Investors can see the glass half full: there is growth but it’s sluggish. Economic indicators are moving in the right direction. The global leading manufacturing indicators are broadly in positive territory, especially in the euro zone. In the US, the ISM manufacturing index expanded for the 3rd consecutive month after 5 months of contraction. In the euro zone, the figures are in expansive territory: Germany is ahead, while the UK is stabilising. In Asia, China’s PMI for the manufacturing sector continues to hover around 50, the level that separates growth from contraction.

In this context, central banks will pursue divergent paths this year. Both the ECB and the BOJ have policy rates anchored in negative territory as they pursue quantitative easing. In the meantime, Statements from the Fed have reminded market participants of the Fed’s wish to gradually raise its key rates sooner rather than later. Although Janet Yellen hinted at an imminent short-term interest-rate hike during the last Fed FOMC, the non-farm payroll figures published last Friday were way below the estimated number. This new data removed almost entirely the probability that the hike would happen in June, leaving the door open for a hike on July 27th.

Equities still our favourite asset class

EPS growth expectationsOur favourite asset class remains equities. The economic context is favourable, and has taken a turn for the better since the beginning of the year. On both sides of the Atlantic, the economic news flow is better than at the beginning of the year. Economic surprise indexes are positive for the euro zone and emerging markets. In the US, they remain negative after the disappointing job report, though the trend is clearly heading in the right direction. 

In the light of an improving economic context, earnings, too, are improving. The earnings revisions ratio has improved in all large regions, except Japan. Howevern expected earnings growth for the coming twelve months looks very low for the US, the euro zone and emerging markets and could be revised upwards.

Finally, the equity market valuation (MSCI World) has globally rebounded and is now slightly above its long-term (since 1991) median value. 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 the European market (at a mid-cycle level), where it remains close to the lows registered in the past three years. Emerging markets are at the bottom of the cycle level.

REGIONAL EQUITY STRATEGY

Slight tactical reduction in the euro zone, with maintenance of our mid-term conviction

We favour euro zone equities. Economic growth should continue to progress in the region, supported by still low oil prices, a relative weak euro, easier credit conditions in peripheral countries and a less tight fiscal policy.

Following this economic growth improvement and taking into account a margin improvement, earnings growth should improve. The political risk nevertheless remains and the countdown to the British referendum has started. We took advantage of the recent rise in European equities to reduce our overweight slightly and added to our US exposure. 

We are still underweight UK equities and are getting into a position to handle any outcome for the referendum.

Still neutral on Japanese equities

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 Yen is still at a penalising high level. In addition, the Bank of Japan, while deciding to postpone a VAT hike till April 2017, added no details to its ongoing monetary policy during its last meeting. The high yen wil probably also have a significant impact on earnings. Earnings expectations look too high.
Still neutral on Japanese equities

Emerging market rebound should continue

Emerging markets suffered during in May for three main reasons:

  • The dollar appreciated, hence decreasing their purchasing power
  • The Fed hinted at a rate hike
  • Brazil is in the midst of corruption scandals at all levels of the political scene, destabilizing investors’ confidence

However, the outperformance of emerging markets since the beginning of the year is set to continue. Valuation and technical factors are supportive to emerging market equities while the stabilization of the USD and of commodity prices should allow a further re-rating of emerging assets.

FIXED INCOME STRATEGY

Convictions

ConvictionsWe still like high-yield bonds as they hold an attractive carry and valuation. Momentum has slowed down recently but remains clearly supportive.

Our fixed income allocation is diversifying out of low-/negative-yielding government bonds. We have more conviction on US corporate bonds, emerging debt and linkers, as we expect consumer-price inflation data to rise gradually.  Assuming an oil price at 45 USD in 2016 and 50 USD in 2017, the US CPI could rise towards 2.5% year-on-year in the coming months, while breakevens are only pricing 1.5% inflation for the coming 10 years.

COMMODITIES STRATEGY

Oil price around 50 USD/barrel (Brent)

  • After April’s rally, all major commodity sub-sectors are in positive territory YTD, especially the Brent and crude oil.
  • Copper, at -1.6% YTD, is the only exception, following heavy speculation by Chinese investors. 
  • Oil prices stabilised in May after a sharp increase in April. The main contributor to the stabilisation of prices was the standstill in US production, while OPEC members were unable to find an agreement on a supply regulation.
  • Gold suffered in May after a risk-on return and the expected rise of the Fed Funds rate. Its price decreased by 6%.

Oil price around 50 USD/barrel (Brent)

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