US growth to accelerate in the second half of the year

We have better macro indicators to hand in the US. While GDP growth was weaker than expected during the second quarter of 2016, we expect activity to gain momentum in the second half of the year.

There are 2 main contributors to the increase in GDP: personal consumption and exports. Personal consumption is supported by a strengthening labour market. Net exports are stabilizing and, as import and export volumes are starting to offset each other, unabsorbed inventories should stop weighing on growth. Overall, the US is mitigating downside risks on a global scale.

Earnings positively surprised in Q2 2016, with 79% beating their forecast. The forecasts were low to begin with and earnings were, in fact, flat (ex-energy). In the second half of the year, we expect earnings to post positive YoY growth. 

Eurozone growth in line with expectations, not impacted by Brexit for the moment

If Brexit made lots of waves on D-Day, its effects have been very local so far, impacting only trade: Euro-zone exports to the UK should decline but, as they do not account more than 3.5% of the region’s GDP, analysts are reassured. So far, Euro-zone growth is in line with expectations, thanks to broad stability in terms of financial conditions. On the UK side, it is a different story. If economic policy uncertainty remains contained in the Euro zone, it is steeply rising in the UK, where the PMI has fallen, while remaining more stable for the Euro zone.

In a nutshell, continental European consumption, confidence by sector, and investments are decent and the chances are that credit conditions will stay favourable for the time being. The European Commission has also decided against imposing economic sanctions on Spain and Portugal for not reaching their budget objectives. Both countries have made significant structural efforts in the past few years in challenging environments.

It is also not the right time to fuel anti-European sentiment. 2016 (2H) and 2017 are periods of electoral campaigns at different levels and in several countries, including Italy, the Netherlands, France and Germany.

In our scenario, we have still been less constructive on a significant re-rating of the market since the Brexit. Even if it turns out to be a very contained event, it brings a risk premium that will weigh on expected growth for the next 12 months.

UK: the Bank of England eases its rate

Faced with weaker macro data, the Bank of England is using the tools at its disposal to support growth. It has eased its bank rate and cut it by 25bp in addition to other monetary easing measures. The fall in confidence has impacted the composite PMI, consumer confidence and GDP forecasts, which are on declining trends while inflation forecasts have been revised upwards. We believe that market performance will now mainly depend on the trajectory of the GBP. Relative valuation is currently rather expensive because earnings have dropped in recent years. A GBP depreciation and the stabilisation of commodity prices should benefit earnings growth. Even so, our global expected return is relatively unattractive for this market.

Renewed potential of Emerging markets: Brexit’s big winners?

Risk aversion measures in Emerging markets are showing a divergence vs. Developed markets, post-Brexit. If investors usually have a higher risk aversion for Emerging markets relative to Global indexes, this has now changed. The referendum outcome created a local, not global, shock. The further from the epicentre you go, the better off you are as an investor.

Except in Eastern Europe, manufacturing activity seems to be finally picking up. Economic consensus forecasts are positive for China and India on GDP growth, with single-digit figures of 6.5 and 7.7%. Russia, on the other hand, is recovering after being badly hit by the declining oil prices.

The relative valuation of Emerging market equities is still very attractive relative to other markets.

1. Economic growth is stabilising, including in China, and
2. There is less fear of an appreciation of the USD thanks to a Fed that, in July, left its rates unchanged for the fifth time in a row.
3. Emerging markets also have the highest medium-term expected return.

We conclude from those factors that Emerging markets have the highest rerating potential.

Equities vs bonds: where do we stand?

In the medium term, we are neutral equities vs. bonds. Equities are relatively attractive but a clear catalyst for further re-rating is needed. On the other hand, bond yields are under pressure, with central banks being globally more dovish than expected this year, and the search for yield remains a central theme.

REGIONAL EQUITY STRATEGY

Shorter visibility implies a nimble approach to investments

Our modest underweight Eurozone and UK is a cautious leftover from the Brexit and the political uncertainty it originated. We have kept our neutral stance on the US and Japan. The US has strengthening macro data and we expect the Fed to increase rates at the end of the year. However, the presidential election campaigns will bring their share of volatility. As for Japan, it is fighting standard Developed market battles: slow growth, low-to-non-existent inflation and an ageing population. The Bank of Japan announced new fiscal and monetary measures to help stimulate growth and disappointed the markets. September will bring more answers.

We have increased our overweight on Emerging market equities. The stabilisation of Emerging market macro data, of commodity prices, the Central Bank of the Republic of China and its accommodative monetary policy and the gradual depreciation of the Yuan should replace the oppressing headwinds with a more supportive environment.

FIXED INCOME STRATEGY

Convictions on credit

On the credit side, we still like high-yield bonds as they hold an attractive carry and valuation. If we are positive on High Yield, we also remain cautious and disciplined investors: having reached our target spreads and the asset class having had a good run, we have cut part of our exposure.

We are also overweight credit on the European and the US sides.

Convictions on government bonds

As a result, our fixed income allocation is diversifying out of low-/negative-yielding government bonds. We have more conviction on Emerging markets and are overweight in both local and hard currency.

The Brexit vote has further accelerated the search for yield: Emerging market debt is the asset class that continues to benefit from the highest inflows.

We are keeping a neutral but well-diversified exposure to core and peripheral European bonds, US corporate bonds and inflation-linked bonds. Breakevens are pricing 1.5% inflation for the coming years and that looks overly cautious.

OPEC production surges and prices decline

• After a brief rally in June, crude-oil prices had a difficult run in July. Prices reached the bottom of their 40-50$ range and, earlier this month, even went slightly below.
• OPEC production levels have reached record highs.
• US production is on a decreasing trend, which has helped prices increase to 50$/barrel. Past that level, some US shale-oil producers will start opening rigs again. Combined with significant inventories, prices are consolidating somewhat.
• Benefiting from the momentum, gold prices have been pulled up not only by the strong decrease in US real rates but also by a growing number of ETFs buying gold. This has pushed prices upwards. Gold has performed by 26% YTD.