Asset Allocation – Executive summary: We remain overweight on equities vs. bonds…
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Nonetheless, we did not reinforce our convictions after the FOMC (Federal Open Market Committee) meeting of 19 September 2013 and the Fed’s announcement of its postponement of QE tapering (which will lead to more uncertainty, vulnerability and volatility depending on macro news flow and investor expectations)
– Preference for Europe vs. US
– Preference for Japan vs. Emerging Markets
– Neutral on the UK
We remain underweight on bonds
– Underweight on Government Bonds
– Overweight on High Yield
Cross Asset Strategy
Macroeconomic context – Synchronised recovery: beneficial to risky assets
All global activity indices for the manufacturing sector are above 50, i.e., in expansion territory, with very strong figures in the US and UK. In addition, the Economic Surprise index stabilised in September at a high level, both in Europe and in the US. In the US, the agreement on the increase of the debt ceiling between Democrats and Republicans fits our scenario. But the deal is temporary and the problem may well resurface in early 2014. In this context and with the recent rise in interest rates, the Fed postponed its tapering and also made it clear that its key interest rate isn’t likely to be raised before 2015.
The euro area is reverting to positive, albeit with moderate growth. While consumption and investments have stopped declining, exports will be the main driver of ‘growth’, when fiscal tightening will be less of a burden in 2014.
Relative valuation – Current context now even more favourable for equities
Rising interest rates: with the exception of 1994, equities have rallied in periods of significant rate increases – usually a reflection of better economic data with contained inflation.
Multiple expansion: current multiples, far from expansive, should indeed continue to expand:
– US price/earnings is at a historical average level adjusted from the cycle and considering long-term growth.
– Europe’s price/earnings is still below its historical average and looks attractive, taking into account the region’s long-term growth prospects.
Earnings – Europe: more room to play a cyclical rebound
Most of the negative revisions have been priced in and earnings should be supportive for the equity markets next year:
– In 2014, earnings should progress given the current economic growth expectations.
– In 2014, any earnings improvement, and the fact that earnings expectations are usually too bearish in periods of economic recovery, should benefit equities.
Regional Equity Strategy
We prefer Europe vs. US
The euro zone could rise further, given its improving economic figures and attractive valuation. There is much more room to play a cyclical recovery, as valuations look attractive considering the region’s long-term growth prospects. A possible reversal of Europe’s earnings revisions trend could be a catalyst next year for European equities, resulting in a relative outperformance compared to the United States, which is losing momentum.
We prefer Japan vs. Emerging Markets
Japan lacks catalysts over the short term, but the valuation is attractive given the expected improvement in company profitability. Growth in Japan will be underpinned by the depreciation of the yen, the accommodative fiscal policy (around 1% of GDP) and more accommodative monetary policy. The emerging region, on the other hand, is still the weakest and could continue to suffer from the reorientation of flows towards the developed markets.
Fixed Income strategy
In the longer term, rates are expected to stay on an upward trend, with a high dependence on the macroeconomic momentum. Taking the shorter-term view, both the current debate in the United States and the latest minutes of the FOMC have postponed the idea of tapering. In this context, there is less upward pressure but greater uncertainty.
We are maintaining our short-duration bet and are still positive on risky assets (economic context favourable, risk aversion contained)
– Preference for High Yield vs. Investment Grade
– We are positive on Convertible Bonds
Commodities strategy
Fundamentals still weak
Commodities are still decorrelated to equities and can only offer tactical opportunities. After the firm correction in the second quarter, the commodity markets, again vulnerable, suffered from oversupply and less dynamic growth in the emerging markets. The excess supply of many base metals (including copper and aluminium) put prices under pressure.
Source: ETFWorld – Dexia Asset Management
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