Waiting for raising rates by Fed
The latest Fed minutes had opened the door to a second rate hike in response to continued solid consumer spending figures, an acceleration in demand for credit, and a squeeze on wages, as the US is almost in full-employment. However, the latest job creation figures (38,000) dashed hopes of a rapid rate hike.
Even so, the 8.1% increase in retail gasoline prices in April, driven by the upturn in crude prices, is beginning to show up in inflation figures. By way of illustration, the median CPI calculated by the Cleveland Fed rose by 2.5% in April on an annualised basis, its biggest increase during this cycle.
Is this a statistical outlier or a leading indicator of a greater slowdown in US growth? Regardless, the Fed must regain leeway and normalise its monetary policy after seven years of growth, and raising rates would be good news!
Historically, in a more inflationary environment, financials and commodities tend to outperform. Even so, should discounted sectors be overweighted after the disappointing recent European and US corporate earnings? At the very least, they showed no positive shift, yet more proof of the softness of current growth.
EQUITIES
The MSCI World gained 2.9% (in euros, +0.2% in USD) in May, with a year-to-date performance now close to zero (-0.3%). Emerging markets gave up lots of ground (-3.7%). Among developed economies and in local currency terms, the Topix turned in the best performance (+6.7%), followed by Eurostoxx (+2.9%) and the S&P 500 (+1.8%).
FIXED INCOME
Ten-year German and US sovereign yields ended the month about where they began it. They remain at very low absolute levels, especially as a rebound in inflation is almost certain by year-end. Credit was up +0.3% for the highest-rated debt and +0.1% for high yield debt, whereas emerging sovereign bonds gave up a little ground (-0.3%).
CURRENCIES & COMMODITIES
The USD posted further gains vs. all currencies. The basket of Latin American currencies lost almost 5%. The euro gave up a little less than 3% on comments by various FOMC members to the effect that a Fed Funds rate hike was imminent.
Commodities diverged, with oil up (+5.2%) and metals and soft commodities down (-1.2% and -1.6%, respectively). The yuan decline, almost to its January lows, also stoked fears.
OUTLOOK
Brexit uncertainties, outflows from European equities and valuations in line with historical multiples are, for the moment, keeping us from raising the weighting of equities in our diversified portfolios.
In this environment, we recommend three equity strategies:
- Overweight sectors offering solid visibility on EPS growth, i.e., automotive, and construction. These sectors can be gradually added to portfolios (buy them on a dip).
- Overweight sectors offering prospects for stable and high dividends, including real estate, insurance and telecoms. This strategy offers the advantage of exposure to quality companies that are a little more decorrelated from equity market trends and of capturing a yield that is currently lacking in bonds in these same sectors.
- Look into commodities, which are trading at an all-time high discount of about 30% to book value. However, this strategy is only for investors able to tolerate sharp price swings.
On bonds we continue to overweight European issuers offering carry opportunities in an environment that, while uncertain, is also being supported by unprecedented ECB measures. The implied default rates of these bonds look too high in a deleveraging environment. Even so, volatility is persistent, and the vehicle of choice is still the target-date fund.
The global economy is still being squeezed in many places, and the markets are very likely to remain hectic. Investors had better have the right reflexes and a steady heart to navigate in these rough waters.
Oddo Meriten portfolio strategy
Oddo Meriten continued to drawn down risks in its portfolios, while setting up options strategies that allowed to capture some of the market gains late in the month.
There was no change in Oddo Meriten significant exposure to inflation-linked bonds. In emerging debt, Oddo Meriten gradually substituted hard currencies for local ones and kept their long euro bias in their portfolios.
Nicolas Chaput
Global CEO & Co-CIO Oddo Meriten AM
Laurent Denize
Global Co-CIO Oddo Meriten AM