Coffee Break 2/19/2018

Following the combined equity/bond sell-off registered over the past weeks, markets are now stabilising. After nearly a decade of uninterrupted deflationary surprises, the consensual view of below-trend inflation is getting hit, as seen with the January US Consumer Price Index and wage data. Let us remind that outside the US there are little signs of inflationary pressures, in particular as the upward movements in currencies against the USD over the past 12 months is easing inflation tensions further.

Looking forward, we expect central bank decisions to push bond yields slightly higher, but this should not be an obstacle for global equity performance as long as the growth/inflation mix does not deteriorate sharply. As long as growth remains strong (or even better than expected just a few weeks ago) risky assets should digest gradual increases in bond yields.

Earnings growth remains a key catalyst for equities vs. bonds and credit. At the current stage, wage growth does not appear high enough to set an inflection point in global earnings per share.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We remain positive on equities with the euro zone and Japan as our preferred regions. We actively manage our options strategies and will remain opportunistic while looking for an entry point.

• The rise in inflation uncertainties in the US should not mask the robustness of the global economic news flow.
  • 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.
• Equities have an attractive relative valuation compared to credit. US equities now trade at 17x 2018 earnings, while their forward price-earnings was still above 20x a couple of weeks ago. In addition, strong earnings growth should remain supportive for equity markets’ performance.

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 but the region is no longer subject to a major political risk premium.
• 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 as earnings have been progressing so far without a depreciation of the JPY. The government’s nominations for the new BoJ troika confirmed the dovish stance. We expect the BoJ will not join other central banks in tightening its monetary policy anytime soon. The visibility on an accommodative policy mix and an above-potential expansion is good.

BOND STRATEGY

• We are negative on bonds and keep a short duration.
• With a tightening Fed and expected upcoming inflation pressures, we assume rates and bond yields should continue their uptrend. In addition to rising producer prices, rising wages, fiscal stimulus and USD weakness could push inflation higher.
• 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, the University of Michigan Consumer Sentiment index came in at 99.9 (preliminary) in February, beating estimates of 95.5, and jumping from January's reading of 95.7. Consumer sentiment hit its second highest level since 2004.
• Consumer price index reached 0.5% in January, its biggest increase in five months. However, this figure did not altered the overall picture on inflation as the CPI increase over the past year remained unchanged at 2.1%.
• The euro zone industrial production rose more than expected in December (5.2% YoY), supporting the stronger and broad-based economic growth.
• The GDP rose by 2.7% YoY in the fourth quarter, unrevised from the preliminary estimate and slightly below the 2.8% level in the previous period. 

EUROPE

Cyclicals led European equities higher last week.

• The risk-on sentiment and positive earnings from well-known cyclical stocks (Airbus, DSM, Kering, Renault…) boosted European markets last week.
• Construction & Materials outperformed, lifted by heavyweights Vinci, CRH and Assa Abloy while Oil & gas lagged despite crude oil bouncing from recent lows.
• Defensives lagged also and Utilities, Real Estate and Telecom were among the worst performers.
• Country wise, the CAC 40 was the best index in Europe due to its cyclical nature and lifted by robust earnings (Airbus, Air Liquide, Schneider...).

US

Best weekly gain since early 2013 for US stocks.

• The market’s rebound appeared to be driven by diminishing fears over high inflation and interest rates.
• The technology-heavy Nasdaq Composite performed best, helped by solid gains from Apple and Cisco Systems.
• Financials, Healthcare, Industrials and Business services outperformed within the S&P 500 Index, while Energy shares lagged despite a sharp rally in oil prices.

EMERGING MARKETS

A return of risk appetite boosted emerging equities last week.

• Oil and commodity exporting countries such as Brazil and Russia were helped by the return of a risk-on stance on markets last week.
• South African equities also soared on Thursday with the rand at near 3Y highs after scandal-ridden President Jacob Zuma resigned, clearing the way for the more business-friendly Cyril Ramaphosa to take over.
• While trading in Asia was subdued with many markets shut for the Lunar New Year holiday, India fell on Friday following a statement by MSCI, considering the move by Indian stock exchanges to restrict data feeds as anti-competitive. 

RATES

US inflation data boosted rates last week.

• The latest US inflation numbers came out better than expected by markets and pushed rates higher, leading EUR core and peripheral and EM rates in a lesser extent.
• With equity markets taking a breather last week, risk appetite came back on most markets.10Y US, UK, Japan and German yields stood at respectively 2.86%, 1.59%, 0.06% and 0.72%. 

CREDIT

After a very volatile period, credit markets saw some relief in the wake of the equity markets’ rebound.

• The synthetic markets saw significant tightening with the Itrax main reaching 51 bps (-5bps from previous levels) and the Itrax Xover reaching 262 bps (-18bps).
• Cash markets ended flat, though some volatility was present especially on the high beta names.
• Markets were probably struggling between the recent correction and the search for appropriate entry points.

FOREX

Slight underperformance of the USD last week.

• Following expectations of a larger US deficit in the coming 2 years, the USD was put under pressure and ended the week lower.
• The CAD was also under pressure last week as the Bank of Canada is expected to take a cautious approach to interest rates hikes amid subdued economic activity, high household debt levels, muted wage growth and inflationary pressures.
• The NOK has partly recovered from the latest depreciation, as it is expected that Norges Bank would be more flexible regarding the low inflation environment, thanks to strong economic data. 

WEEKLY MARKET OVERVIEW

 

UPCOMING FACTS AND FIGURES