Investors warmly welcomed the relaxation of regulatory constraints in the financial sector and the tax reform announced by Donald Trump but it appears that these measures should take some time before coming into effect. Therefore, financial markets are currently not moving much on the so-called Trump trade. But three driving forces are sustaining risky assets:
- The on-going Q4 2016 earnings season confirms the end of the earnings recession in the US and Europe.
- The economic momentum at the turn of the year continues to be solid and synchronised throughout all regions.
- Central banks continue to be accommodative.
In this context, we maintain our positive view on US, euro zone and Japanese equities.
Our current investment strategy on traditional funds:
grey : no change
blue : change
EQUITIES VERSUS BONDS
We remain overweight in equities versus bonds:
- The macro news flow is still well-oriented. Global growth is expanding in a synchronised way combined with a potential of US reflation through fiscal stimulus, tax cuts, and regulatory easing in a robust labour market context.
- Central banks are decoupling but they mostly keep a dovish stance:
- The ECB will keep a steady hand given political uncertainties and will extend its quantitative easing at least until December.
- Waiting for more clarity on fiscal stimulus, the Fed is in no hurry to hike its rates. Its tightening cycle is at odds with accommodative policies in Japan, the euro zone and the UK. Markets are pricing two Fed hikes in 2017 and another two in 2018, below the median Fed projection.
- Equities have an attractive relative valuation compared to credit, and their expected return should be boosted by the end of earnings recession in the US and Europe.
- Oil markets continue their rebalancing after the OPEC agreement. However, US rigs have been re-opening, implying a greater production which could likely weigh on oil prices.
- Important political risks nevertheless remain: upcoming elections in Europe (The Netherlands, France and Germany) and “Brexit” negotiations. Moreover, the wide range of possible outcomes of Donald Trump’s presidency includes the risk of policy error. Slippage in the timing of the fiscal stimulus appears to be a new source of uncertainty.
REGIONAL EQUITY STRATEGY
- We have maintained our overweight on euro zone equities, as we expect a gradual improvement from the high discount due to political uncertainties. Recent surveys point to some acceleration in activity.
- We have maintained our underweight in UK equities as the uncertainties surrounding the conditions of “Brexit” and its impact on the economy are nowhere near resolved. We avoid domestically-oriented small and mid-caps and still have a relative value strategy long FTSE 100 against a short FTSE 250.
- We are overweight on US equities. Sound consumer expenditures consolidating oil prices and a post-election stimulus should support an improving US earnings outlook.
- We are positive on Japan. The country benefits from an aggressive domestic policy mix, stronger US growth and a weaker currency. Furthermore, the Bank of Japan has kept its stimulus unchanged, leaving its target on 10Y Japanese government bond yields around zero and upwardly revised its growth forecasts to 1.4% for the current fiscal year, and to 1.5% for next year. They have mentioned the US economy as the main foreign threat due to concerns over Donald Trump’s policies.
- We have maintained a neutral positioning on emerging markets.
- We have maintained a significant duration underweight as we expect stronger inflation figures and US fiscal policy easing to push bond yields higher.
- We continue to diversify out of low/negative yielding government bonds:
- We have implemented a new relative value strategy: long German Bund / short French OAT due to increasing uncertainties surrounding the French presidential election. We also see the strategy as a hedge against the European political risk.
- We took our profits on our relative value strategy: long Italian BTP / short Spanish Bonds.
- We remain positive on inflation-linked bonds. We expect the recent rise in inflation expectations to be sustained as wages and consumer price inflation data continue to rise gradually, led by the US. In addition, upcoming fiscal easing looks likely. The expected re-rating of inflation protected bonds is now well underway.
- We have a slight overweight in emerging market debt, both in local and in hard currency terms.
- We are slightly positive on high yield, even as the significant spread tightening has reduced the potential, the carry remains attractive.