23 MAY


Asset Allocation , Topics

The synchronization in the current expansion is remarkable

Executive Summary

  • ˜The macroeconomic background remains positive. EU structural and cyclical data are supportive and still surprising on the upside, while US cyclical momentum is in a soft patch.
  • Central banks are expected to be at the forefront in the coming months, with one Fed rate hike priced in for June and potential ECB tapering announcements after the summer.
  • EMU and emerging market equities remain our main convictions. The global equity markets are missing a new catalyst to continue the current uptrend.
  • We are maintaining our cautious positioning in UK equities but hold a lower underweight on the GBP against EUR ahead of the upcoming British elections.
  • We took profit on our US overweight, as the narrowing gap between the “soft” survey data and “hard” activity constitutes a warning signal for US equities.


The synchronization in the current expansion is remarkable

United States: Q1 GDP growth was weak…again!

The US once again started the year with a weak quarter. Consumption disappointed and inventories contributed negatively to a first-quarter annualised growth of 0.7%. Economic indicators remain, nevertheless, well-oriented. For instance, the ISM manufacturing index, at 54.8, remains firmly above 50, despite the recent drop. Economic growth should accelerate in the second quarter, supported by improving investment momentum, increased exports (thanks to Asian demand and a stable USD) and improving consumption. Although the rise in hourly earnings has stabilised since last summer, wage growth – driven by a declining unemployment rate amid a strong job market close to full employment – should gradually pick up. In the background, the tax reform discussion has been launched by the US President, but its financing remains a pending issue, implying an execution risk.

In this context, we have slighty revised downwards our GDP forecasts for the United States to 2.1% in 2017 and 2.4% in 2018, assuming a moderate pace and magnitude for the coming policy stimulus.

Euro zone: growth showing further signs of acceleration

Economic activity remains upbeat and seems ready to accelerate further. Services as well as manufacturing PMIs reached new highs in April and point to a broadly shared acceleration in activity. Equipment investment could surprise to the upside, while extra-euro exports are gaining momentum. The recent appreciation of the euro could, however, be a threat. Meanwhile, consumption – supported by faster job creations – should remain well oriented.

Despite the positive outcome of the French presidential election, with the victory of pro-European candidate Emmanuel Macron, the upcoming French legislative elections leave some uncertainty.

In this context, we left our GDP growth forecasts unchanged, at 1.8% for 2017 and 2.0% for 2018. The recovery is thus more robust and the euro area is in a better position to face adverse shocks.

Central banks at the forefront in the coming months

Outside the US, central bank stimulus remains significant. The ECB has only just started to decrease its monthly asset purchases, while the balance sheets of the major central banks are still growing. Central bank meetings in June and September will be key.

  • The Fed considers the weaker activity in Q1 as transitory and is paving the way for a hike in June unless activity shows clear signs of weakness.
  • The ECB left its accommodative monetary policy unchanged, despite the eurozone’s confirmed recovery, and should continue its asset purchases at least until December 2017. However, ECB tapering is likely to take centre stage in Q3.
  • Although it has increased its economic forecasts, the Bank of Japan kept its policy steady, with a target yield for the 10-year Japanese government bond at around 0%.

United Kingdom: update on “Brexit” negotiations

The 2-year Brexit negotiations have been underway since the official UK notification to leave the European Union. During the special European Council meeting on April 29th, the 27 EU countries unanimously agreed to conduct the negotiations in two phases despite Theresa May’s request to negotiate trade deals and divorce conditions at the same time. The first phase will aim to:

  • clarify EU citizens’ rights in the UK and UK citizens’ rights in the European Union;
  • negotiate the size of the divorce bill;
  • tackle the border issue between the Republic of Ireland and Northern Ireland.

The second phase, on the future trade relationship negotiations, will start afterwards or at least when the European Council has determined that sufficient progress has been achieved in the first phase towards reaching a satisfactory agreement on the arrangements for an orderly withdrawal.

Amid the Brexit negotiations, Theresa May has called for a snap general election in June in order to secure political unity for the implementation of her “Brexit” Plan.

In this context, UK Q1 GDP growth – mostly dragged down by services – came in at 0.3% as opposed to 0.7% the previous quarter. The recent inflation increase (inflation reached 2.3% in March for the second month in a row) is likely to weigh on consumption.

Cross-asset: we continue to favour equities over bonds

Equity markets have performed well since the beginning of the year and the global context remains supportive. Despite the fact that US cyclical momentum is on a soft path, expansion is on-going. The Eurozone has  taken the lead in the current phase. For the first time since 2007, not one single country in the Eurozone has registered negative annual growth. Meanwhile, central banks remain highly accommodative outside the US.

At the same time, equities are still more attractively valued than credit and their expected return should be boosted by improving earnings. Furthermore, valuation multiples can withstand the expected increase in inflation.

Key risks remain geopolitical despite the receding European risk premium. We will continue to monitor the following events closely:

  • French parliamentary elections;
  • Brexit negotiations;
  • the unpredictability of the new US president.

In this context, we have maintained a positive strategic view on equities. However, we also recognise tactically that markets are currently missing a new catalyst to continue their uptrend.


Neutral on US and Japanese equities

  • We are waiting for more clarity on fiscal stimulus and see the narrowing gap on the downside between survey optimism and actual activity as a tactical warning on US equities. We expect stronger growth and a rise in corporate earnings, especially under President Trump’s expected spending policy. However, the latter is now more uncertain and could take longer than initially expected by the market. As a result, we revised our expected earnings growth downwards, from 10% to 7%. Furthermore, the reflation trade has faded and investor positioning is now close to neutral. Valuations remain high, so earnings growth is crucial to US equity market performance.
  • The yen has stopped decreasing against the US Dollar, as Donald Trump’s future economic and fiscal policy is more uncertain. However, pressure on the USD should be maintained. Separately, the country is benefiting from improving activity indicators, a supportive domestic policy mix and relatively attractive valuations. The correlation between the Nikkei and the Yen remains very high, as currency depreciation leads to upwards earnings revisions.

Overweight on eurozone equities; negative on the UK

We have further increased our overweight on EMU equities as the region is benefiting from a more robust and broadening economic expansion, an attractive valuation, an increase in corporate profits and a supportive investor sentiment attracting global inflows.

  • Political uncertainty: the French election outcome led to a sharp decline in the political risk premium. A retreat towards average uncertainty would lead to an EMU equity outperformance of 5% relative to the US. Meanwhile, risk aversion in the euro zone remains at a low level.
  • Economic momentum: economic surprises remain solid, but they could now be considered as toppish.  
  • Earnings growth: earnings revisions continue to improve, with a better-than-expected Q1 season, which benefited from stronger domestic and external demand.
  • Investors are coming back to the EMU equity market. They are now overweight in EMU and underweight in the US, but there is still significant space for inflows, given last year’s massive outflows.

Meanwhile, “Brexit” negotiations continue to justify our negative stance on UK equities:

  • Earnings growth will no longer benefit from GBP depreciation as the base effect will fade after June.
  • Stabilizing commodity prices are no longer supporting earnings growth and domestic fundamentals are weakening while downside risks remain.
  • Relative valuation is rather expensive, as earnings have dropped in recent years.

Overweight on Emerging markets

We have maintained our emerging market equity overweight (since mid-February).

  • USD remains broadly stable;
  • lesser probability of outright economic and trade war;
  • upwards revision of our expected earnings growth, as the synchronized upturn has gathered steam since the beginning of the year. Expected nominal earnings growth is now at 10%, from 8% the month before;
  • attractive valuations;
  • improving technical set-up.

Meanwhile, we remain positive on India:

  • We have reached the end of demonetisation.
  • Fundamentals confirm our positive view at country level: 7.1% GDP growth expected in 2017 and receding inflation
  • PM Modi, who is a strong adept of long-term structural reforms, did well in the recent regional elections.
  • An improving current account makes India less vulnerable to external influences, a major theme since Donald Trump’s election.


Diversification out of low-yielding bond segments

  • Despite the recent long-term yield set-back, we remain confident that longer-term US bond yields – supported by a hawkish Fed and an improving European economy amid fading political risks – will rise in the coming months. We are therefore keeping our underweight in duration and short on US Treasuries.
  • We are keeping a small diversification in high yield. The carry of the asset class remains attractive and default rates are low but we see little room for further spread compression.
  • We have a slight overweight in emerging debt, both in local and in hard currency. The emerging debt asset class is benefiting from strong fundamentals, as risks of a China slowdown and commidty rout have declined. Meanwhile, growth is recovering across all regions. Despite the fact that emerging debt spreads are close to our target, yields remain attractive against US Treasuries and there is still a significant expected return.
  • Despite the recent setback for reflation trades, it’s not the end of them. After a run of positive surprises and commodity price effects, inflation momentum will continue to stabilize, but at a slower pace. Global inflation will be driven by a rising US CPI due to the prospect of higher wages and US fiscal easing.  As a result, we remain positive on inflation-linked bonds.


Commodities lost some ground in April, largely due to a decline in iron ore, copper and oil prices.

  • Brent crude oil ended April at 52.02 USD/barrel. OPEC members’ production is in line with last year’s agreed level, but the continuing US production remains a significant headwind.
  • The drop in iron ore prices was due to fundamental reasons. The iron ore market faces a significant cumulative production excess in the coming two years. Also, the iron ore demand from China is declining on a year-on-year basis.
  • The decline in copper prices is the result of an accelerating decrease in speculative positions. Fundamentals remain positive, with an expected production deficit over the next three years.