Last week, US stock markets fell sharply over fears Donald Trump would delay his tax and regulatory reform. The S&P 500 closed 1.8% lower on Wednesday, its biggest one-day fall since September. US stocks then dragged down Asian shares with the Nikkei 225 index closing down by 1.3% while the Hang-Seng index dropped by 0.6% the same day. On the currency side, the USD lost some ground against its main peers and fell almost 2% against the JPY which has been a traditional safe haven. Political risk came roaring back with the VIX reaching its highest level in nearly one month. This is a good reason to remain cautious on US equities.
Oil prices surged on growing expectations that exporters would extend output cuts at their next meeting following headlines that Saudi Arabia and non-OPEC Russia already agreed to a 9-month extension.
This week, we will closely monitor the OPEC meeting on Thursday and any new development regarding the US political turmoil.
Our current investment strategy on traditional funds:
grey : no change
blue : change
EQUITIES VERSUS BONDS
We are neutral on equities as we keep a portfolio protection and hold a short duration on bonds:
- Global expansion dynamics are less uniform than at the turn of the year. However, European recovery is well on track and should lead to above-trend growth in 2017-18, leading us to raise profit expectations. We think that the euro zone and emerging economies are best placed to leverage on these dynamics.
- Central banks are expected to be at the forefront in coming months:
- The ECB left its monetary policy unchanged, making no changes to its key interest rates or bond buying programme. However, QE tapering should become a central theme after the summer.
- After the Fed interest rate hike in March, two additional moves are expected this year, starting in June. The next step in the Fed tightening will be a balance sheet reduction.
- Equities have an attractive relative valuation compared to credit, and their expected return should be boosted by the end of the earnings recession in the US and Europe.
- Oil markets continue their rebalancing. However, while OPEC members are bringing back oil production to more durable levels, US rigs have been re-opening, implying a greater production.
- Political risk has switched from Europe to the US. The geopolitical tensions in Syria and North Korea, the slippage in the timing of the fiscal stimulus due to the lack of political success in Congress and escalation of sensitive issues question the credibility of the Trump presidency.
REGIONAL EQUITY STRATEGY
- We remain overweight on euro zone equities. The French election outcome led to a sharp decline in the political risk premium. A more robust and geographically broadening economic expansion throughout the region and an accommodative central bank underpin the attractiveness of the region’s risky assets. Furthermore, profits are revised upwards while relative valuations are attractive and non-resident flows are picking up gradually.
- We maintain our negative stance on UK equities. Besides the uncertainty surrounding the “Brexit” negotiations, earnings growth will no longer benefit from GBP depreciation as the base effect will fade after June. Also, commodity prices are not supporting earnings growth anymore and domestic fundamentals are weakening while downside risks remain.
- We keep our neutral stance on US equities. The US cyclical recovery stalled in Q1 and activity data has yet to catch up with survey optimism. Donald trump’s unpredictability adds to the uncertainty. Reflation trade positioning has reversed back to early-November levels.
- We have a neutral exposure to Japanese equities. Stronger global growth and a supportive domestic policy mix are among the main performance drivers, but a weaker currency is warranted to gain more conviction.
- We hold an overweight on emerging market equities, with India as our preferred market.
- We maintain our underweight on bonds and keep a short duration. With a hawkish Fed and continuing inflationary pressures, we expect interest rates to maintain their uptrend. The improvement in the European economy could also lead euro zone yields higher as political risks recede.
- We continue to diversify out of low/negative 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 remain positive on inflation-linked bonds as we expect a rise in core inflation by fiscal easing, higher wages, less deflationary pressure in China. Potential US protectionist measures are a wild card.
- We hold half of our relative value strategy: long German Bund / short French OAT as a hedge against the European political risk ahead of the June Parliamentary elections.
- We have a slight overweight in emerging market debt, both in local and in hard currency terms. Emerging market bonds benefit from strong fundamentals as risks in China and a commodity rout have declined.
- We are close to a neutral high yield exposure. The spread compression has exceeded our targets on both sides of the Atlantic, but the carry remains attractive.
- On the currency side, we keep an exposure to the NOK to benefit from oil prices evolution. We hold a lower underweight on GBP ahead of the upcoming British elections.