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Weekly Investment View | 2nd April 2017
Claude-Henri Chavanon | MD, Head of Global Asset Management, NBAD
The bell-weather S&P500 rose by 0.82% over the week, making 5.9% for the first quarter, in a reversal of the bout of nerves suffered the previous week following the US healthcare vote disappointment. The bears had seen the failure of that vote as part of the vindication of their views, saying that the difficulties of getting the replacement Act in place would be repeated with other imminent legislation such as tax reform (which we refuted in last week’s report). We had reduced our overweight position in US (and European) equities immediately prior to that vote, although only with the tactical aim of reversing this upon the realization of the market correction we discussed in January’s Outlook 2017. The correction may still occur in the weeks to come – but many investors seem determined to buy the dips. European large-cap equities rose by 1.8% over the week (and were ahead by 6.8% for the quarter), as investment sentiment and the flows of funds continue to improve for the sub-asset class, for the moment looking beyond immediate political uncertainties. For the first quarter, the MSCI World index rose by 6.4%, a very good performance, although one eclipsed by that of the MSCI Emerging Markets index, up 11.4%. The Barclays Aggregate fixed income index rose by slightly less than 0.1% over the week, and was up by 0.8% over the quarter, with the yield on the US 10-Year Treasury 2.5 basis points lower (the yield on the US 2-Year only fell fractionally). The US dollar was 0.6% firmer on its index over the week, and 1.8% lower over the quarter; the dollar index stands at 100.35, in a short-term reversal of a technical correction towards the 99 level seen intra-day early last week. Factors driving this will have included a fall in eurozone headline inflation, to 1.5% in February (vs. 2.0% in January), a Reuters article suggesting the ECB’s monetary policy had been interpreted ‘too hawkishly’, and possibly the upward revision in Q4 US economic growth (from 1.9% to 2.1% – marginal, although in the right direction).
Elsewhere, the South African rand fell by 7.3% over a week during which rumours of the sacking of their Finance Minister came to fruition. Lest we forget, the UK Government served Article 50 notice on Brussels, although sterling rose marginally as the short position was already believed to be substantial. The US Conference Board consumer confidence index stood out for us, posting 125.6 for March, vs. expectations of a fall to 113.8, and although this could always be revised downwards, in our view such data holds the key to the outlook for the dollar (still positive, we believe), and to likely US equity market movements.
“Mnuchin continues to manage expectations”
Steve Mnuchin, US Treasury Secretary, continues to do a good job in the part of his role coming under the heading of ‘manager of economic expectations’. He has said that US economic growth in the region of 3.0-3.5% looks possible once the policies of the new Administration are rolled-out. He and his team are looking at the different options of how tax reform (and presumably infrastructure spending) can be funded. A comprehensive tax reform package (of corporate and personal taxes) has been targeted to be delivered by Congress’s August recess, although Mr Mnuchin has hinted that it may take a little longer, perhaps into the autumn. He has been quoted as saying that markets could improve ‘significantly’ once the policy rollout is underway. We never expected this to be fast, going back to comments made in the Outlook. In quoting a 3.0-3.5% growth range, he surely believes that is beatable in time. Meanwhile, let’s not forget that US GDP growth was 3.5% in the third quarter of last year. Elsewhere, in our reading last week there was mention of the possibility that the funding of Trump’s ‘Wall’ would somehow be ring-fenced, or treated separately from other proposed government spending. Also, readers should note that the Administration used three fund technicalities to effectively push out the problem of the debt ceiling way beyond the end of April, perhaps to October/November. In terms of dealings with the Chinese (and especially regarding trade), during his upcoming meeting with President Xi, Trump is sure to be reminded that the US has a surplus with China in services – and we wouldn’t be surprised to see the Chinese offer to make substantial FDI commitments, to at least help in the evening-out of the overall balance of payments picture between the two countries (in line with what Alibaba’s Jack Ma has already said).
President Trump last week (upon the failure of the healthcare vote) learned a hard lesson about most politics in civilized societies being based on compromise. While many commentators continue to bleat on about an imminent trade war, we continue to think that such possibilities are overblown. Returning to consider the extent to which investors are genuinely concerned about Trump’s policy rollout taking longer than expected, and not being as large, we believe current market action actually reflects a degree of relief that the pace of change ( – and the presumed financial risks to be taken) will be more moderate than earlier expected. It is the ‘business-friendly’ tone that investors in US equities like, as well as the increased likelihood of infrastructure and other spending not being so inflationary. Also, if corporate taxes only get reduced to a base level of 20% (Paul Ryan’s number), rather than Trump’s 15%, there will still be bottom-line earnings benefits, as well as positive multiplier effects. Looking at the S&P500 consensus overview on Bloomberg, while some of the 11.27% earnings growth assumed for 2018 comes from buybacks, this still seems not to be a demanding expectation – and this does look (due to previous QE) to be an extended ‘late-cycle’. The P/E ratio for 2018 for the S&P is a moderate-looking 16.3x, down from 18.2x for the current year.
“Sterling has already been heavily shorted”
As of last Wednesday, the Brexit clock is now ticking, with the start of two years of what are likely to be difficult negotiations ahead. EU officials must of course do their best to make sure no other (good – or fairly good) countries leave the bloc, while British Prime Minister, Theresa May, and her team must do their best to deliver the will of the UK electorate as cheaply as possible. The ‘EU27’ are not meeting until the end of this month to begin to discuss their strategy for the UK’s exit, so the markets may reduce their focus on Brexit for a few weeks. As mentioned in the overview, sterling has likely already been well ‘shorted’. The position of the Scots, having decided upon another independence referendum, does complicate matters for the UK, but it is their right to have chosen this path given the way things have panned out since the last one. The fall in sterling has led to an ‘exporting sweet-spot’, while the effect on inflation has so far been quite well contained. In the short-term the EU has decreed that no discussions on future trade deals may take place until the initial terms of the divorce have been settled (i.e. the deemed outstanding liabilities). Already the EU has been using confusing verbiage probably underlining why the UK voted to leave in the first place, a reminder of the considerable bureaucracy resulting from thousands of regulations imposed by Brussels. The discussions to come will be highly complex, involving the UK’s liability to future spending plans (and including peripheral states) already agreed, as well as awkward items such as the funding of EU staff pensions. The analysis of sterling as a currency, and the UK equity and gilt (bond) markets, are probably amongst the most ‘perfect’ markets that exist. In the Outlook 2017 our FX experts determined that sterling’s ‘fair value’ was likely in a range of $1.35-1.40, and we stand by that recommendation, expecting a gradual drift upwards as the year progresses – complete with Cable’s expected volatility over short periods.
INVESTMENT SUMMARY: There are signs that markets, especially equity markets, have begun to trade slightly more normally i.e. with more volatility – perhaps in line with a VIX index in the 12-15 range, rather than 10-12 (currently at 12.37). We explained in last week’s report why we would not extrapolate the Obamacare repeal failure, yet we are still fully prepared for an equity correction led by the US that appears overdue. If we fail to see the opportunity to buy back our recently ‘top-sliced’ positions in US and European equities in the weeks and months to come, the portents of that would be bullish. Any signs of fiscal stimulation in Europe would be very welcome, and further underline our structural overweight stance in that sub-class.
“We are happy to remain overweight in global equities”
We continue to like Indian and MENA equities and are overweight, although admit that the performance of EM equities as a group in recent months has surprised us. Indian equities appear to be in a new medium-term uptrend, with little overhead resistance. MENA equities remain good value, and the all-important oil price continues to trade in our forecast range of $45-60 for WTI. $65/barrel is still possible in early 2018 (based mainly on better demand and ‘Big Oil’ supply constraints after the capital expenditure reductions of recent years) – yet the price does look ‘capped’ towards the top of that range. We have reserved judgement on China and its markets, pending more clarity. The Chinese economy is doing well (with the usual statistical caveats), and the authorities there are tightening a credit squeeze to take some of the steam out of asset prices (especially properties in Tier I cities). There are indications that Chinese onshore equities could qualify for MSCI EM index inclusion this June, although the initial percentage inclusion may be quite low. Sectorally, and with particular reference to US equities, we continue to favour Information Technology (borne out by the NASDAQ going to new all-time highs last week, and driven by recent good corporate results), and Financial Services (whose deregulation in the US does not appear to require the approval of Congress). We remain slightly underweight in Fixed Income, via underweights in Sovereigns, and continue to prefer High Yield to Investment Grade. The multi-year bull market in bonds has not ended. We are underweight in Alternative Investments (essentially hedge funds and commodities, although still neutral in gold), and with below-average Cash, as we continue to generally favour being overweight in risk assets. The Asset Allocation Committee meets late this week, and as usual we will update you regarding any investment decisions taken.
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