30 January 2017

Asset allocation: positioned for growth and inflation

Improved macro-economic indicators, rising inflation in the developed countries, pro-growth policy in the United States etc. These major factors will again be acting as catalysts on the financial markets in the first half of the year. By Gaëlle Malléjac, Active Management Investment Director

[Gaëlle Mallejac]

The strongest and most immediate force at work is a macroeconomic “alignment of the planets” – a relatively rare synchronization of different factors. In plain terms, we are witnessing a global and continuous progression in the various indicators of economic activity in all the developed countries.

This progressive improvement in the economic situation is accompanied by a rise in prices, principally linked to the price of oil

Interest rates: a globally upward trend in 2017, but without excess

The “reflationary” trend that began in the second half of 2016 and has sustained the increase in interest rates in the United States is expected to continue. However, various nuances should be noted. For example, we estimate that in the United States the inflation forecasts for the first quarter of 2017 will not trigger excessive rises in bond yields, because this increase has essentially already occurred. This view has been reinforced by the fact that the recent rise in the dollar has given the Fed the necessary freedom to avoid over-vigorously hiking its key rates.

In Europe, where the increase in interest rates has been less pronounced than in the United States, inflation forecasts are also expected to rise, fuelled by the decline in the rate of the euro against the dollar. Our forecast is therefore an environment of globally rising interest rates, with a more marked upward trend in Europe than in the United States: The Bund (German state bond) could rise to 0.5% by June, thereby slightly reducing the spread between it and the 10-year American Treasury Note, but without any risk of causing a destabilizing surge in inflation.

The economic stimulus plan touted by the Trump government across the Atlantic is another preponderant factor. After the short-term effect of the initial announcement, which was generally well received by investors, the markets will ultimately judge this plan on the details of the measures actually implemented, between tax cuts and public investment spending. The challenge is to determine whether the protectionist dimensions of the Trump policy (with its risk of deterioration in trade relations) is liable to negate the beneficial effects of the measures aimed at stimulating economic recovery. We consider that at current levels, some of the good news has already been integrated into the markets.

Preserving a selective approach to assets

Under these conditions, we will continue to prioritize inflation-linked bonds in our fixed-income component, and, more globally, we will give preference to credit markets over sovereign debt. The bonds of companies in the high-yield BB and BBB rated segment remain attractive in the euro zone, because they are less exposed to interest rate risk. At the same time, we have recently adjusted our position on financial debt. This sector offers some particularly attractive valuations, benefiting from the return to a steepening interest rate curve, the reduction in specific risk and, finally, the relaxing of regulatory pressures.

In the equity segment, we are now opting for a balanced position between high-yield securities, cyclic securities and financial securities. We are preserving our selective stock-picking approach, without geographical or directional bias, and we are picking the investments best exposed to the revival of economic growth and reflationary trends. These companies benefit from a significant leverage effect related to the economic cycle. For example, securities in the construction, infrastructure and oil industries could do particularly well under the future American stimulus plan. Another specific factor that seems to be gaining ground in Europe, following on from the United States, is that of mergers and acquisitions. We are taking positions not only on targets but also on buyers. External growth represents a good solution to the current market context of measured acceleration in growth, since it reinforces investor confidence and heightens the attractiveness of financial investment.

Finally, although the economic climate is generally dynamic, the possible increase in political risk in 2017 (given the electoral calendar in Europe) is a hypothesis that has to be rigorously integrated into the construction of a coherent asset allocation strategy. We are anticipating this type of risk and its potential materialization on the markets by taking a nuanced approach, focused on specifics. In particular, this approach is reflected in recourse to tactical and hedging positions in the credit segment, via synthetic indices (CDS), and by under-exposure to French debt, because we must not under-estimate the volatility that could hit the markets with the approach of the French elections.

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