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Investment Strategy – June 2018


The infernal T…rio

Over coming months, investors must carefully monitor the three following issues: Trump, Tariffs and ¨Technos¨.

Trump. The US President is actually beleaguered on three fronts: politics, economics and defense. Important developments are soon expected to unfold on Mueller investigation on trade and potentially with North-Korea / in the Middle-East. If US Democrats were to lead significantly in summer polls – or even gain next Fall mid-term elections – severe tumult will emerge.

Tariffs. Global temperature declined lately. A revisited
NAFTA agreement seems possible. A revised US-SouthKorea is likely to be opportunistically confirmed just after Kim-Donald talks. China is contemplating to offer some concessions, namely by opening segments of its markets (financial services, automobiles, etc.). The purpose is dual. First, engage gradually with the new – pretty heterogenous – team of US key representatives recently nominated, to gauge its actual demands! Second, save time ahead of the very important publication, by end of May, of US Treasury Department restrictions over Chinese investments.

Techno-firms. Tide turned for the US juggernauts following Facebook slippages. Policy-makers are considering different measures of ¨castration¨: anti-trust, taxation and privacy regulation. The whole business model of monetizing confidential data is under coincident attacks. Europe may find a convenient way of playing regulator in chief, thereby resist to US pressure.

US mid-term elections, next November, are pivotal


Inevitable collide

In the US, the Capex cycle will probably not turnaround, despite the new – supportive – fiscal landscape voted last quarter. Confidence is also missing, because of tariffs talks. Large quoted firms definitely prioritize financial engineering to Capex. Increase in productivity will not be significant, which is a fundamental pillar of sustained expansion. US cycle might not be prolonged by the virtuous multiplier effect. Global trade system will face serious headwinds near -term. There is growing traction in the US for charging China’s discriminatory trade and investment practices. Washington will probably impose restrictions on China’s investments (namely technology related) in the US. Chinese SEOs could be banned from buying US assets under the International Emergency Economic Powers act (1977), regularly used to freeze terrorist organizations’ capitals. No doubt, this would be a highly corrosive / unpleasant decision. National security could be invoked more smoothly via a Senate Bill (called FIRRMA) to control / calibrate innovative private investments both in the US and abroad by domestic firms.

Political discipline to adjust simultaneously public spending and taxation no longer exists since Clinton era. Consequently, the debt-to-GDP ratio kept on deteriorating over past years. The Fed will confront growing risks of short-term overheating and of rising twin deficits. A Federal budget deficit of 5%, in times of prosperity, is indeed unprecedented. Under the joint action of a rise in debt payments, increase in healthcare and social security spending, it may become unmanageable over next decades. This would dramatically impact on future monetary policy. In that scenario, a tug of war between monetary and fiscal dominance would unfold, setting the stage for a global confidence crisis. Takeover by fiscal policy would spell a vicious circle of monetization-inflation-currency crisis, “à la Nixon” (the unilateral cancellation of the direct international convertibility of the USD to gold in 1971). But the recent appointments at the Fed (Powell, Clarida, Williams) will fortunately prevent from this dire scenario. Anyway, solvency is not the ultimate issue, as central banks can technically create as much money as needed to absorb it.


US huge plans on infrastructure are delayed

The financial wealth of States and of municipalities is going to deteriorate significantly, in the aftermath of the 2018 fiscal reform. The long awaited private – public partnership process will not take-off short-term, as the private sector still remains on the back foot regarding developments of US domestic politics…

Watch for a possible investors’ indigestion after several months of global tensions. The trade war and related battles over investment have just started
A fiscal and monetary policy collision will take place, when stimulus wears-off and tightening culminates (some time in

US Fed will probably be under growing strain, as the ultimate gate-keeper of US orthodoxy


Inflation shock? No!

US bond yields and oil prices moved in sync over the last three years. Both broke out lately triggering some fears that the world may experience a redux of former inflationary-fuelled oil shocks. This looks unrealistic, as oil price spikes are only temporarily impacting on CPIs. They rather have a deflationary impact on economies, by dampening consumption (sort of a tax on households).

Some inflation acceleration will take place in the US, arguably exacerbated by oil, in coming quarters. This will not derail markedly from the Fed long-term target of ¨about 2%¨. Indeed, below the surface, fixed income markets have not validated the hypothesis of an inflation slippage. In this respect, the latest ultra-mediatized rise of US longterm government yields- over 3% – is more psychological than practical.

Latest inflation figures in Europe, Asia and emerging remain pretty calm, if not disappointing. The buoyancy of the German economy and labour market, which fuelled significant wage increases last quarter, is not translating into higher prices. China inflation stalled. A visible deceleration of credit growth is underway. The latest improvement in banking assets quality gives policy-makers margin of maneuverer to become gradually more accommodative, like the latest cut on banks’ reserve requirements. The sharp and worrying PPI rise in 2017 (up to 8% yoy) is clearly over, with a much moderate pace around 3% now.China CPI should continue to range between 1,5 and 3%.

A change in inflation regime is not in the offing, despite cyclical pressure in the US.

The latest German CPI numbers – at 1,6% for both core and headline – surprised on the downside



Further signs of an investment regime change?

The volatility resurgence is now well-acknowledged by equity markets. As well as the less liquidity friendly environment, resulting essentially from the dual impact of the strong economic momentum and of Fed balance sheet shrinking. A welcome consolidation phase is underway, following last January euphoria. Other asset classes have remained pretty calm. A contagion from equity volatility to fixed income and currency has not taken place (yet). The prevailing landscape of the past 10 years, where bonds and equities were stuck in a stable regime, generated huge capital inflows into systematic strategies like ¨risk parity¨, but also into momentum investments. Basically, these strategies thrive, if a) volatility does not gyrate and b) correlations remain stable. Both pre-conditions seem more fragile and less likely these days.

Any significant rise in fixed income volatility would trigger major outflows from these strategies and significant collateral damages in financial markets, probably of a similar magnitude as in Q1… Similarly, a too quick rise of the USD, triggering a contraction of global investable liquidity, would have the same impact, starting in emerging assets.

There remains significant capital invested in ¨momentum assets¨. Unwinding of these carry trades may result in volatility spilling over to other asset classes (than equities)

Scarcity assets, including energy and precious metals may prove decorrelated and immune to corrections if serious confrontations (commercial and military) were
to unfold


  • Cash


  • Bonds
  • Alternative investments


  • Equities



The USD strengthening is more than an upheavals, technical factors and positioning are both supporting this view.

The USD strengthening is more than an upheavals, technical factors and positioning are both supporting this view.
The USD, on a trade weighted basis, has just excessed, for the first time since May last year, its 200-day moving average, signaling a tentative trend change. The sizeable bearish currency position (as well as on long-dated US bonds) shows the potential for a massive short covering. The bearish position on US bonds hits a record level, raising the prospect of a simultaneous short covering. The FOMC left, as expected, rates unchanged and acknowledged the inflation’s progress of reaching the 2% target. The statement reaffirmed that the Fed intends to continue to “gradually” tighten its monetary policy. Officials expect inflation to run near the Committee’s symmetric 2% target over the medium term i.e. a signal of the Fed’s willingness to allow inflation to modestly overshoot. This is not a major surprise as headline and core PCE are already near this level. Those are the reasons why we consider the Fed tone as less hawkish.

The EUR/USD has finally broken out of its well-defined year -to date range. We see scope for further downside correction. Euro area data have continued to worsen, and the ECB acknowledged that a much slower exit would be emphasized . The market (consensus) is still in favor of a higher EUR while it curbs the economic expansion.

BoJ kept its policy unchanged as expected. It slightly downgraded its inflation forecast and more interestingly dropped its reference to the expected timing of a 2% inflation achievement. According to Kuroda, the deletion was due to potential miscommunication risk. We think that the removal of an unrealistic timeline should allow greater policy freedom. However, it should have limited near-term impact on the JPY. The currency stays prone to fluctuations in global risk sentiment and the broad USD dynamics. However, it is still the most efficient risk-off currency and the cheapest G-10 one.

GBP seems to have passed its peak as markets reassess the potential for UK growth and the BoE’s policy path. The poor Q1 GDP seems to have entombed the BoE Governor Carney’s hopes for further rate hikes this year. Our conviction for hikes thereafter, however, was already low.

As expected, the EUR/CHF is flirting with the historical level of 1.20 and should consolidate. The SNB reaction function will now become a clear focus. First, the rhetoric could become less dovish around 1.20, even if the mission is not over. An unexpected move higher could permit an earlier rate hike than expected, and even more importantly, before the ECB. The big elephant in the room, dealing with the outsized balance sheet, will be the next decade big challenge.


USD and yields will do much more damage to EM if moves do not halt

The coming weeks look pivotal for the ongoing EMFX outlook as the USD rally and US 10-year yields have reached critical levels. If the move stops here, there may be some breathing room for EMFX and potentially a limited recovery. But if the USD rally extends, EMFX will be in trouble.

EM carry trades rather thrive when 2 very different environments unfold. The best cyclical opportunities for broad EMFX exposure arrive when global markets have negatively overreacted and EM assets and currencies can be picked up from very cheap levels – these are rare and fantastic opportunities. Otherwise, carry traders need the prospect of prolonged periods of smooth sailing and complacency, and a slow and steady rise in risk appetite. For the coming months, we are unlikely to see the latter type of opportunity, which means that opportunities may only show up in relative value terms or once we reach the occasional excess in risk aversion. Patience is the keyword for now.







Higher yields is now a 2019 story

Higher yields is now a 2019 story
In 3 of the last 4 cycles, US 10-year Treasury yields peaked right around where the Federal Funds (FF) did. In 1988, the 10-year hit a top yield of 9.4%, just below the FF peak. The same happened in 2000, just below 7%. And in 2007, just before the Great Financial Crisis, both reached 5.25%. Only in 1994-95, when Greenspan doubled the rates in just one year, the 10-year peak exceeded that of FF. Such a redux looks unlikely. At that time, the Fed communication was extremely secretive and there was a huge disconnect between markets and the Fed, which is no longer the case. The yield and FF relationship is logical as long-term rates should reflect the weighted average of short-term rates plus a risk premium. Therefore, the terminal Fed Fund target must be considered as a long-term cap. So, long-end yields look attractive. Furthermore, bond yields follow a relatively clear historical seasonal pattern. They tend to rise (on average) in the first 4 months of the year, and then decline until September. Finally, the recent FOMC message confirms that some FF tightening depricing looks likely over the coming weeks.


The main risk to a bull bond scenario is, of course, inflation

The US economy does not surprise to the upside anymore. The PCE inflation report was in line with expectations. Core PCE is just under 2%, as it was some months ago after Trump election. Services inflation grew by the highest percentage since 2008, with the latest increase driven in part by rising medical care services, a government policy driven component. The telecom services (Verizon) effect has also boosted consumer inflation, but it is over now. Fed inflation expectations like the Trimmed Mean PCE inflation (Dallas Fed), remains well below the 2% target. And, a St. Louis Fed report shows a 70% probability that inflation will remain between 1.5%-2.5% over the next year. The NY Fed Staff UIG measures, which is not an official forecast, shows that the “prices-only” measure increased modestly to 2.29% in April. Outside the US, there is no evidence that the European inflation is gaining momentum. Macro is already decelerating, loan growth remains positive, while at a slow pace, and more worrying, M3 is decelerating. So, if Q2 GDP disappoints, the ECB may delay its QE exit agenda.


The same old song on credit

Geopolitical tensions have eased, trade war rhetoric has not worsened, and supply was rather low. By consequences, credit was broadly stable, even if slightly more volatile in the US. This positive tone can still last for a few weeks, as issuance volumes would stay limited, earnings quality surprised to the upside, and, trade and geopolitical tensions eased. Hence, credit can still perform well, and we would not be surprised to see spreads inch tighter slowly in the coming weeks.


EM a source of volatility

The most at-risk part of the credit spectrum is the usual suspect in periods of higher yields and/or USD i.e. EM bonds.
EM assets surged in 2017 and held up well throughout the first phase of markets volatility (Feb-March), bolstered by investors’ confidence in economic growth and the benefits of a weak USD.
However, leading indicators suggest that EM export growth should weaken in the coming months. So, higher rates and USD pose another threat.
However, those bonds are still offering much higher yields even though they are perceived as riskier. In addition, the fiscal position of these countries is in no way comparable to that prevailing in 1998, 2008 or even 2013. We maintain our allocation to this segment.


  • Investment Grade
  • High Yield
  • Hybrid/Sub
  • Emerging hard currency
  • Emerging hard currency


  • US Treasury, Inflation
  • Peripheral


  • German Bund
  • Emerging local currency



Too early for a bear market

In each indices decline, one fears a major correction. But the indices resist. Expected at +18% at the beginning of the earnings season, the increase in US profits will eventually be at +23%, the strongest increase since Q3 2010. A reservation however: 35% of this increase is directly linked to the tax reform. The rise in US revenues is even more impressive at +9%.

The consolidation phase in which we have been since midJanuary combined with the rise in profits has resulted in a decline in stock market valuations. For the S&P 500, the 12months forward PE ratio has fallen from 20x at the end of 2017 to 16.7x, the Euro Stoxx from 15.7x to 14x and the Nikkei from 20x to 16x. The low inflation regime persists, even though inflation should temporarily rise in the United States, and fully justifies the current stock valuations.

Analysts are anticipating $850 billion of share buybacks in the United States in 2018 ($530 billion in 2017). The technology and health sectors will be important contributors, with Apple in the lead. Since 2013, Apple has returned $210 billion of capital to shareholders. This number is more than the market value of all, except the 20 largest, listed companies in the US. The Cupertino company has just announced an additional buyback of $100 billion and a dividend payment of $13 billion. And there is still some room, because the Apple net cash position is $145 billion, while Apple wants to reduce its balance to 0.

Mergers/acquisitions in dollars reach levels never equaled, on a year-to-date basis, both globally and in the United States for a total amount of $1,711 billion. In average, operations are 63% larger than in 2017. Surveys show that a growing number of CEOs are planning to make acquisitions until 2019. Mergers/acquisitions can increase revenues quickly, but are done more and more in a defensive logic to counter giants like Amazon or Netflix. The Healthcare sector was the most active in 2018, accounting for more than 17% of deals globally and more than 21% in the United States. Operations in the Energy/Refining sector are accelerating with lately the purchase of Andeavor by Marathon Petroleum for $36 billion.

The end of the USD decline in early February and its strengthening since mid-April resulted in an outperformance of European and Japanese markets. The dollar should continue to strengthen against the euro. We are therefore overweighting Europe and maintain the one on Japan.

Swiss equities, namely the segment of small and medium companies (SPI Extra), remain interesting. After falling against the euro, the Swiss franc falls against the dollar. At 23x the 12-month profit, the SPI Extra has a much higher valuation than the SMI at 15x; but adjusted for profit growth (PEG ratio), valuations looks equivalent.


The emerging zone underperformed

The rise of the dollar and higher volatility, as well as better prospects for the US economy and a normalization of the Fed’s monetary policy, are not a good mix for emerging markets. There is downward pressure on emerging currencies. In April, we observed net capital outflows from equity funds and emerging bonds, for the first time since November 2016.


We stay overweight the Energy sector

The rise in the price of crude results from strong demand, controlled output between Saudi Arabia and Russia and geopolitical tensions. Venezuela has seen its production fall by a third since 2016. The US exit from the Iranian nuclear deal would result in a reduction of Iranian exports. Refineries are still in a maintenance period, so they order less oil. As of early June, they will resume their purchases in a tight market, which could cause rising prices.

We stay neutral on Technology, as in the current economic cycle, we believe Consumer Discretionary should perform better. Technology will remain under the tax burden of governments and increasing constraints on the management of private data. However, the growth rate remain solid.


  • Europe, Switzerland, Japan
  • Small/Mid Caps
  • Value
  • Discretionary, Energy, Financials, Health Care


  • US
  • Emerging, China
  • Large Caps
  • Growth
  • Staples, Industrials, IT, Materials


  • UK
  • Telecommunications, Utilities


Alternative Investments

The new US nationalist policy should result in high volatility on raw materials.

The new US nationalist policy should result in high volatility on raw materials.
There are doubts in the market about the strength of the agreement between OPEC and Russia on a reduction in output. But geopolitical tensions in the Middle East and the exit of the US from the Iran nuclear deal added a geopolitical risk premium.

The rise in the oil price is also linked to the upcoming listing of Saudi Aramco, a major strategic decision for Saudi Arabia that will be a source of financing for its economic and social reforms developed by MbS. Saudi Arabia is suspected to target a price of $80 a barrel of Brent, even $100, to support the valuation of Aramco.

A month ago, aluminum prices climbed with US sanctions against Russia, and today the oil with the exit of the international agreement on Iran’s nuclear deal. Iran, Venezuela and the sharp rise in military tensions in the Middle East could push the price above $80. The ENI’s CEO is worried and perceives a risk. Iran exports 2.6 million barrels a day, mainly to China, India, Japan and South Korea, and a return of sanctions could result in a loss of 1 million barrels/day, unless Iran and its clients decide to use euro or Yuan as trading currencies. World demand increases by 1.6-1.7 million barrels per day. Saudi Arabia has reported that it could (somewhat) offset a supply shock.

It is difficult to predict the evolution of the oil price because fundamentals are dominated by (geo) politics. For commodity traders, such low visibility had not been seen since the 80s.

Four of the last five US recessions – 1973, 1980, 1990, 2008 – were preceded by a sharp rise in oil prices. It may be different today because the United States has become the world’s third-largest oil producer and the negative effect on US household consumption (rising gasoline prices) is offset by the rise in 1) investments (jobs, production, pipelines, rail/truck transport), particularly in shale states – New Mexico, North Dakota, Oklahoma and Texas, and 2) oil exports.

In 2018, many analysts expect a stable oil price to slightly rising towards $80 a barrel of Brent. We do not believe that producers will let prices flying to $100 at the risk of triggering a sharp economic slowdown, according to an IMF analysis. Then, in 2019, a decline to $60 is expected due to a production increase in US, Brazil and Canada mainly. The listing of Aramco will also be a source of prices easing.


  • Industrial metals


  • Precious metals
  • Energy
  • Real Estate
  • Hedge Funds



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JUNE 2018

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