Coffee Break 1/8/2018

Highlights

Global: PMIs across the world have accelerated further at the turn of the year.
US: Non-farm payrolls increased last month but well below expectations.
Asset allocation: We have entered the year with a risk-on stance.

Asset Allocation :

We have entered the new year with a risk-on stance as visibility, valuations and volatility are favourable. We expect the evolution of these 3 “V” to be crucial for adding value over the coming months. Virtually all equity markets worldwide have responded positively to better-than-expected economic news flow at the turn of the year. In this context, bond yields have risen but we note a slight spread compression of European periphery vs core. This is reassuring news, as it would indicate that economic vigour trumps political uncertainty after the elections in Catalonia and ahead of the Italian general elections in March.

As a reminder, the recent acceleration in the synchronised global expansion happened before the coming into effect of the US tax reform. Further, as central bankers have indicated recently, there should be a cautious withdrawal of post-crisis ultra-accommodative policies which could continue to put some upside pressure on government bond yields. Looking forward, we therefore expect a continuation of positive (but somewhat less) growth momentum and little (but somewhat more) inflation pressures. As momentum slows down but the expansion continues, we would not be surprised to see a first step into a slightly higher volatility regime over the course of 2018.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We remain positive on equities via both 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 US dollar.
Central banks are turning less accommodative:
- The Federal Reserve started its balance sheet reduction in October, hiked in December and should hike three times this year.
- The ECB has recalibrated its program, buying less bonds as of this month. A rate hike should not occur before 2019.
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. We have increased our exposure to European small caps on the basis of good visibility on the domestic European profit cycle and less FX sensitivity.
We have kept a neutral tactical stance on emerging markets equities.
We have become less negative on UK equities. We have reduced our underweight by 1% vs the euro zone. The hawkish BoE monetary policy stance has put a barrier to the GBP depreciation, challenging overseas profit growth while “Brexit” negotiations are progressing.
We remain neutral on US equities. Donald Trump has recently signed the tax bill passed by Congress, but the FY 2018 spending legislation is still pending. The transition from Janet Yellen to Jerome Powell should be smooth as he presents himself as “a pragmatic moderate”, who would - largely - continue the Fed’s current policies.
We are positive on Japanese equities. Following the elections, the Prime Minister Abe’s mandate has been validated, hence we see an increased visibility on the policy mix for the coming quarters. Strengthening growth and a supportive domestic policy mix are among the main performance drivers and the BoJ confirmed that it would not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY. Furthermore, 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.
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 observed recently is not expected to continue.

Macro :

In the United States, non-farm payrolls increased by 148,000 in December, well below expectations. An unexpected loss of 20,000 retail positions, despite the holiday shopping season, held back the headline number.
However, the unemployment rate was in line with estimates of 4.1%.
The euro zone economy gathered further growth momentum at the end of 2017 with a Markit PMI Composite Output Index at 58.1 in December, its highest reading since February 2011 and up from 57.5 in November.
But, inflation in the euro zone slipped further away from the European Central Bank’s target in December as average consumer prices index rose by 1.4% YoY.

Equities :

EUROPE

European equities enjoyed a good rally last week

Risk-on positive sentiment and numerous strong global economic data led European shares up.
Cyclicals outperformed defensives by led by Automobiles.
Euro zone Banks rallied on higher bond yields and tightening spreads in peripherals.
Country wise, Italy and Spain outperformed while UK lagged dragged down by Diageo, Compass and a profit warning by Debenhams.

US

Strong start of the year for US Equities

All of the major indexes started the year with new highs.
The Dow Jones Industrial Average passed the 25,000 threshold last Thursday, less than a year after breaking through 20,000 for the first time.
Energy stocks were particularly strong, helped by rising oil prices.
Utilities and Real Estate stocks were weak, held down by a sharp rise in long-term bond yields.

EMERGING MARKETS

Strongest start since 2006 for Emerging equities.

In Asia, China and Taiwan rallied due to the positive data released during the week.
Korea also showed its strength, led by tech blue chips, after North Korea stated it would meet with South Korea for talks this Tuesday.
Russia and commodity exporting countries in Latin America also led the rally as tensions in Iran and ongoing OPEC-led output cuts have pushed oil prices to their highest level in over 2 years.

Fixed Income :

RATES

Global government rates rose over the week driven by credit risk appetite and solid economic data.

On the US front, data were more mixed, non-farm payrolls were weaker than expected while unemployment remained stable at 4.1%.
On the other hand, the publication of PMI data came in above consensus for December.
10Y US, UK, Japan and German yields stood at respectively 2.45%, 1.23%, 0.06% and 0.43%.

CREDIT

Strong start of the year for credit, especially for high beta instruments.

Cash credit spreads tightened by 2 bp for Investment Grade and 5 bp for High Yield.
Regarding derivatives, iTraxx Main tightened by 1 bp and iTraxx Xover by 11 bp.
The first week of 2018 saw issuance level reaching EUR 9bn of bonds from Automobiles and Banks.

FOREX

Commodity related currencies outperformed EUR and USD last week.

The rise in energy and metal prices were positive for commodity related currencies (NOK, CAD, NZD, AUD) which outperformed the EUR and USD.
Combined with better-than-expected data, the NOK and the CAD were the top performers.
After strengthening at the end of last year, the EUR did not keep its momentum and was stable last week. With slightly rising yields, the risk-off currencies suffered (JPY & CHF).