The current context is favourable for risky assets, especially equities

-       Market rhythm is dictated by the 3Vs:

• Visibility on growth with contained inflation;
• Volatility, which has reached a historical low on all asset classes and may slightly rise with slowing economic surprises;
• Valuations, which have become expensive in the absence of a bubble.

Visibility on the policy mix has  further improved.

• In the US, the tax reform is now effective, but debt-ceiling and government-funding issues are still pending. On the monetary side, the US central bank started its balance sheet reduction in October 2017 and is expected to hike its policy rate in March.
• In the Eurozone, the ECB has recalibrated its programme by buying (fewer) bonds until end-September, marking the beginning of the end of quantitative easing. A rate hike should nevertheless not occur before 2019.
• In Japan, last year’s elections validated Shinzo Abe’s mandate. The country is benefiting from this increased policy-mix visibility (to be applied over the next few years) and its highly accommodative central bank.
•  In China, President Xi has strengthened his grip, leaving little room for surprises (good or bad).

In this context, EMU equities are our strongest conviction, followed by Japan, while we remain negative on the UK.

The global economic momentum remains supportive of riskier assets. The outlook for the world economy appears solidly anchored above 3% growth, with fundamentals improving in all regions. Inflationary pressures remain subdued. This justifies our positive stance on equities and our low duration. The main equity market risk would be a stronger-than-expected rise in inflation/bond yields.

Risks to the scenario. The main risk to our expectations would be an abrupt end to the Goldilocks environment. A persistent rise in the oil price, leading to an acceleration in inflation, could be one trigger; a sharp slowdown in growth would be another – due either to a monetary policy error or a significant slowdown in the Chinese economy.

GENERAL OVERVIEW: Equities vs. Bonds 

The 3Vs – visibility, volatility and valuation –­ have been dictating market rhythm since the start of 2018. Leading indicators seem to confirm that the current expansion is gaining momentum, enabling better visibility on growth (at least for H1 2018). We think that the Goldilocks context (above-trend growth and below-trend inflation) should continue for a few months yet. Furthermore, economic publications and surprises indicate that volatility could rise. Hence we maintain our conviction of inflation pressures rising above the 2.5%-3% range. Although we are still awaiting Q4 earnings, valuations are high for some assets, particularly US equities. Nevertheless, valuations are showing no signs of an end to the bull market in equities, and strongly differ from one region to another. In addition, the equity risk premium is still more attractive than the long-term average. As a result, we continue to favour equities over bonds and maintain a low duration.

REGIONAL EQUITY STRATEGY

Positive on equities

EMU equities are our strongest conviction. Despite potential wobbles in Italy, Catalonia and Germany, the region is no longer subject to a major political risk premium and should benefit from:

• strong economic growth momentum, with an economy that keeps growing above its long-term trend growth;
• an accommodative central bank;
• double-digit earnings growth within the Eurozone, where we have a preference for small caps, which are less sensitive to euro appreciation and benefit usbstantially from strong domestic cyclical momentum.

We have a neutral stance on US equities. The US economy is bracing for its strongest growth this decade and for an increase in inflation pressures. Growth had already started to accelerate at the turn of the year, even ahead of the tax cuts, which will be beneficial for companies’ earnings. As a result, the Q4 earnings season will be key.

We are negative on Europe ex-EMU equities. The hawkish Bank of England monetary policy stance has put a barrier to GBP depreciation, challenging overseas profit growth. Despite the agreement after the first round of Brexit negotiations, the region is finding it difficult to set up new trade relations.

We have a positive stance on Japanese equities. Prime Minister Shinzo Abe’s has the mandate to push reforms and the Bank of Japan should remain the most accommodative central bank. Earnings growth is present, even without a depreciation of the Japanese yen. Technical analysis considers Japanese equities as the best performer in 2018.

We have a neutral exposure to emerging market equities. EM equities have performed well since the fiscal tax reform passed, with improving fundamentals, an improving global cycle and US Dollar weakness.

FIXED INCOME STRATEGY

Negative on government bonds

With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to gradually increase. In addition to rising producer prices, we expect rising wages and potential stimulus to push inflation higher, although this is taking longer than expected to materialise. 

The improvement in the European economy could also lead EMU yields higher.

We have a neutral view on credit, as spreads have already tightened significantly and a potential interest-rate increase could hurt performance.

On emerging market debt, the ongoing monetary easing represents an important support for this asset class.