Although the economic context has been robust since the beginning of the year, momentum, as measured by the economic surprises, has slowed somewhat outside the US, as the expansion becomes more mature. Fundamentals remain, nevertheless, solid.
Inflation pressures seem overestimated by the market. Although it is true that inflation is gradually coming back in the US, it remains tame on a global scale, while real yields remain remarkably low. Meanwhile, markets are converging towards the US central bank’s progressive monetary tightening.
Geopolitics have, nevertheless, captured investors’ attention. In the US, Gary Cohn resigned, while Donald Trump is creating trade war fears. In Europe, Italian elections confirmed the rise of populism. Investors are thus showing signs of anxiety, considering inflation and a possible bond market crash as the main concerns, according to the BofA-ML Fund Managers’ Survey. In this context, we have adopted a more cautious short-term view on equities.
For fixed income, expected returns remain slightly negative, except for the emerging-debt and high-yield asset classes, where sovereign rate forecasts are not too far from current levels and spreads have already reached our target.
In this context, our fundamental, technical and quantitative analyses lead us to favour Equities over Bonds.
Economic indicators, as well as technical and quantitative analyses, seem to be converging to make EMU equities less attractive than the US and the emerging markets. The Euro appreciation had an impact on European corporate profits, leading to lower expected returns for this region. In the same way, Japanese equities have been subject to yen appreciation. In the US, expected returns have increased, thanks to strong earnings from the growth that comes with Trump’s tax reform. However, this had already been largely priced in by equity markets
Neutral in US equities: Trump’s fiscal easing has now been integrated into earnings growth expectations.
We have trimmed EMU equities to neutral: despite solid fundamentals,the market needs new catalysts to accelerate the momentum. As Euro appreciation is impacting European corporate profits, we have lowered our expectations to +8%.
Japanese equities: the visibility on an accommodative policy mix and an above-potential expansion is good news, but the market has suffered from yen appreciation.
Emerging market equities remain a resilient asset class, with an attractive expected return.
We have maintained a negative view on Europe ex-EMU equities. Earnings growth will no longer benefit from GBP depreciation as the year-on-year effect fades. Domestic fundamentals are weakening and downside risks remain.
Negative on government bonds but positive on high-yield and emerging debt
With a tightening Fed and expected upcoming inflation pressures, we assume rates and bond yields will continue their uptrend. We thus continue to diversify out of low-yielding government bonds. Our strongest conviction is emerging debt, as the ongoing monetary easing is highly supportive of this asset class. Also, emerging debt is benefiting from strong global economic growth and the increase in commodity prices. Meanwhile, fundamentals remain solid, with low public debt, an improving current account and a still-attractive carry.