In 2017, market conditions will be more favourable to equities than to government bonds
Three major themes will drive the markets in 2017: firstly, the combination of moderate growth and short-term rise in inflation rates, secondly the renewed support to growth and financial stability by monetary policies, which will be favourable to risk assets, and, finally, the return of political uncertainties.
The anticipated prospects and potential for growth and the raised expectations of inflation will have an influence on both the equities and fixed income markets. Positive but modest growth by nature increases the attraction of risk assets. “However, we estimate that the potential rise in stock markets is relatively restricted, in the order of 6% for the Euro Stoxx index in 2017 and 8% for the S&P 500,” cautions Gaëlle Malléjac, Active Management Investment Director.
Containing fixed income risk
Given limited economic growth, the Groupama AM team maintains its positioning on niche growth securities and in the field of M&A. This type of transaction is considered to be a potential source of increasing valuation, in particular for the acquiring company. “We are expecting an increase in momentum for mergers and acquisitions in the United States. Encouraged by Donald Trump, if US companies repatriate profits from their foreign subsidiaries to the United States, this could lead to the return of capital available for external growth,” she explains.
The departure from zero inflation territory in the developed countries ‒ starting with the USA, where Donald Trump’s economic programme is expected to be based on reflationary measures and budget expenditure ‒ will in the short-term fuel a rise in interest rates. “That is why we are maintaining our underexposure to sovereign debt in our portfolios, more precisely those with long-term maturities, which are sensitive to interest rate risk. By contrast, the momentum is in favour of inflation-indexed debts, both in the Eurozone and in the United States.”
The credit market appears to be less exposed to interest rate hikes than sovereign bonds, even if a resurgence of volatility should be expected. For their part, stock markets have already responded to the anticipated rise in interest rates, since a rotation of styles and sectors already began last summer.
The increased spread of stock market performance justifies a stock-picking approach
Monetary policies will continue to support the markets. The European Central Bank will doubtless continue its quantitative easing programme and purchase even more corporate debt, in particular given the rarefaction of certain debts, such as German sovereign bonds. “The accommodative policy of the ECB is good news for the credit market, while its asset purchases limit the risk of widening credit spreads. We are primarily focusing on BBB and BB rated bonds, for their higher yields, which provide better hedging in the event of a hike in interest rates,” explains Gaëlle Malléjac,
The third and final factor that we must not neglect is the increase in political uncertainty, with a densely packed electoral calendar in the Eurozone over the next fifteen months. The probability of seeing a non-traditional party coming to power in Europe constitutes a risk of destabilization for the markets. “We are expecting increased pressure on the political risk premium in the Eurozone. We are therefore remaining cautious with regard to “peripheral” sovereign bonds, for which we are awaiting possible increases in spreads before adjusting our position.”
On the equities markets, we expect this to be reflected in a wide performance spread, which justifies our highly selective stock-picking approach. “From the sectoral point of view, we can note the impact of the change in political context in the United States, which holds promise for the infrastructure, energy, defence and health sectors.”
In terms of asset allocation, Groupama AM is according preference to equities and more particularly small and mid caps and “value” style stocks over fixed income instruments. “However, investors must show caution until the stock markets have regained their main motor of performance, namely growth in profits,” concludes Gaëlle Malléjac.