Should I stay or should I go?

6 years ago - Published by Oddo BHF Asset Management in Finance, Fundamental Analysis

Global equities have powered ahead in recent weeks, in line with our pro-growth investment stance. Our view remains that the global macro backdrop should continue to support investor economic confidence and drive the valuations higher over the next year.

Still, there is a risk for some near-term disappointments, given that the Chinese housing market and industrial economy are maybe downshifting more than investors acknowledge. Also, the US ISM manufacturing index has been boosted by US dollar weakness and is likely to pull back somewhat.

Moreover, global equities are overbought, at least from a shorter-term perspective. Earning season was strong in the US but slightly disappointing in Europe. To go further up we need some more catalysts. US fiscal policy may provide some more fuel in the US economy engine but final date and full outcome is still not on the table. US Senate Republicans recently unveiled a tax plan that differed from the House of Representatives’ version on several key fronts.

It’s fair to say that, if yields remain anchored, then equities will receive the full benefit of the strong growth outlook and stock prices would move up on the back of solid profits and a depressed cost of production.

But upward pressure may now gradually build on yields. The deleveraging needs of the global economy have shrunken materially in recent years. The corollary is that developed nations (mainly European ones) are no longer dampening aggregate global economic activity and the disinflationary pulse is easing. Something being dismissed by many investors and leaving room for surprises. M Powell is going to stick to the previous line and hike at least 3 times next year. Asian central banks have changed their bias towards more hiking (Korea, Malaysia, Thailand and somehow China).

This year’s wave of US disinflation has been primarily driven by a couple of idiosyncratic non-business cycle factors, the most significant being a telecom pricing war. Without these, the 2017 drop in consumer price inflation and wage growth would not be apparent. Importantly, the forces leading to lower prices in these sectors were not the result of weaker domestic demand. If anything, they are a source of reflation and support the case for further rate hikes.

For long term investors, stay tuned. For more active investors and for tactical reasons, take profit on equities (mainly US) and partially on credit. Limit your duration exposure. There is not enough to gain and too much too lose. Betting on a non-resurgence of inflation seems today very audacious.

Our 6-month view

Central scenario: robust global growth (US, Europe, Emerging markets)

Europe

  • Growth acceleration fueled by improving credit conditions and decrease in unemployment
  • Monetary policy normalization gradually setting in even if i) it is still very accommodative, and ii) financial market trends will be more dependent on the development of the real economy than on the support by the central banks

US

  • Economy running at cruise speed
  • Some positives to be expected after Trump’s tax reform plan
  • Monetary policy normalization has been and should continue to be gradual but questioning about timing and pace

 

Alternative scenario: inflation rebounds more than expected with some growth

  • Wage and/or oil price acceleration
  • Reduction of growth potentials once again
  • Rapid increase of sovereign yields

 

Alternative scenario: growth slowdown and risk on global trade due to protectionism

  • US: consumption & gross Fixed Capital Formation slow down again
  • China: risks of economic rebalancing
  • Japan: “Abenomics” fall flat
  • Europe: a Japanese-like growth

 

 

Portfolio positioning

In October, the rally in equity markets made further gains: the MSCI World All Countries (in $) ended the month 2.1% higher. All the regions witnessed positive growths. Japan topped the ranking (+5.6% in Yen), followed by the emerging markets (+3.5%). The Eurozone and the USA posted similar performances, e.g. a bit more than 2% (in local currencies).

Concerning rates, we had a more mixed bag. In Europe, 10-year Sovereign yields softened by 10 bps over the month, whereas they tightened in the US by almost 5bps. In Europe, the move in sovereign yields supported the credit asset class, which registered a gain of about 1%, both for Investment Grade and High Yield.

 

October also marked the beginning of the result season. In the US, where close to 75% of companies have published their results, sales and profit growths once again did not disappoint with respectively a 5.8% and 8.5% increase. The same applies to the Eurozone, where sales and profit growth increased by 2% and 5%.

 

In our balanced portfolio, we added at the beginning of the month 3% to our Japanese equity positions – with a hedged currency risk – as we believed the prices did not take enough into account the positive news flow, from a macroeconomic as well as microeconomic points of view. Valuation levels looked much more affordable in Japan than in other regions. And they still do.

Regarding equities, we also arbitrated between our raw material sensitive positions and European banks, that have been reinforced. The idea is to benefit from any steepening movement of the yield curve, a trend that should start one day or the other.

 

Currencies & commodities

Some volatility

 

 

The rally in oil prices continued as the OPEC (+ Russia) are admittedly ready to extend their deal to regulate output. Furthermore, inventories continued to decline.

Iron ore stabilized in October after loosing some ground in September, whereas most of the other industrial metals (copper, nickel, lithium …) benefit from the expected development of demand for electric cars.

  • The USD appreciated in October, in the backdrop of the leading situation of the Fed in the monetary policy tightening cycle.
  • The very dovish stance of the ECB added negative pressure on the Euro. Furthermore, the German and Austrian election results as well as the Catalonian crisis did not help the single currency.
  • The yen depreciated. Abe’s winning bet in calling for anticipated elections gave a new impulse to the country
  • The stability of the CNY, e.g. a pause in its appreciation trend, also helped the USD to appreciate.

 

Past performance is not a reliable indicator of future performance and is not constant over time.

Sources: Bloomberg, ODDO BHF AM SAS | Data as of 10/31/2017

 

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