Too early to take profit, yet

The political risk is now behind us in France, it is time to go back to fundamentals. While underlying conditions in the global economy are strengthening, some data may disappoint and trigger a countertrend setback in markets. The economic surprise index has recently weakened (mostly in the US and the UK), the Chinese economy could slowdown later this year and Trump’s promises are being pushed back or diluted. As the equity market is now up 10%, is it time to take profit?

The slack in the global inflation figures could persist over the next few weeks, but this should be a temporary move. Indeed, the cyclical macro backdrop remains supportive for equity prices and negative for bonds. Eurozone inflation accelerated to 1.9% YoY in April from 1.5% in March. More importantly, core inflation accelerated strongly to 1.2% YoY, from 0.8%. We need to admit that this acceleration was exaggerated by the timing of the Easter holiday. Even so, core inflation is likely to move above its previous range of 0.7%-0.9%, whereas 10 years German rates are still trading at 0.40%! Not easy to reconcile… We do recognize that the emerging markets picture is more balanced.

Our downbeat view on the Chinese economy has encouraged us to be cautious in metals & mining sectors. Conversely, India’s structural reforms will support economic growth and capital inflows. Can recent oil prices correction trigger a global market turmoil? On a 6-12 month view, fundamental supply conditions will likely remain too plentiful. Fundamental demand conditions are expected to soften from very strong levels, but this is unlikely to trigger a price collapse to late-2015 lows. Bottom level is fundamentally defined by current break-evens in the U.S. shale patch, namely WTI $35-40/bbl (not that far from today’s prices).

OPEC next meeting statements will certainly aim to refraining from oil price excesses. We are keeping our favorable stance towards Eurozone risky assets. Halfway through the first quarter earnings season, 82% of the Euro STOXX companies that have reported have turned in positive surprises for sales and 75% for earnings. So far, sales are up an aggregate 9.5% year-on-year, with EPS up 25%. Moreover, the earnings recovery is broad-based, with the high level of positive earnings surprises distributed across all sectors except for energy and consumer services. No need to say that corporate earnings growth remains the main driver for long term equity performance. To answer our first question, it is too early to take profit. We remain constructive on global equities levered to business spending and overweight Eurozone equities. For diversification purposes we recommend selected EM sovereign debt, European high yield short duration corporate bonds and try to avoid developed government debt. We would keep that positive mood unless we get real signals that our scenario is at risk and as long as central banks are not making any communication mistakes.

The equity market rally continued into April, with the MSCI World All Countries gaining 1.6% (in dollars), driven mainly by the Eurozone (+2.4%) and emerging markets (+2.2%), while US and Japanese markets also posted gains (+1% in foreign currency). The relief felt after the first round of the French election showed up in banking stocks (+6.3% in the euro zone), and in the euro (+2.3% vs. the dollar).

In sovereign bonds, the 10-year German yield was almost unchanged during the month, at 0.32%, due mainly to Mario Draghi’s ongoing accommodative tone, while the 10-year US yield even slipped a bit, to 2.28% from 2.39%. In corporate bonds, investment grade paper gained 0.5%, while high-yield bonds were up 1.1%. And, lastly, emerging debt rose by 1.6%. Our equity exposure was once again close to 50% in late April but after several changes made throughout the month.

At first, we set up hedges, generally through options, prior to the French election. We then made some geographical rotations, including a shift back to Japanese equities (to 4% of AuM) and a reduction in the weighting of the UK. Our US weighting is almost 14%; we still believe these markets are overvalued, despite the excellent reporting season. In interest rates, we used a portion of our money-market exposure to increase our weighting of emerging debt, this time in hard currencies, with all of this now accounting for 4% of the investment. Meanwhile, we initiated a position in an absolute-return bond fund. All in all, the portfolios’ exposure remains very conservative. In Forex, dollar exposure came to about 12% at month-end and sterling exposure to 5%. With the idea of an import tax seemingly having been set aside, the US dollar lost a source of support.

Nicolas Chaput

Global CEO & Co-CIO
Oddo Meriten AM

Laurent Denize

Global Co-CIO
Oddo Meriten AM

Gunther Westen

Deputy Head of Asset Allocation
Oddo Meriten AM

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