US recession fears have eased, while the euro zone remains on track

The macro news flow reflects the sluggish growth. In the US, as expected, first-quarter GDP growth was quite weak (only 0.5% annualised QoQ). Recession fears have dissipated, but growth has simply slowed down. Leading indicators are overall improving compared to the start of the year. The ISM manufacturing is again above 50 points, the level that divides growth from contraction, while the ISM non-manufacturing showed its second  consecutive improvement, for the first time since July 2015.

Investor convictions are low, as confirmation from hard data is needed. Before improving in the second half of the year, the second quarter could also be sluggish.

In the meantime, the euro zone is still heading in the right direction. The first Q1 GDP estimate was better than anticipated, showing growth of 0.6 %. Spain and France stand out, with their respective figures of +0.8 and +0.5%. That trend should continue in the coming months. Leading indicators (PMIs) have strengthened after a difficult first few months of the year. In particular, improvement has spread beyond Germany, thanks to improved economic momentum in Italy and Spain. In the UK, weaker growth and deteriorating leading indicators across the board reflect the uncertain business environment ahead of the EU referendum.

Political risks remain

Although political tensions have eased somewhat in recent weeks, they remain an important risk factor for our core scenario:

• Market-based measures of Brexit risk (e.g., CDS, GBP) appear to have peaked recently. In terms of growth, businesses in the UK have adopted a wait-and-see attitude for the first half of the year, putting investments on hold. The referendum will take place on 23^rd June.
• The United Kingdom is not the only country to contribute to the political risks weighing on the markets, and that is something we have taken into consideration in our allocation. Spain failed to form a government following last December’s election. June 26^th is the date set for the new vote.
• In addition, negotiations on Greece are making little progress. June 7^th is the next scheduled repayment date (for the sum of 306 million EUR).
• In the US, the Presidential election in November will most likely oppose Hillary Clinton (D) to Donald Trump (R). The probable nomination of the latter comes as a surprise.

Equities remain our favourite asset class

Despite political uncertainties, equities remain our favourite asset class. The economic context is favourable and has improved in all regions. In the US, after significant better macroeconomic news across the board since mid-February, the most recent data have been softer. Also in Europe, economic surprises, although still negative, are improving.

Earnings revisions have improved and are turning positive in the US for the first time since September 2014, certainly helped by the weaker currency. Earnings revisions in the EMU are still negative but the Q1 earnings season did not deteriorate sentiment.

Equity market valuation (MSCI World) has globally rebounded and now stands slightly above its long-term median value (unchanged since 1991). In relative terms, the resilience of the US equity market has further increased the huge gap between the US market on the one hand (still close to its previous peak level, as measured by the cyclically adjusted PE) and, on the other, the European market (at a mid-cycle level), where it remains close to the low registered over the past three years. 

In emerging markets, valuation could eventually converge upwards. Growth expectations seem more credible in the developing countries, but equities carry an additional risk premium.  

Euro-zone equities remain our main mid-term conviction

We favour euro zone equities relative to the US and the UK. Economic growth should continue to progress in the region, supported by still-low oil prices, a relatively weak euro, easier credit conditions in the peripheral countries and a looser fiscal policy. Following this economic growth improvement and taking into account a margin improvement, earnings growth should improve. We thus maintain a slight overweight stance in the euro zone, held back by current political risks. The removal of political risks should unlock the potential of euro-zone equities.

Meanwhile, we continue to underweight UK equities. Uncertainty linked to Brexit fears is starting to weigh on sentiment and GDP. Consumer confidence and leading business indicators have declined significantly.

Neutrality on Japanese equities maintained

In our view, liquidity support is still there as the BoJ continues to inject 80tn JPY/y and corporate profit growth remains supportive. We nevertheless remain vigilant, as the Bank of Japan recently disappointed the markets. The BoJ was expected to expand its monetary stimulus, but announced no further action. This inaction resulted in a stronger JPY and a fall in equity values.

The Yen is expected to stay at a high level until the next G7 meeting, scheduled to take place in Japan at the end of May. 

Diversification out of low/negative-yielding government bonds

• We still like high-yield bonds as they hold an attractive carry and valuation. Momentum has slowed down recently but remains clearly supportive.
• We are positive on inflation-linked bonds, as we expect consumer-price inflation data to rise gradually. 

Towards a stabilisation of oil prices

• After the April rally, all major commodity sub-sectors are in positive territory YTD.
• Oil prices continued to increase sharply during April, leading us to believe that we were moving towards a stabilisation. Fundamentally speaking, we still expect a rebalancing of the oil market in the summer, mainly due to falling production in the US. During the adjustment, oil-price volatility should remain high.
• Gold has hit its 2015 high but failed to cross the USD1300/oz level.