Economic Outlook and Investment Strategy - May 2015
Multiple Transitions Going On
The Multiple Transitions theme is confirmed and it’s going in the direction we expected.
The decline in oil prices and the movements in the forex market have allowed some short term income redistribution across countries: Euroland and Japan benefited the most via exports and improved domestic demand.
In the Euro area, we see structural reforms in Italy, Spain and eventually in France gathering steam. However, this cyclical recovery is uneven while internal imbalances, such as high unemployment, remain a concern.
In Japan, while monetary policy continues to play a major role, some structural reforms have been taken shape with respect to the job market and in the agricultural sector. In our view, April will be a crucial month in assessing the progress of the wage negotiations and whether they will confirm a plus 1% YOY increase. The good news so far is that it appears the growth rate will be higher than last year, when it posted a limited 0.2%.
The US suffered a weak first quarter, mostly as a consequence of bad weather conditions. The labor market is progressively adjusting, investment is set to pick up but we have not seen the wage increases we expect to confirm a structural recovery.
China’s slowdown is policy induced and signals the progressive transition towards a more balanced economy.
Central Banks Dominating the Scene
Monetary policy will likely continue to dominate the macro and financial dynamics.
Uneven growth and recent cyclical factors highlighted the out of sync nature of monetary policies across the board.
The European Central Bank finally launched its massive quantitative easing program. Size, target and conditions have been explicitly spelled out to strengthen the ECB’s credibility, to affect term premia (as shown by the yield curve flattening), to anchor short term expectations and, last but not least, facilitate a progressive weakening of the euro.
In our view, the ECB has have been successful in hitting all 4 targets.
With respect to the Federal Reserve, it seems to have been confirmed that global data will drive policy action. We believe that the speed of the Fed’s tightening will be more important than the starting date. However, should economic conditions not deteriorate dramatically we expect a slow movement to start in Q3 2016.
The People’s Bank of China recently cut the reserve rate by another 100 basis points, confirming its easing and supportive stance.
Geopolitical Risks Remain On The Top Of Our Wall Of Worries
Tensions around Russia and Ukraine, Greece, and the Middle East are the areas of major concern.
We believe that as a consequence of monetary policy decisions, declining oil prices and FX dynamics, macroeconomic risks are reduced.
Euro depreciation and quantitative easing from the ECB have reduced deflation risk, although it remains on our radar screen.
As we think geopolitical risks may have a material impact in a market where valuations are tight for almost every asset class and where liquidity is fading, we believe that it is worth keeping hedges in place to protect risk assets as much as possible from volatility spikes.
While we have a long term constructive view on risk assets, in the short term we prefer to exercise a degree of caution by having hedges in place.
Investment Themes For The Rest Of The Year
Central Bank a-synchronicity represents one of our major investment themes.
It partly justifies our constructive view on risk assets and may generate relative value opportunities across and intra yield curves and in the forex market.
According to this theme, we see the US yield curve flattening and we believe that the US dollar may benefit.
However, we cannot exclude a short term retracement of the US dollar, after the strong and rapid movement versus the Euro and Yen.
The same rationale, plus favorable relative valuation, motivates our positive view on European equities vs US Equities.
We are also positive on Japanese equities.
Among Emerging Markets, we prefer Chinese and Indian equities, as we see China and India as the countries most committed to implementing structural reforms.
In general, we prefer markets with solid earnings growth, where the policy dividend is consistent and sustainable. Economic and stability conditions which reflect an ability to implement a credible reforms agenda represent another of our top down criterion.