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Outlook 4Q18 - Equities

15 Oct 2018

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Equities

(slide 31)

3Q18: developed markets continued to outperform emerging markets

(slide 32)

US: Buyback yield has declined despite a record amount spent in buybacks, while interest rates continue to increase…

  • 1Q18 repatriation flows by US corporations of cash parked abroad were impressive;
  • Higher amount available to buybacks, capex and dividends, which could also be supportive of economic growth;
  • Previous peak in share buybacks occurred in 2007;
  • Lower growth / higher inflation would be consistent with a lower annual price change for S&P500;
  • Could we have a period of relative calm on the trade front into year end? (Mid-term elections, G-20 meeting)

(slide 33)

US: earnings growth will slow in 2019…

  • Higher bond yields remain a key risk to financial markets and the global economy.

(slide 34)

US: focus remains on signs that margins could be rolling over

  • Wage growth has not yet accelerated enough to penalise margins;
  • The trend in US margins has been helped by tax cuts;
  • S&P operating margins remain key for equities over the coming quarters;
  • The NFIB survey suggests that deregulation and taxes have fallen as perceived problems for corporates;
  • Risks: higher wage growth, a stronger US Dollar, weaker economic activity, increased regulatory scrutiny in the tech sector, new EU privacy rules, US-China trade tensions.

(slide 35)

Global: corporate debt market as the weakest link in the US financial sector (US corporate bond ETFs, foreign inflows, weaker liquidity and market-makers)

  • As the FOMC goes from neutral to tight money, risk assets could be increasingly challenged, with higher volatility being progressively observed;
  • Slow rate rises as the pace at which US inflation is increasing remains gradual. Monetary policy settings largely dependent on the inflation outlook;
  • We continue to watch corporate bond yields. If the rise in rates impair US growth, it should be reflected in credit spreads;
  • Higher real corporate yields would impede corporate investment & GDP growth. High-yield credit usually underperforms in late-cyclical expansions.

(slide 36)

Global: a somewhat defensive sector bias… Will value work now that yields are on the rise?

  • Premature to turn wholesale defensive? The yield curve has not inverted… but (1) global growth may continue to decelerate over the coming months and (2) credit spreads are widening;
  • Monetary tightening will continue. Evidence of deteriorating profit growth would support a more cautious allocation;
  • 3-month US Treasury bill rate stands at 2.255% vs. S&P500 DY forward 12-month of 2.1%;
  • Low-beta US vs. high-beta EM and Eurozone.

(slide 37)

Emerging markets vs. Developed markets; France vs. Germany; Economic growth in EM has held up far better than financial markets

  • Current trends: strong US GDP growth, continuing FOMC rate hikes, rising long-term bond yields, appreciating US Dollar, ongoing trade war, rising inflation, higher oil prices and moderate slowdown in China;
  • There are still a lot of bottom fishers in EM;
  • France: Macron’s popularity has slumped, GDP growth rate has fallen… But the government is still pushing ahead with structural reform (boost potential GDP growth and contain the growth of public spending).

Oil Market

(slide 38)

Oil markets remain a risk to risk assets. Energy sector remains a hedge to an oil-price spike due to Iran sanctions and supply disruptions in Iraq and Venezuela

qIran’s oil exports have already declined over recent months;

qWill the US tap into its Strategic Petroleum Reserve? Is Saudi Arabia closer to its spare capacity limit than it would like the market to believe?

  • In Venezuela, the economic crisis will probably keep depressing production (a coup would cause a stronger disruption);
  • US shale production has surprised on the upside (bottlenecks?);
  • Sinopec  & India cut its imports of Iranian crude oil;
  • US special envoy for Iran (Brian Hook) opens the possibility that the US could be willing to reduce its demand from Iran.

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