readings of the PMI surveys suggested that German and Spanish economies were in a good shape while the Italian economy was slowing down. Again, political uncertainty weighted on Italian yields (+16bps over the week).
• In the UK, yields decreased despite the BoE lowering the likelihood of a future rate cut saying the economic impact of the "Brexit" may be lower than previously thought. The central bank increased its growth projections for 2016 and 2017 while signalling that inflation could rise further due to the depreciation of the GBP.
• Over the week core sovereign rates slightly eased with the 10Y US, UK, Japan and German yields standing at respectively 1.78%, 1.14%, -0.07% and 0.13%.

CREDIT

A complicated week for credit market and risky assets, driven by uncertainties about the US presidential election.

• Strong results in the continuity of past weeks, especially for corporate and on the back of mitigated macroeconomics data.
• Both equity and oil prices suffered last week. In this context, Credit market widened: Cash bonds (Investment Grade: +3bps, High Yield: +18bps) underperformed synthetic indices with Itraxx Main and Cross-over widening by +5bps and +10 bps respectively.
• The primary market was quite with majority of issues coming from corporates.

FOREX

The USD was the main underperformer last week following rising uncertainties over the US presidential election.

• The CHF and JPY benefited from the risk-on effect related to the US elections and appreciated.
• The GBP appreciated strongly mid-week after the decision issued by the High Court that the British government must consult Parliament before proceeding with formal negotiations over its withdrawal from the European Union.
• The NZD also performed well last week following the publication of good macroeconomic data.

COMMODITIES

Negative week for commodities with the GSCI Light Energy index losing 2.6%. It nonetheless remains positive for the year (+0.9%).

• WTI oil prices fell by about 5% last week and Brent fell by more than 3% after the Energy Information Administration issued that 14.4 million barrels were added to inventories, marking the largest increase in nearly three decades.
• Natural gas prices tumbled by 9% last week as the US Energy Information Administration reported that domestic natural gas stocks increased by 54 cubic feet.
• Cocoa futures fell last week by close to 4%, as the December/March spread collapsed, indicating weakening near-term demand. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES