Investors keeping a close eye

US economic data are clearly rebounding. Nonetheless the relative fragility of certain data, especially on prices and wages inflation, and concerns about the “spillover effects” expressed during the last FOMC meeting (on the deterioration of the situation in Greece) have again placed a question mark over the timing of the first rate hike. Economists’ consensus is now shared to define on when the Fed will act and September no longer appeared as a consensus.

We think that the US central bank can nevertheless afford at least a first hike in H2: the rebound of the economy justifies this second step following the normalization of financial conditions and, given the global context of abundant liquidity, the Fed would not be taking too much of a risk. Whatever the month selected for this first rate hike, it appears sure that, as Yellen has already indicated, the Fed will continue to be cautious and closely monitor communications.

As said, the current environment continues to be globally characterized by abundant liquidity. Indeed, the ECB and the BoJ have maintained their bond purchasing programme (EUR 60bn/month and YEN 80trn/year respectively). We have also noticed two things. First, contrary to its declaration, the European Central Bank has not yet accelerated its purchases to offset the lack of supply during the summer time (see chart 3). We consider this a good sign, as the ECB could consequently have the capacity to limit contagion in the case of a Grexit and possible spread-widening on peripheral bonds. Second, the ECB has started to buy state-owned corporate bonds, meaning that they could end up being more supportive than initially expected.

As a consequence, liquidity should continue to boost the financial markets. We do not see a strong increase in yields either in the US or in the Eurozone until year-end (our target is 2.7% for the 10Y US rate and around 1% for 10Y German rate).

REGIONAL EQUITY STRATEGY

Outcome of Greek crisis crucial

From a fundamental point of view, equities retained their attractive valuation compared to bonds, despite being less appealing in absolute terms.

We are now neutral on Eurozone equities 

Even if we have often experienced, in the recent history of the Eurozone, last-minute “surprises” and unanticipated creative deals, we consider that the probability of no agreement being found is now the most likely scenario. That could lead to a Grexit. In this light, we have continued to decrease our overweight on Eurozone equities (by implementing hedging strategies or reducing exposure to these equities).

However, we still have a positive view on this asset class over the longer term and are ready to reincrease our exposure if and when the Greek crisis is resolved or the contagion limited.

In this case, the Eurozone will continue to be supported by its stronger fundamentals:

• a more attractive valuation when compared to bonds than US equities;
• stronger earnings growth, while US earnings are penalised by a strong USD and the energy sector;
• the euro and oil price depreciation, which should continue to be favourable to Eurozone equities.

We sold our exposure to Chinese equities

Chinese equities suffered in June, declining by more than 20% since their June 12 record high. The sell-off could have been triggered by a combination of factors:

• a raft of IPOs, which locked up an estimated 6.7 trillion yuan ($1.1 trillion) worth of funds, capturing liquidity from the market;
• the reduction in margin financing, as brokerage generally liquidates clients’ positions if no margin is added to cover losses. The volume of margin loans outstanding may have declined by 6%, or $23 billion, since June 18;
• the banning by China’s securities regulator on brokers cooperating with "fund-matching companies" (companies that provide margin funding to virtually anyone who subscribes);
• a stretched valuation of A-shares while economic growth is sluggish.

In this context, and despite the measures taken by the government to limit consequences, we have decided to sell our position and await further stabilisation of the current situation and strong signals of a better environment.

Overall, we have maintained our neutral exposure to emerging market equities as their cheapness is less obvious when we compare their PE-to-earnings (PEG) growth and as dispersion continues among the various emerging countries, sectors and individual stocks.

Still positive on Japan while decreasing our overweight

We kept our positive stance on Japan but, having reached our first target level, we have decreased our overweight. Japanese equities remain supportive for exactly the same reasons

• more attractive valuations and the BoJ’s additional measures should trigger a potential increase in earnings;
• investors’ expectations of a substantial future increase in shareholder returns, helped by solid earnings growth and strong cash holdings.
• the change in the asset allocation of the GPIF, Japan’s leading pension fund, which is indicative of the sustainable support for Japanese equities.

FIXED INCOME STRATEGY

Slightly increased duration

Following the recent increase trend in interest rates, we have decided to increase the duration of our bond portfolio while staying shorter than our benchmark. We think that taking into account the abundant liquidity and the current financial and economic environment (low inflation rates, cautious attitude of the Fed), yields are close to their fair value and the selling pressure should decrease. Moreover, if a Grexit occurs, the ECB should accentuate its intervention and the Fed delay its first rate hike.

We also continue to diversify our bond portfolio to riskier, higher-yielding bonds, which continue to benefit from the combined actions of the ECB and the BoJ (which are easing financial conditions) and by the more cautious approach that the Fed could adopt in its management of the interest rate increase.

Moreover, as high yield and emerging debt still offer the best carry-to-risk ratio (risk-return measure: yield-to-maturity divided by 1-year volatility), we have kept our overweight position in these asset classes.

COMMODITIES STRATEGY

Still too early to be positive on commodities, especially oil

Although probably much of the bad news on excess supply and lower global economic growth has already been discounted, it is still too early to turn positive.

Oil: we remain cautious. Even though oil rig counts have stopped decreasing, the physical market is still driven by overcapacity and high stock levels. OPEC production has increased since March and was, in June, above the call on OPEC (see charts 4). In this context, and as a deal between Iran and the six world powers (UN Security Council plus Germany) has never been so close, we think that the repricing will be long.

Base metals are being penalised by the disappointing activity in the US and Chinese manufacturing sectors of the first months of the year. Nonetheless, the oversupply problem is going to be resolved for some base metals such as copper, zinc and nickel, with supply shortages from 2016-2017. We consider it too early to invest in this asset class.

Finally, gold prices are negatively correlated with US real interest rates, which should finally start to increase in 2015. We also noticed that gold has not benefited from the increasing stress linked to the uncertainties on Greece.