Over the past week, investors continued to follow the escalating tensions between the Spanish central government and Catalonia. However, we expect macro-financial risks linked to the repercussions of the Catalan independence referendum to remain contained. On the medium-term, we remain confident on solid economic fundamentals in Spain, as growth has been remarkably resilient to political uncertainty. Nevertheless, on the short-term, we think it is premature to commit any risk budgeting to Spain as an independence declaration would likely prompt Madrid to seize power from Barcelona, which could exacerbate the tensions. We keep our positive stance on equities unchanged.
Separately, we expect markets to turn their attention to the 19th Congress of the Communist Party in China. President Xi, facing slower structural growth due to demographics and productivity, is expected to announce an expansive global agenda, based on digitalisation and anti-pollution policies. He has also made stability a priority and the recent track record is rather positive. As the party will replace five of the seven members of its standing committee, the leadership transition could show strongman politics replacing prior consensus-driven practice. Beyond short-term headwinds from a potentially stronger USD, our investment conclusion is that emerging markets’ growth will remain sustainable.
This week, we will follow the EU council summit, as progress regarding the “Brexit” negotiations will be monitored.
Our current investment strategy on traditional funds:
grey : no change
blue : change
EQUITIES VERSUS BONDS
We are positive on equities and remain negative on bonds, maintaining a short duration:
- Global economic momentum is accelerating further with economic news-flows surprising on the upside.
- We concentrate our portfolio’s regional positioning on the euro zone, Japan and the Emerging markets. While we are still positive on Japan, we suspect that Emerging Markets could face some headwinds given the strengthening of the USD.
- Central bank stimulus will fade gradually:
- The Fed is starting its balance sheet reduction this month.
- The ECB will likely announce its tapering this month.
- Overall, central banks are confident on the synchronised global growth context and are prudently adopting a tightening bias.
- Equities have an attractive relative valuation compared to credit. .
- The main risks for equity markets remain (geo)political, with different degrees: Catalonia, the Chinese congress, North Korea. We add the US to the list, where the monetary policy uncertainties due to the upcoming reshuffle of the Board of Governors of the Federal Reserve adds to the fiscal policy uncertainties but should be clarified in the coming weeks.
REGIONAL EQUITY STRATEGY
- We continue to favour euro zone equities. Earnings momentum remains strong. As a result, the expected price/earnings for the coming twelve months will probably remain around their long-term mean next year. Sentiment has improved and flows have been returning. The pause in the recent increase of the EUR acts as a support after a more challenging summer for EMU equities.
- As a result of the strengthening USD and technical indicators, we are reducing our exposure to Emerging markets equities down to “neutral”.
- As we are gearing towards a soft “Brexit”, we are adopting a neutral view on GBP.
- We remain negative on UK equities. Beyond the difficult “Brexit” negotiations, the shift in the BoE’s monetary policy stance has put a halt to GBP depreciation, weakening the repatriation of overseas profits realised by UK corporates.
- We keep our neutral stance on US equities. There is an execution risk in the announced fiscal stimulus and pro-growth policies. Nevertheless, on the policy mix, we see progress on fiscal stimulus along with a tightening Fed. We note that the House and the Senate Budget Committees both approved versions of the FY 2018 budget that included general directions to act on tax reform.
- We are positive on Japanese equities. A strengthening growth and a supportive domestic policy mix are among the main performance drivers and we have gained more conviction that the BoJ will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY. Despite the elections next Sunday, political risk should be limited.
- We are negative on bonds and have a low duration. We expect rates and bond yields to resume their uptrend from this month’s low, driven by a tightening Fed, and potential upcoming inflation pressures. The improvement in the European economy could also lead EMU yields higher.
- We continue to diversify out of low-yielding government bonds:
- We have a neutral view on credit, as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
- We have a diversification in inflation-linked bonds.
- We keep our diversification to emerging market debt, as the on-going monetary easing represents an important support.
- We are more or less neutral on high yield.
- On the currency side, we expect the EUR/USD exchange rate to strengthen over a 12 month horizon after a temporary weakness.