Coffee Break 3/5/2018

A weakening cyclical momentum outside the US meets a more hawkish Fed policy stance than expected only a few weeks ago.

The overall picture in the US remains supportive as confidence is high, as seen by the surge in consumer confidence to a near-record high and the rise in the ISM manufacturing index. In addition, labour markets are tight, wages are gradually accelerating and house prices are increasing. The new Fed Chair Jerome Powell reached a similar conclusion during his testimony to Congress last week. Clearly, the transition to the Powell Fed coincides with a robust macroeconomic context, increased fiscal spending and a protectionist stance on trade – all this might well lead to a more hawkish monetary policy stance than expected last December.

Moreover, valuations are less demanding now, but fiscal reform is already priced-in by analysts as expected earnings growth in the US for 2018 is now close to 20%, leaving little upside.

As a result, we see a less favourable risk-reward on the short term and we therefore adopt a neutral stance on equities.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We adopt a neutral equity stance by reducing our euro zone exposure. The rise in US inflation uncertainty should not mask a temporarily weaker global economic news flow.

• Global growth momentum outside the US is likely to have peaked.
• US trade policy (including USD) appears as a major policy unknown, as risks start to materialise.
• Global monetary tightening is progressive, but the US are tightening first:
  • The Federal Reserve started its balance sheet reduction in October, hiked in December and should continue its hiking cycle in March.
  • The ECB has recalibrated its programme, buying less bonds as of January. A rate hike should not occur before 2019.
• Geopolitical risks remain an obstacle.

REGIONAL EQUITY STRATEGY

• We have reduced our euro zone equity exposure to neutral. Recent data show the first signals of a lower cyclical growth. The economic expansion in the region remains solid, but markets expectations have increased, and this is more likely to lead to disappointments.
• 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. The US policy mix is evolving as fiscal policy becomes more accommodative and monetary policy more restrictive. We note that economic activity has further accelerated at the turn of the year implying that the growth/inflation mix is not deteriorating yet.
• We are positive on Japanese equities as earnings have been progressing so far without a depreciation of the JPY. Being overweighed on Japanese equities has been a winning trade for us so far. Japan benefits from the global expansion and the BoJ will not join other central banks in tightening its monetary policy, leaving credit conditions accommodating.

BOND STRATEGY

• We are negative on bonds and keep a low duration.
• With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to continue their uptrend towards 3% on 10Y US government debt.
• 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 on emerging market debt, as the on-going monetary easing represents an important support.
  • We are neutral on high yield. 

• In the US, durable goods orders dropped by 3.7% in January, below a consensus expectations of a 2% decline. This was the biggest decline in six months and followed a 2.6% jump in December.
• However, US factories expanded in February at their fastest rate since May 2004 as shown by the ISM manufacturing index standing at 60.8, coming from 59.1 in January.
• In the euro zone, inflation tumbled to its lowest level in more than a year in February at 1.2%, while core inflation remained steady at 1%.
• The Markit Eurozone Manufacturing PMI was revised slightly higher to 58.6 in February, from a preliminary reading of 58.5. Although it showed the slowest expansion in factory output in four months, the manufacturing sector's performance remained one of the strongest seen over the 20-year survey history.

EUROPE

Softening global momentum put a negative spell on European equities.

• New US trade tariffs on steel and aluminium weighed on Basic Resources shares.
• With bond yields trading lower, Defensives stocks significantly outperformed Cyclicals with Consumer Staples and Healthcare among the winners.
• Country wise, the DAX lagged due to its cyclical nature and the FTSE was a relative performer in a downbeat market.

US

Stocks recorded sharp losses for the week.

• The statement before Congress of the new Fed Chair Jerome Powell, signalling a more hawkish Fed, sent US stocks lower last Tuesday.
• Spike in interest rates remains the biggest threat overhanging the markets.
• Information Technology and Consumer Staples shares held up best in the S&P 500 Index during the week, while Industrials and Business services shares fared worst.

EMERGING MARKETS

Emerging market equities fell to two-week lows last week.

• Steelmakers took a pounding last week after US President Donald Trump said he would impose hefty tariff on imports of steel and aluminium.
• Manufacturing data from across emerging markets were still in expansion territory but growth in China’s manufacturing sector in February cooled to its weakest level in more than 18 months, raising concerns that a slowdown in the world’s second biggest economy this year could be sharper than expected.
• At the same time, Central and Eastern European markets are experiencing slower growth. 

RATES

Lowering sovereign rates following the latest Fed comments.

• In his first testimony before Congress, new Fed Chair Jerome Powell highlighted stronger economic growth and more confidence in reaching the inflation target.
• This led to increased expectations of rate hikes for 2018-2019 and a risk aversion move, driving sovereign rates lower.
• Fears over a trade war also mounted, as Donald Trump announced a +25% tariff on imported steel and 10% on imported aluminium.
• Going forward, results of the Italian elections and the SPD ballot are due while the ECB will hold its next meeting on Thursday.
• 10Y US, UK, Japan and German yields stood at respectively 2.83%, 1.44%, 0.06% and 0.62%.

CREDIT

Resilient Investment Grade credit cash market

• Good start of the week for iTraxx indices but by midweek spreads widened following a more hawkish Fed comment and concerns over the proposed commercial tariffs in the US.
• High grade fund flows back to negative after a week of inflows.
• Second-best week of the year in terms of supply.

FOREX

Strong week for the JPY.

• The JPY was in a upbeat mood last week after the release of a statement by the BoJ telling that the central bank would start thinking about how to exit its unprecedented easing programme around fiscal year 2019.
• Other performers in the major currencies universe were the EUR, the USD and the NOK.
• As worries on trade agreement in the NAFTA negotiations amplified, currencies such as the CAD and the MXN underperformed slightly last week.

WEEKLY MARKET OVERVIEW

 

UPCOMING FACTS AND FIGURES