Overall, our mid-term base scenario remains supportive for equities against bonds. Growth should remain robust, though momentum is somewhat fading outside the US beyond the second half of the year.
Inflation is gradually increasing, but does not represent a major concern to us, while monetary tightening remains progressive. Higher volatility might create opportunities, especially as equity market valuations have become less stretched after the recent corrections.
Nevertheless, we are currently neutral on equities as we see an increase in downside risks to our base scenario, such as the peaking macro momentum, accelerating monetary tightening in the US and intensifying concerns on protectionism. Clearly, we are looking for a better entry point and gain more conviction to add risk to our portfolios.
Our current investment strategy on traditional funds:
grey : no change
blue : change
EQUITIES VERSUS BONDS
On the short term, we see a less favourable risk-reward momentum. We maintain our neutral stance on equities and we decrease our Japanese equity exposure to neutral.
- Global growth momentum outside the US is likely to have peaked.
- Global monetary tightening is progressive, but the US are tightening first; given the accommodative fiscal policy.
- The Federal Reserve started its balance sheet reduction in October 2017, hiked in December 2017 and in March 2018.
- The ECB has recalibrated its programme, buying less bonds as of January. A rate hike should not occur before 2019.
- The escalation of tensions on global trade represent a new development and a major uncertainty.
REGIONAL EQUITY STRATEGY
- We maintain our neutral stance on euro zone equities. The region still displays a robust economic expansion but activity indicators show some signs of weariness. The ECB remains accommodative, and is not in a hurry to become hawkish. Corporate earnings momentum has weakened and euro zone equities currently lack new catalysts.
- We are underweight on Europe ex-EMU equities. The Bank of England’s more hawkish monetary policy stance has put a barrier to GBP depreciation, challenging overseas profit growth. “Brexit” negotiations remain a risk, while negotiations on new trade relations don’t seem to progress much. Britain also has a lower expected earnings growth and thus lower expected returns, this justify our negative stance.
- We took a partial profit on our US equities exposure. We see the positive impact of Trump’s tax reform and deregulation, and improving earnings growth. Nevertheless, the US trade policy (incl. USD) appears as a major policy unknown, as risks start to materialise.
- We have trimmed our Japanese exposure towards neutral. Visibility on an accommodative policy mix and an above-potential expansion remain positive for Japan. But, the stock market is highly correlated with the JPY performance, which, currently fulfils a safe-haven role and appears disconnected from the accommodative Bank of Japan.
- We have become neutral on emerging markets equities. They are impacted by a tightening Fed and the geopolitical noise around the budding trade war between the USA and China. In addition, the high weighting of the tech sector (28%) is adding volatility.
- We are underweight on bonds and keep a short duration
- With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to show an uptrend towards 3% on the 10Y US government debt. In addition to rising producer prices, rising wages, fiscal stimulus and tariffs on trade could push inflation higher. The Fed will continue its hiking cycle beyond March.
- The overall improvement in the European economy could also lead EMU yields higher over the medium term (towards 0.9% on the Bund). The ECB remains dovish in its Quantitative Easing plans and is opposed to a strong euro.
- We have a neutral view on credit as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
- The on-going monetary easing represents an important support for emerging market debt.