Coffee Break 3/12/2018

Equity markets in the euro zone were able to recover last week some of the ground lost since the beginning of the month. In particular, Italian and German markets outperformed.
Following the general elections, Italy will have to face a new period of political uncertainty before a new coalition can emerge, but this outcome was largely anticipated. In addition, Italian equity valuations show a discount relative to the euro zone and therefore already integrate a substantial risk premium. Finally, we note that earnings continue to be revised upwards in Italy – contrary to Germany.
The fact that German mainstream parties have agreed, 5 months after the general elections, to form a new “grand coalition” certainly constitutes a support. But on the other hand, the loss in cyclical momentum which has started to emerge outside the US is likely to hit German stocks, which are particularly exposed to cyclical sectors (Automobiles, Chemicals, Industrials). In relative terms, the earnings momentum is no longer in favour of German stocks. Looking forward, protectionist measures would add new pressure on German stocks.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We see a less favourable risk-reward and have trimmed our equity holdings towards neutral.
The rise in US inflation uncertainties 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 negative on UK equities. There is less than one year to set up new trade relations in the “Brexit” negotiations and little progress has been made since the start of the year. A hawkish Bank of England monetary policy stance has put a barrier to GBP depreciation, challenging overseas profit growth.
• 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 reduced our duration by a further 0.25Y
• 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 the 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, Non farm payrolls increased by 313K in February, beating markets expectations of 200K. Employment rose in construction, retail trade, professional and business services, manufacturing, financial activities and mining.
• Markit Economics also reported a reading of 55.8 for February’ Markit US Composite PMI, higher than January’s final reading of 53.8..
• In the euro zone, gross domestic product rose by 2.7% YoY in Q4 2017, in line with markets’ expectations. GDP growth stood at 2.3%, slightly below earlier estimates of 2.5%.

EUROPE

Cyclicals and exporting companies led European equities higher last week.

• Technology rallied lifted by heavyweights SAP, ASML, Infineon and STM. Utilities outperformed also, boosted by Engie’s results.
• Euro zone Banks underperformed, dragged by the Italian ones and Media was the worst performing sector dragged by WPP, which couldn’t bounce following last week’s profit warning.
• Geographically, Italy was still the best performer despite the Italian elections result, lifted by Atlantia and Telecom Italia.

US

Rebounding US stock market.

• Last week, all of the major indexes went back into positive territory for the year to date.
• The technology-heavy Nasdaq Composite Index fared best and managed to set a new intraday high on Friday.
• Small caps also performed well.
• Along with IT, Financials, Industrials, Business services and Materials led the S&P 500’s gains for the week, while Utilities lagged.
• The economic environment seems to be the most prominent tailwind, with stocks recording their biggest gains on Friday, following the release of the Labor Department’s employment survey.

EMERGING MARKETS

Positive week for Emerging markets.

• At the start of the week, worries over a US led global trade war sent emerging markets shares to their lowest in a month.
• Asian equity indexes ended the week higher as North Korea committed to ”denuclearisation” and offered to hold the first-ever US-North Korea summit.
• This news sent the South Korean market up, to a five-week high and Chinese stocks also added around 1%.
• Egypt continued to climb during the week, reaching another all-time high as it benefits from its central bank’s decision to cut interest rates. The first time it has done so since letting the currency float freely in 2016.

RATES

The Italian elections led to a brief period of volatility.

• Last Sunday’s election in Italy led to the victory of populist parties. This brought some volatility on markets on Monday. But finally, the BTP remained quite resilient and ended the week at a level of 1.99%.
• The week also saw the ECB meeting with small changes of wording from Mario Draghi, which, brought the Bund upward.
• The Bund finally regained its level of the beginning of the week after Mario Draghi had reviewed his inflation forecast from 1.5% to 1.4%. This reinforces the consensus for a first hike not before Q2 2019.
• In the US, NFP exceeds expectations with 313k job creations against 200k anticipated (highest since July 2016). However, hourly earnings were a bit disappointing, which tempered inflation expectations.
• 10Y US, UK, Japan and German yields stood at respectively 2.89%, 1.50%, 0.025% and 0.57%.

CREDIT

Widening cash credit spreads last week.

• The main fact of the week was the issuance in the financial sector of a Restricted Tier 1 in USD by Scor for the first time, a Perpetual with a first call date at March 2029 ($625mln).
• Cash credit spreads widened by 2bps for Investment Grade and remained flat for High Yield.
• Regarding derivatives, iTraxx Main and Xover respectively tightened by1bp and 4bps over the week.
• Rather intense activity on the primary market with issues over EUR 9.5bn of non-financials and EUR 18bn of financials.

FOREX

Declining JPY last week

• After a good performance on the previous week , the JPY declined by 1.2% and the CHF sustained the main trend.
• These two currencies suffered on the back of improved risk sentiment after concerns over the US tariff plans and geopolitical tensions surrounding the Korean peninsula eased.
• The EUR/USD cross was stable on the week.
• The AUD outperformed as it is expected that Australia would be granted an exemption by the US authorities on steel and aluminium tariffs, as Canada and Mexico.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES