Equity markets in the euro zone were able to recover last week some of the ground lost since the beginning of the month. In particular, Italian and German markets outperformed.
Following the general elections, Italy will have to face a new period of political uncertainty before a new coalition can emerge, but this outcome was largely anticipated. In addition, Italian equity valuations show a discount relative to the euro zone and therefore already integrate a substantial risk premium. Finally, we note that earnings continue to be revised upwards in Italy – contrary to Germany.
The fact that German mainstream parties have agreed, 5 months after the general elections, to form a new “grand coalition” certainly constitutes a support. But on the other hand, the loss in cyclical momentum which has started to emerge outside the US is likely to hit German stocks, which are particularly exposed to cyclical sectors (Automobiles, Chemicals, Industrials). In relative terms, the earnings momentum is no longer in favour of German stocks. Looking forward, protectionist measures would add new pressure on German stocks.
Our current investment strategy on traditional funds:
grey : no change
blue : change
EQUITIES VERSUS BONDS
We see a less favourable risk-reward and have trimmed our equity holdings towards neutral.
The rise in US inflation uncertainties should not mask a temporarily weaker global economic news flow.
- Global growth momentum outside the US is likely to have peaked.
- US trade policy (including USD) appears as a major policy unknown, as risks start to materialise.
- Global monetary tightening is progressive, but the US are tightening first:
- The Federal Reserve started its balance sheet reduction in October, hiked in December and should continue its hiking cycle in March.
- The ECB has recalibrated its programme, buying less bonds as of January. A rate hike should not occur before 2019.
- Geopolitical risks remain an obstacle.
REGIONAL EQUITY STRATEGY
- We have reduced our euro zone equity exposure to neutral. Recent data show the first signals of a lower cyclical growth. The economic expansion in the region remains solid, but markets expectations have increased, and this is more likely to lead to disappointments.
- We have kept a neutral –tactical- stance on emerging markets equities.
- We have become negative on UK equities. There is less than one year to set up new trade relations in the “Brexit” negotiations and little progress has been made since the start of the year. A hawkish Bank of England monetary policy stance has put a barrier to GBP depreciation, challenging overseas profit growth.
- We remain neutral on US equities. The US policy mix is evolving as fiscal policy becomes more accommodative and monetary policy more restrictive. We note that economic activity has further accelerated at the turn of the year implying that the growth/inflation mix is not deteriorating yet.
- We are positive on Japanese equities as earnings have been progressing so far without a depreciation of the JPY. Being overweighed on Japanese equities has been a winning trade for us so far. Japan benefits from the global expansion and the BoJ will not join other central banks in tightening its monetary policy, leaving credit conditions accommodating.
- We reduced our duration by a further 0.25Y
- We are negative on bonds and keep a low duration.
- With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to continue their uptrend towards 3% on the 10Y US government debt.
- We continue to diversify out of low-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 have a diversification in inflation-linked bonds.
- We keep our positive stance on emerging market debt, as the on-going monetary easing represents an important support.
- We are neutral on high yield.