Coffee Break 2/5/2018

Investors, benefiting from the current goldilocks environment, are wondering if and when the tide will turn. Bond markets are now more in synch with equity markets and both are telling us that there is no recession around the corner.

The current US expansion has received an extension of life partly thanks to the legislative success of the US tax reform. It added some fiscal stimulus with lower taxes and more disposable income. US 10Y bond yields have risen by 40bp since end-November, mainly led by rising inflation expectations. The normalisation in bond markets is not yet complete…. the economy is healthier and inflation is starting to rise. The era of extraordinarily low rates is ending: it is “normalising”, going back to “normal”.

The first data release of January confirms that the strong global growth is going on (i.e. Global PMIs, US Consumer confidence and labour market). Hence, the bond sell-off is linked to a growth shock, pushing cyclical inflation expectations higher and leaving real yields at low levels. Beyond forecast upgrades across the board, in particular for the euro zone, evidence of the current growth shock is that safe haven bonds and, more generally, defensive assets have sold-off in recent days. We will continue to monitor how the corporate sector integrates the acceleration in nominal growth. The first indications, as seen in the earnings seasons point to upward earnings revisions.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We remain positive on equities via both the euro zone and Japan.

• Global economic momentum is accelerating further, however geopolitical risks remain.
  • We concentrate our portfolio’s regional positioning on the euro zone and Japan. Emerging markets are benefitting from supportive fundamentals and a weaker USD.
• Central banks are turning less accommodative:
  • The Federal Reserve started its balance sheet reduction in October, hiked in December and should hike three times in 2018.
  • The ECB has recalibrated its programme, buying less bonds as of January. A rate hike should not occur before 2019.
• While fundamentals remain investors’ focus for the time being, the recent US government shutdown and upcoming debt ceiling discussions might create some uncertainty.
• Equities have an attractive relative valuation compared to credit.

REGIONAL EQUITY STRATEGY

• We remain positive on euro zone equities which are supported by a strong economic and earnings momentum and relatively attractive valuations. Some political hurdles are nevertheless present.
• We have kept a neutral tactical stance on emerging markets equities.
• We have become less negative on UK equities.
• We remain neutral on US equities.
• We are positive on Japanese equities. Japanese earnings have been progressing so far without a depreciation of the JPY.

BOND STRATEGY

• We are negative on bonds and have a low duration. As the momentum in rising bond yields accelerated, we further reduced our duration in the US and Germany by around 0.25.
• With a tightening Fed and expected upcoming inflation pressures, we assume rates and bond yields should continue their uptrend.
• 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 positive stance to emerging market debt, as the on-going monetary easing represents an important support.
  • We are neutral on high yield. The correction on US High Yield market observed recently is not expected to continue. 

• In the US, nonfarm payrolls grew by 200,000 in January, while wages saw their biggest jump since the end of the Great Recession, the Bureau of Labor Statistics reported on Friday.
• The ISM manufacturing PMI is also stable at 59.1 (down by 0.2 from December) and has beaten expectations (58.8). Supplier deliveries, inventories, backlogs of orders and new export orders improved, while new orders, production and employment growth eased.
• In the euro zone, the economy expanded at its fastest rate in a decade in 2017 as according to Eurostat, GDP rose by 2.7% YoY in the last three months of the year. Overall in 2017, GDP rose by 2.5%, the fastest rate since the 3% rise in 2007.
• Meanwhile, sentiment remains firm with a Markit Composite PMI of 58.6 from 58.1 in December. It is the strongest pace of expansion in the private sector since June 2006, as companies hired more staff and inflows of new orders were high. 

EUROPE

Consolidation for European equities last week.

• European markets were dragged down by the Healthcare sector as Novo Nordisk, Roche and Lonza dropped on weaker results.
• Oil & gas companies went also down as the USD bounced back and crude oil took a leg lower.
• All sectors traded in the red except Media, which, was a relative performer with SES, UBM and Sky up.

US

First weekly loss for US stocks this year.

• Energy stocks led the declines following lower-than-expected earnings results from Chevron and ExxonMobil.
• Health care shares also lost some ground mid-week following news that Amazon, Berkshire Hathaway and JPMorgan Chase planned to create a common health care system for their US employees.
• Financials fared better, helped by rising bond yields.

EMERGING MARKETS

First weekly loss of the year for Emerging Equities.

• Asian shares suffered consolidation after a very strong month of gains, dragged down by the Technology sector which has outperformed YTD.
• South Africa chalked up the biggest losses of the week as markets were cautious, ahead of President Jacob Zuma meeting with his party, as some are speculating he could be removed from the presidency.
• China also headed for its worst week in over a year, as a sell-off in small caps rippled across the broader market following huge corporate losses and a shadow banking squeeze. 

RATES

Mildly rising rates in the US and the euro zone.

• On the US front, rates strongly rose supported by good macro data (ISM Manufacturing, non-farm payrolls, and some inflationary pressures).
• Moreover, the FOMC meeting pointed out the healthy performance of the US economy and markets are integrating a rate hike for March (a 99% probability).
• Euro government rates rose in a lesser extent, still driven by a good economic trend in the euro zone.
• 10Y US, UK, Japan and German yields stood at respectively 2.78%, 1.57%, 0.086% and 0.73%. 

CREDIT

The primary markets remained relatively quiet over the week with very few issues.

• The rise in sovereign rates led to some steepening in credit spreads, though overall, the spreads to govies remained relatively stable (-2 bps).
• Financials suffered over the period with subordinated debt (CoCos) bearing the brunt of the rise in spreads and witnessing some underperformance.
• Synthetic markets suffered more than cash indices as the ITraxx Main and especially the Xover widened (to 45 bps and 247 bps) respectively. 

FOREX

Positive week for the EUR and the USD.

• Last week, the EUR and the USD outperformed all major peers thanks to ongoing strong momentum for the EUR and a better-than-expected US jobs report.
• The AUD was hampered as investors recalibrate lower the RBA rate hike expectations after disappointing inflation data.
• The JPY weakened significantly, trading sideways during the week before taking a new leg lower as the USD jumped following the strong US labour report. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES