Coffee Break 4/30/2018

Last week, all eyes were on the ECB committee. Following a virtually unchanged press statement – in which the ECB kept its faith in a “solid and broad-based expansion of the euro area economy” – the press conference contrasted somewhat, showing a clearer sense of caution. As a result, 10Y bond yields declined, even beyond the euro zone. US Treasury yields, in particular, fell for the first time in eight days, after gaining 20 basis points.

We learned that the ECB Governing Council did not discuss monetary policy, implying no preparation for an imminent and important policy decision such as a potential announcement regarding the fading-out of the Quantitative Easing. Hence, we see an increased likelihood of a monetary easing extension beyond September which, in turn, is unlikely to be announced before July 26th.

The implications for asset allocation are threefold:

• The transatlantic yield spread hit a 29 year record of 240 basis points and could extend further as central bank policy divergence is now manifest;
• As euro-based investors, we are positioned for a temporary weakening of the currency, in particular against the USD;
• A weaker euro and a continuing growth momentum give some support to euro zone equities, notwithstanding the latest economic indicators, which suggest that the growth cycle may have peaked.

This week will again be important for bondholders due to the Fed meeting (without press conference though), the US Treasury quarterly refunding plan announcement, PCE inflation, ISM data, and the April job report.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We have kept our exposure to equities unchanged but we are looking for an entry point to increase risk exposure as we expect an underlying favourable background.

• Growth beyond the 1st half of 2018 should remain solid, self-sustained and synchronised in developed and emerging markets.
• We expect a gradual rise in inflation, but no inflation fear.
• Global monetary tightening is progressive.
• The good start of the Q1 earnings season should support the equity markets.
• However, we note an increase in downside risks: macro momentum is peaking, monetary normalisation is accelerating in the US and concerns about protectionism remain.

REGIONAL EQUITY STRATEGY

• We are neutral on the euro zone. The region still displays a robust economic expansion but activity indicators show some signs of weakness. The ECB remains accommodative, and is not in a hurry to become hawkish. Corporate earnings momentum has weakened and euro zone equities currently lack new catalysts, not only a weaker currency.
• We are underweight on Europe ex-EMU equities. The Bank of England’s monetary policy stance has put a barrier to GBP depreciation and we expect a further firming of the currency, challenging overseas profit growth. “Brexit” negotiations remain a risk, while negotiations on new trade relations are stalling. UK profit growth expectations have slightly been revised upwards since the start of the year but still register lower expected earnings growth and thus lower expected returns than the continent, justifying our negative stance.
• We have a neutral stance on US equities. We acknowledge, the improving earnings growth and the positive impact of Donald Trump’s tax and deregulation. Nevertheless, the US trade policy is a major policy unknown.
• We keep our Japanese exposure to neutral. Visibility on an accommodative policy mix and an above-potential expansion remain positive for Japan. The recent currency weakness is a support for the stock market which remains highly correlated to the performance of the JPY.
• We are neutral on emerging markets equities. They are impacted by a tightening Fed and the geopolitical noise around the budding trade war between the USA and China. In addition, the high weighting of the tech sector (28%) is adding volatility.

BOND STRATEGY

• We are underweight on bonds and keep a short duration
• With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to continue their uptrend. In addition to rising producer prices, rising wages, fiscal stimulus and trade tariffs could push inflation higher. The Fed will continue its hiking cycle.
• The overall improvement in the European economy could also lead EMU yields higher over the medium term. The ECB remains dovish in its Quantitative Easing plans and is opposed to a strong euro.
• We have a neutral view on credit as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
• There is a supportive environment for emerging debt and we believe spreads can tighten further. The carry is among the highest in the fixed income universe and so are expected returns. It is also an attractive diversification vs other asset classes. 

• In the US, Q1 GDP came in at an annualized rate of 2.3%, above the 2% consensus expectations and the best Q1 figure since 2015.
• New orders for US manufactured durable goods rose by 2.6% MoM in March, following an upwardly revised 3.5% surge in February. This increase was mainly driven by higher demand for transportation equipment.
• In the euro zone, the preliminary PMI composite from Markit came in slightly higher than expected in April at 55.2, in line with March’s PMI.
• In the UK, Q1 growth came in at an annualized rate of 1.2%, the weakest since the second quarter of 2012.

EUROPE

Positive results for European equities.

• European stocks broadly gained as investors digested a flood of corporate earnings and welcomed a seemingly dovish monetary policy statement from the European Central Bank.
• Germany’s exporter-heavy DAX 30 lagged the broad European region, while France’s CAC 40 outperformed.
• In the UK, the FTSE 100 Index of blue chip posted healthy gains for the week.

US

Flattish week for US equities

• Investors reacted negatively to the last flow of earnings reports.
• Utilities and Real Estate sectors outperformed within the S&P 500, while Industrials performed worst.
• Stocks suffered from the earnings releases by Caterpillar and 3M as they provided lower profits outlook.
• But Thursday brought the week’s best daily performance after Facebook and Amazon soared following the release of revenues and profits that easily beat estimates.

EMERGING MARKETS

Slightly negative week for Emerging markets.

• South Korean stocks were up last week after the meeting held between the North and South Korean Presidents as they agreed to end their 70 years of estrangement and pledged to pursue denuclearization of the Korean Peninsula.
• Hong Kong and China were the week’s standout underperformers, led lower by the Technology sector following a report that the US authorities were investigating Huawei.
• Resources stocks underperformed as base metals took a leg lower and Energy outperformed as crude oil continued the recent rally. 

RATES

Performing week for the rate market.

• Mario Draghi had a cautious tone at last week ECB meeting, pointing to the recent moderation in the euro zone activity indicators with no further steps of QE exit being discussed.
• On the data front, US growth was stronger than expected at 2.3% vs. 2% anticipated.
• On the contrary, UK growth figures were slightly below expectation at 1.2% vs. 1.4% anticipated.
• 10Y US, UK, Japan and German yields stood at respectively 2.97%, 1.47%, 0.055% and 0.58%.

CREDIT

Stable credit spreads during the week.

• No change last week with the cash market ending at 92bp while the iTraxx Main was at 54bp.
• High beta sectors like Sub Insurance or corporate hybrids were a touch wider.
• So far, quarterly results were below expectations in Europe with 50% of the companies disappointing while 80% of the US companies did better than the consensus.
• Less supply last week due to blackout period with 3.4bn in Investment Grade non-financials, and almost nothing from Financials.

FOREX

Grand week for the USD.

• Last week, the USD had an impressive performance as 10Y T-bills yields briefly touched the 3% mark and the US economy kept performing.
• No relief for the SEK as the local central bank delayed plans to raise rates, arguing that rates needed to stay low to revive inflation.
• The GBP sank last week as the UK economy registered its worst Q1 performance since 2012.
• The EUR got hurt following Mario Draghi’s comments that the euro zone momentum softened at the start of the year.

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES