Our allocation remains pro-cyclical

Asset Management - 18.11.2016

Since Donald Trump’s election, markets have been massively playing the reflation trade. Equity markets have rebounded and bonds have corrected on falls in US bond markets. And there has been strong sector rotation into cyclicals and financials and a sharp rebound in the US dollar. (English version)

Note that emerging markets equities fell sharply this month due to the rising dollar but also because of mounting concerns over the impact a return to protectionism might have on the most exposed markets. Elsewhere, European sovereign spreads, including in France, have widened considerably against Germany. The wave of populism observed first during the Brexit campaign, and now in the US, has increased worries, amid a particularly busy electoral agenda in Europe, of a political backlash that could undermine the European Union.

Key points
  • Reducing our European equity overweight
  • Closing out our US Treasury underweight

In the circumstances, we think it makes sense to reduce our equity overweight, especially in Europe:
- as has sometimes been the case in the past, the speed and force of bond market shifts could end up dragging down other asset classes.
- sovereign spreads have widened sharply but have so far had little impact on European equities but that could change when the reflation trade runs out of steam.

We have also taken profits on our US Treasury underweight but have maintained hedges on the short end of the yield curve as we still think the risks from the Fed’s looming rate hike have not been fully priced in. At the long end, markets are now priced for average inflation of 2% over the next 10 years, an assumption which strikes us as reasonable.

Generally speaking, markets have adjusted to a more reflationary scenario following Mr Trump’s election, a move which is in tune with our asset allocation stance. But it is, for the time being, very tricky to predict which policies will effectively be rolled out and this uncertainty warrants a premium. Following these big market moves, risks now look more symmetrical and although our allocation remains pro-cyclical, we think a more cautious bias is called for.

The US elections and Donald Trump’s programme add weight to our preferred investment themes.

    Our convictions for November Changes compared to previous month
EQUITIES
US
Europe
  Euro
  United Kingdom
Japan
Emerging countries
FIXED INCOME
US
Euro
Investment Grade
High Yield
Money market
DIVERSIFICATION    
Convertible bonds
Dollar

 

Next headline events
  • Italy’s referendum on December 4
  • Next ECB meeting on December 8
  • Next Fed meeting on December 13-14
  • Next BoJ meeting on December 19-20