What approach should investors take?
In an environment of low global growth and slight deflation, high yield corporate bonds continue to offer attractive return prospects as long the current low default rate remains. Moreover, the distortions prompted by the ECB's asset purchasing programme are causing a crowding out effect and accentuating a steeper credit curve. Time is notably an ally in this configuration, as it speeds up a positive carry!
Where equities are concerned, investors must decide between waiting for a yield correction to reprice risk premiums or continuing to follow financial theory and switch investment to a risk premium that continues to point to equities.
We would opt for a cautious approach. First of all, if yields correct with a lot of volatility, risky assets could suffer losses. Then, if for example wage increases accelerate without a corresponding increase in growth and productivity, company earnings could suffer.
However, we think this is a good time to start rotating to certain sectors that could benefit from a slight increase in long rates. Not yet to the banking sector, as we recommend a neutral stance in this case until we have more visibility on the risks associated with Deutsche Bank and Italian banks, but rather the insurance sector for which we believe dividends coupled with a stable earnings outlook and low valuations in relation to historical levels offer the most relative value.
In bonds, we have increased hedging against the risk of rate hikes (investment grade debt, emerging debt) and added to our positions based on anticipations of an increase in inflation (at breakeven, i.e. no interest rate risk).
Let’s not forget that the next three months will bring political risks the consequences of which are difficult to assess.
Don’t hesitate to buy in the event of a fall, or to favour high yield assets and sector arbitrage, which we feel are the most appropriate strategies in this environment.
For the Market analysis:
The global equity markets continued to rebound in September, with the MSCI World All Countries gaining 0.6% (in $). The lion's share of these gains came from emerging countries (+1.3%) while other regions remained stable at best (USA, eurozone), if they did not post losses (Japan). However, eurozone banks came under attack again (-3.8% over the month) due in particular to uncertainty surrounding Deutsche Bank.
Fixed income showed diverging trends with quasi-stabilisation in the US (+0.01% to 1.59%) but there was a further decline in Germany (-0.06% to -0.12%). Credit remained stable in the case of investment grade bonds and slightly negative in high yield (-0.5%). Finally, emerging debt turned in a further increase of 0.3%.
Currencies also showed little volatility. While the EUR/USD increased (+0.7%), it remains within a narrow band. Given the BoJ's announcements, the USD/JPY could have seriously tested the 100 mark, but it didn’t. Emerging currencies also showed little variation against the US dollar.
We nevertheless feel that the central banks significantly changed position in September, and in a relatively synchronised manner.
In our balanced portfolios, exposure to equities was brought back to around 25% at the end of the month, with sell-offs in full (emerging countries, Japan) or in part (European banks) depending on the zone and theme.
Conversely, given the increasingly uncertain outlook as regards the timing and extent of a rate hike in the US, we have reduced our hedging of government debt and strengthened the theme of emerging debt, which we have nevertheless partly hedged.
Lastly, our dollar position in the portfolio was halved to around 10% of the assets.
If our scenario concerning the central banks is confirmed (see p. 1), we will accentuate the moves we made in September, and to perform a sector rating of greater magnitude.
Global CEO & Co-CIO, Oddo Meriten AM
Global Co-CIO, Oddo Meriten AM
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