Macroeconomic data have yet to catch up with the “post-Brexit” world

Macroeconomic data keep showing slight improvements in major corners of the world. In the US, the scenario of accelerating GDP seems to be on track. Exports and new orders are on an upward trend following a weaker dollar earlier this year. This should result in economic growth and an increase in earnings. In addition, consumer confidence is now back at pre-2008 levels. Consumption is the main pillar of the US economy and employment an important factor that the Fed will look at when making decisions later on this year on when to raise interest rates. Uncertainty could, however, creep back in with the presidential election campaign.

In Europe, expected GDP growth is around 1.6%-1.7% (see chart), which, although modest, is still in expansion territory. Consumption should continue to be dynamic, but we expect harder times for exporting firms due to last year’s appreciation of the Euro. Extra-euro-area exports are running much higher than intra-euro-area exports: any appreciation of the currency has therefore a significant impact. Clearly, finding new sources of growth is the region’s main challenge.

In the UK, the Brexit-confidence shock is hitting an economy that was already slowing down in the run-up to the late June referendum. The country is relying on BoE Governor Mark Carney and the central bank to keep a looser policy mix to support business and consumer confidence.

As yet unclear are the full consequences of the Brexit for  the global economy, which had been showing signs of stabilization and geared towards improvement. On the positives, the UK now has a new PM in Theresa May, Home Secretary for 6 years and determined to make a success of the Brexit.

In search of yield, investors are rotating their assets from equities into bonds

The current volatility, political uncertainty and concerns deriving from the Italian banking sector have been plaguing the markets. What will happen to the Italian financial sector remains to be seen. Under these circumstances, investors – in search of yield – are taking refuge in more resilient markets such as emerging markets and fixed income. Indeed, the Brexit created a local but not global shock. Its epicentre is the UK and Europe the first region to potentially suffer from the consequences. Emerging Markets, albeit linked to the global context, have shown resilience. They have also been supported by the Fed, which keeps postponing the next interest-rate increase and has remained particularly dovish.

We have shifted our focus to Fixed Income and increased our exposure to Emerging market debt, both in local and in hard currencies.

REGIONAL EQUITY STRATEGY

Shorter visibility implies a nimble approach to investments

Before the Brexit referendum, we reduced our exposure to European equities. We are currently underweight both European and UK equities. In adidition, while we have added to our US equity exposure, we are maintaining a neutral position. The Presidential election campaign might mitigate the encouraging development of inflation, employment and consumption.

We have also decided to take a neutral stance on emerging market equities: the short-term evolution will depend on the evolution of the USD, the Fed’s timing for an interest-rate hike and the global context.

Still neutral on Japanese equities

We are neutral on Japanese equities. Different GDP growth scenarios are possible depending on Japanese PM Abe and the Bank of Japan’s announcements. Looking at the trade-balance contribution to growth, exports and retail sales, growth should be positive in Q2 but the environment could become more challenging during the second half. Shinzo Abe ordered a new round of fiscal stimulus spending after a significant election victory last weekend. The objective is to support the corporate sector, which is struggling due to weak demand and the rise in the Japanese yen. The size of the package is not known but the news was enough to hike the NIKKEI up 4%.

Economists are starting to question Abe’s focus on public-works spending. In the long term, it will not solve the country’s biggest structural issues – a declining population and workforce.

FIXED INCOME STRATEGY

Convictions on credit

On the credit side, we still like high-yield bonds as they hold an attractive carry and valuation. Momentum remains clearly supportive. We are also overweight credit on the European and the US sides.

Convictions on government bonds

Our fixed-income allocation is diversifying out of low- or negative-yielding government bonds. We have more conviction on Emerging markets, on which we are overweight.

The Brexit vote has further accelerated the search for yield. As a result, Emerging Market debt is the one asset class to have registered significant inflows in recent weeks.

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 in 1.5% inflation foir the coming years, which looks overly cautious. 

Stabilisation of supply of & demand for oil

• Supply of, and demand for, oil have stabilised, hence its price as well. The oil-price evolution had become dependent on a US production decrease given that OPEC could not come to an agreement. The US oil-production decrease is on track. Rig numbers have bottomed and some rigs have re-opened.
• Gold had an impressive run in H1 2016, with a 28.8% price increase. Gold prices have been mainly supported by the drop in bond rates, the strong decrease in US real rates and its status as a safe haven in these uncertain times.