Weekly Insights 8/16/2017

Highlights

  • US: initial weekly jobless claims below 300,000 for 127 straight weeks, the longest such stretch since 1970.
  • Euro zone: Investor sentiment remains stable, buoyed by strong current conditions.
  • Asset allocation: The current escalation of geopolitical tensions does not alter our fundamental view that global expansion continues, led by the euro zone. We maintain our overweight on equities and remain negative on bonds. 

Asset Allocation :

The escalation of geopolitical tensions between the US and North Korea has recently triggered a spike in volatility, an equity markets’ correction, a decline in interest rates and a rebound in the price of gold. However, this risk-off move is far from resulting in a panic with only few equity indices close to their key support levels.

This situation does not alter our fundamental view that global expansion continues, led by the euro zone. However, European equities did not benefit from this economic outperformance due to the recent appreciation of the EUR which has already led to a weakening in relative earnings revisions. Nevertheless, we expect the EUR/USD exchange rate to stabilise, supported by the US and European Central Banks’ monetary policy divergence. This should trigger a relative re-rating of euro zone equities. We keep our preference for Italian equities and EMU small caps as they are relatively immune to the currency’s appreciation due to their strong domestic exposure.

In the coming weeks, we will closely follow geopolitical developments, UK and US political events as well as the central bankers meeting in Jackson Hole.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We hold a slight overweight on equities and remain negative on bonds, maintaining a short duration:

  • Global expansion dynamics are well underway.
    • Most recent data confirmed that the European recovery is well on track and is leading to above-trend growth in 2017-18.
    • The economic news flow is starting to become more supportive in the US, while emerging markets are benefiting from a good economic momentum and a weaker USD.
    • In this context, we concentrate our portfolio’s regional positioning on euro zone, Japan and Emerging markets.
  • Monetary policy divergence between both sides of the Atlantic should remain:
    • We consider that investors are too complacent about Fed policy adjustments while they are much more cautious on the impact of ECB decisions. Despite a possible tapering announcement, the ECB will continue to expand its balance sheet next year. At the same time, the Fed could start reducing its own balance sheet by October 2017 and accelerate the pace of its balance sheet’s reduction in 2018. The meeting in Jackson Hole this month should give more clarity.
  • Equities have an attractive relative valuation compared to credit.
  • The main risks for equity markets remain political and have switched from Europe to the US:
    • Italian elections are unlikely to be held in 2017. The Italian risk on a medium-term horizon appears manageable and is already priced in by the markets.
    • In the UK, the “Brexit” negotiations are making little progress.
    • Protectionism fears have decreased, but have not completely disappeared. The geopolitical tensions in Syria, North Korea, Russia and potentially Iran add to uncertainties.
    • In the US, after the collapse of the healthcare reform, the 2018 budget and the tax reform will be key for the credibility of Donald Trump’s presidency. Slippage in the timing of the fiscal stimulus continues to be a source of uncertainty.

 

REGIONAL EQUITY STRATEGY

  • We remain positive on euro zone equities. The on-going, more robust and geographically broadening economic expansion, the accommodative and prudent central bank and the strong corporate earnings momentum underpin the attractiveness of the region’s risky assets. However, earnings growth expectations have already been revised downward as the EUR appreciation could hurt European exporters but strong domestic demand should be a support. We are still positive on Italian equities. We also keep our exposure to banks. The sharp decline in the European political risk premium and recent bank rescues are restoring confidence.
  • We maintain an underweight on Europe ex-EMU, especially the UK. The uncertainties surrounding the UK’s political situation, the “Brexit” negotiations and the impact on the economy lead us to avoid the region. Domestic fundamentals are weakening and downside risks remain.
  • We keep our neutral stance on US equities. The US soft patch could now be behind us. Economic surprises have started to recover from extreme negative levels. We however continue to identify an execution risk in the expected fiscal stimulus and will follow upcoming updates from lawmakers.
  • We hold an overweight exposure to Japanese equities. A strengthening global growth and a supportive domestic policy mix are among the main performance drivers. Furthermore, the BoJ confirmed its highly accommodative monetary policy leading to a weaker JPY. The recent cabinet reshuffle has put a halt to the decrease in PM Abe’s approval ratings.
  • We maintain an overweight on emerging market equities. They benefit from attractive valuations in a robust global growth context. USD weakness, along with US soft patch, have supported this region which has outperformed the broader market. Fed balance sheet adjustments could create more uncertainties on Emerging markets, but the global cycle and accommodative domestic monetary policies should support them.

 

BOND STRATEGY

  • We maintain our underweight on bonds and a short duration. We consider the decrease in interest rates is linked to the recent risk-off move and we therefore expect EU and US sovereign yields to resume their uptrend over the medium-term, driven by a tightening Fed, and potential upcoming inflation pressures. We expect rising wages and potential stimulus to push inflation higher, although it takes longer than expected to materialise.
  • 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 overweight on emerging market debt, as the on-going monetary easing represents an important support.
    • We are close to a neutral high yield exposure: we have revised our spread targets downwards, the duration effect is less negative and the carry remains attractive.
    • On the currency side, we maintain a lower USD overweight exposure as the EUR/USD exchange rate broke key resistance levels.

 

Macro :

  • In the US, initial weekly jobless claims increased by 3,000 to 244,000 for the week ending August 5th, above market expectations of 240,000.
  • Claims have now been below 300,000 for 127 straight weeks, the longest such stretch since 1970.
  • US consumer prices increased by 1.7% YoY in July, missing market expectations of 1.8% and following a 1.6% gain in June. Prices rose at a faster pace for energy, food, medical care commodities and transportation services.
  • In the euro zone, the Sentix index dropped slightly in August to 27.7 against 28.3 the previous month. Investor sentiment remained stable, buoyed by strong current conditions but future expectations slumped amid growing concerns over the U.S. economy and the potential impact of a widening car emissions scandal in Germany.
  • Industrial production fell by 0.6% in June compared to the previous month, due to weaker production of capital goods, consumer and intermediate goods. 

Equities :

EUROPE

Negative week for European Equities.

  • Investors took the increasing geopolitical risk factors as an excuse (or opportunity) to take some profits across all segments.
  • The pan-European Stoxx 600 index logged one of its worst weekly losses this year. The FTSE 100 hit a three-month-low on Friday, and on Thursday Germany’s DAX 30 briefly traded below the 12,000 level for the first time since April.
  • The Eurostoxx 50, the CAC40 and the IBEX also underperformed, mainly due to the sell-off in Financials.
  • Basic resources stocks led the march downward, further fuelled by a commodities sell-off and a cautionary statement from China on iron ore prices. Banks, oil & gas and some technology stocks also weakened.

US

All the major US equity indexes went down last week.

  • Growing concerns over a potential conflict between North Korea and the US and some disappointing corporate earnings reports sent most of the major indexes down last week.
  • As for stock-specific news, Walt Disney traded down after reporting weak Q2 results (declines in cable subscriptions and advertising revenue). Disney’s announcement of a forthcoming launch of a digital streaming platform weighed on Netflix shares.
  • Several major retailers also lost ground after disappointing earnings reports.

EMERGING MARKETS

Global sell off last week for Emerging equities.

  • Tension between North Korea and the United Stated threatened global stock equity markets and the South Korean market was particularly hit by the fall of tech stocks as foreign investors saw this the event as a good way to take some profits.
  • India fell the most among emerging markets as weak corporate earnings made investors a lot more anxious.
  • China also took a huge dent from technology giant Tencent, after news emerged that its successful messaging app, WeChat, and two other Chinese tech heavyweights are being probed by the government, accusing the three of violating cyber security law. 

Fixed Income :

RATES

Government bonds rallied over the week amid the resurging political tension.

  • Against this backdrop, peripheral spreads widened while core curves flattened, especially in the front end.
  • In the US, inflation figures were muted, with core CPI modestly up by 0.1% MoM (vs. 0.2% expected).
  • 10Y US, UK, Japan and German yields stood at respectively 2.22%, 1.10%, 0.05% and 0.42%. 





CREDIT

Risk-off mode last week in a context of very low liquidity and geopolitical turmoil.

  • The pressure was more important on Cash than on Synthetic indexes, and more specifically on financials.
  • Spreads widened by 5bp for the Investment Grade segment, by 47 bps for Cocos and by 30 bps for Sub-insurance. 





FOREX

The geopolitical tensions boosted safe haven currencies.

  • The JPY and CHF got stronger and outperformed all the major currencies.
  • On the opposite, the KRW weakened by almost 2%.
  • The NZD had a tough week due to the central banker’s comments on strong currency and the negative impact on inflation expectation.


Market :

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES