Weekly Insights 4/26/2017

Highlights

  • European equity investors have welcomed the positive outcome of the first round of the French presidential elections.
  • Asset allocation: We have increased our euro zone equity exposure while maintaining a positive stance on emerging markets. 

Asset Allocation :

Last Sunday, investors have closely watched the results of the first round of the French presidential elections. As predicted by polls, Emmanuel Macron and Marine Le Pen qualified for the second round. European equity investors have welcomed the positive outcome of this first round, as the most disruptive scenarios have been avoided, with pro-European candidate Emmanuel Macron in the lead to become France’s next president. As an immediate reaction, European equity markets rallied strongly the morning after the election. The CAC 40 index was up around 4% with French banks leading the charge. On the fixed income side, the spread between the French and German 10-year bonds tightened amid a strong bid for French bonds and for those of the riskier peripheral countries. Meanwhile, safe-haven assets are coming off, as the French elections result revives risk-on sentiment, while Germany yields jumped. On foreign exchange markets, the euro was the big mover, with a EUR/USD up by more than 1%.

In this context, which is in line with our central scenario, we have increased our euro zone equity exposure, after a tactical protection ahead of the election week-end, while maintaining a positive stance on emerging markets.

In the coming days, we will closely monitor both ECB and BoJ meetings Thursday and the second round of the French presidential elections on 7 May.

Our current investment strategy on traditional funds:

Legend
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:

  • The US cyclical expansion, the economic recovery in Europe, the global inflation momentum and decent growth in China are all supportive for equities in a rising rates context. A higher nominal growth is ultimately supportive for corporate profits.
  • Central banks’ actions are decoupling but their tone has turned less dovish:
    • The ECB has started the new downsized stimulus programme until December 2017, standing ready to increase the programme in terms of size and/or duration “if the outlook becomes less favourable or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation”. 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 by the central bank.
  • 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 events keep uncertainty levels high. The geopolitical tensions in Syria and North Korea, the US house’s failure to approve the healthcare reform, the UK officially triggering Art.50 of the Lisbon treaty and the French presidential elections, are all implying high dispersion of possible outcome.

 

REGIONAL EQUITY STRATEGY

  • We are overweight on euro zone equities. Fears of political disruption in France are almost entirely removed and the European political risk premium has receded. This region also benefits from a supportive cyclical expansion and a less mature economic recovery compared to the US. Moreover, the valuation gap between the US and the euro zone is still above average looking at 12 months forward price/earnings, supporting the attractiveness of the region’s risky assets. Also, earnings revisions are positive and should underpin a market rebound. And, finally, international allocators stand ready to put money to work in Europe, which should lead to supportive fund flows.
  • In the UK, with the official notification that the country would leave the European Union, we maintain an underweight position on equities. Although the upcoming elections announced by Theresa May present little risk, the uncertainty surrounding the “Brexit” negotiations can potentially weigh on the British economy.
  • We continue to take our profits following a supportive first quarter and reduce our stance on US equities and are now just below, but close to neutral. We are waiting for more clarity on fiscal stimulus and see the gap between survey optimism and actual activity as a tactical warning on US equities. US stock markets have benefitted from post-election optimism among consumers and businesses but activity has yet to follow sentiment. The expected fiscal stimulus should support the earnings outlook further but there is an execution risk.
  • We have a neutral exposure on Japanese equities. Stronger US 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.

 

BOND STRATEGY

  • 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, barring political risks.
  • 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 and the prospect of protectionist measures. Potential US protectionist measures are a wild card.
    • We maintain a relative value strategy: long German Bund / short French OAT ahead of the second round of the French presidential elections. We see the strategy as a hedge against the European political risk.
    • We have a slight overweight in emerging market debt, both in local and in hard currency terms. The carry remains attractive and negative financial implications of the US presidential elections, due to a stronger USD, are receding.
    • 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 have reduced our short in GBP in function of the upcoming British elections. Prime Minister Theresa May surprised markets by calling a snap general election in June in order to secure political unity to support her “Brexit” plan. According to the latest polls the conservatives would win with around 43% of the votes.

 

Macro :

  • In the US, the Philadelphia Fed Index fell to 22 in April compared to 32.8 in March. The reading still pointed to an expansion in the manufacturing sector but at the slowest pace in four months with a slower growth for new orders, shipments and unfilled orders.
  • The initial jobless claims increased by 10,000 to a seasonally adjusted 244,000. However, the reading suggested a rebound over the March survey week that had recorded initial claims of 261,000.
  • In the euro zone, the Flash Composite PMI climbed to 56.7 from March’s 56.4, confirming the continuing economic recovery.
  • In Germany, the Ifo business climate index rose more than expected to 112.9, from 112.4 in March, hitting its highest level in nearly six years. Company executives are more upbeat about the current state of Europe's largest economy. 

Equities :

EUROPE

“Risk on” mode for European equities after the French elections results.

  • The CAC 40, France’s blue-chip equity index, the CAC 40 jumped by 4.1% on Monday to its best close in nine years.
  • The Stoxx 600 index also climbed as financials overcame weakness in miners.
  • From Tuesday on, M&A and earnings results were back in focus, shifting back investors to fundamentals and away from politics… for now...

 

US

Satisfying start for the earnings season.

  • All the political question marks, in the country or abroad (French elections) weighted on the markets, but major US markets ended the week higher.
  • Disappointing figures from General Electric (stagnating sales figures) weighted as well, despite earnings above expectations.
  • Mattel was one of the worst performers and weighted on the Nasdaq, because of a massive drop in Barbie’s sales.

 

EMERGING MARKETS

Geo-politics was again a key factor for emerging markets performance last week.

  • The Chinese GDP beat expectations for Q1, with a pace of 6.9%
  • North Asian stocks were mixed as tensions over the situation on the Korean Peninsula softened.
  • In South Africa, investors are increasingly sceptical that a mooted no-confidence vote on President Jacob Zuma will be successful.
  • Brazilian stocks recovered at the end of the week, supported by a rally in shares of miner Vale following solid Q1 production figures.
  • Turkey recovered following the referendum, but investors still doubt whether the Turkish government will keep the rule of law and private property rights going forward. 

Fixed Income :

RATES

The outcome of the first round of the French elections triggered a strong risk-on mode in Euro rates with the OAT-Bund spread back to 50bps.

  • With no adverse surprise, core markets yielded higher while peripheral spreads tightened markedly (around 25bps in Spain, Italy versus Germany).
  • 10Y US, UK, Japan and German yields stood at respectively 2.3%, 1.01%, 0.01% and 0.33%.


 

CREDIT

Light flows the last week as market participants were waiting for the French elections results.

  • Credit indices ended the week with a slight spread tightening (ML Investment Grade Credit: -1bp to 121bp).
  • French credit outperformed thanks to the “market friendly” polls (Macron leading).
  • The election outcome was in line with expectations and credit spreads tightened considerably with French banks around 20bp while French Non-financials were at 5-10bp. Peripheral issuers performed very well as well.
  • Credit derivatives outperformed cash with Sub financials 23bp lower, X-over -18bp and Main -6bp.


 

FOREX

Thanks to the positive poll result in France, election risks has slightly faded and market reacts positively: risk-on mode activated.

  • Consequently the EUR jumped versus all major peers as market sees Emmanuel Macron winning the second round.
  • Furthermore, risk-on mode made the JPY weaker. 





COMMODITIES

Commodities were slightly up over the past week (GSCI Light Energy up by 0.46)%. The index remains nonetheless negative for the year (-2.34%).

  • Energy slumped following a disappointing set of DoE crude inventory stats.
  • Base metals slumped mid-week in dramatic declines, on worries over Chinese deleveraging policies among other issues.
  • Precious metals were mixed, with the more rate/USD/safe haven plays gold and silver modestly lower. 

Market :

WEEKLY MARKET OVERVIEW


UPCOMING FACTS AND FIGURES