Summer Refresher: Q3 2017
Macro & Market Views
After a contrasted reality check in Q2, the next three months could witness a return to entrenched long term trends. U.S. activity and reform dynamics could rekindle and we expect the EMU recovery to gather pace in an improved political landscape. While the frailty of the inflation pulse surprised everywhere – and supported belief in a continued central bank accommodative bias – normalization stamina may step up going forward. Oil prices could be key in driving markets’ inflation expectations and we foresee stabilization near U.S. shale oil marginal costs.
Washington seems ready for a compensatory refresher over the summer when the Trump administration would push its agenda. Although an acid test will ensue, from depressed expectations, minimal achievements would surprise positively. Similarly, a growth bounce back looks feasible as well as a gradual recovery of wage inflation. We believe that this crucial missing piece should soon fit right in and comfort the Fed on its normalization tracks. We are slightly underweight on Treasuries. U.S. equity stretched valuations are at risk but un-stretched technicals keep our recommendation to neutral, protected with thematic calls.
The main message in EM is selective value picking, while the quest for yield remains intact and until Fed tightening takes hold in investors’ mindset. In Asia, Chinese equity has led the way, and we expect a regional catch-up. Japan on its end could be worth exploring with a domestic equity bias.
The green light is on in EMU politics thanks to the rise to power of a pro-business and pro-Europe leadership in France. Summer sessions could deliver structural reforms and we expect them to pave the way to a full strength cyclical upswing. Risks are now confined mainly to Italy, although electoral anxiety may wait until next year. The ECB’s looming tapering could also be a source of disruption but we believe that Mario Draghi will be able to temper rising yields with an ever-shifting dovish-hawkish rhetoric. A window of opportunity has opened up for a full overweight on EMU equity.
We expect a more demanding environment for micro hedge fund styles. Rich valuation and peak earnings growth would result in less momentum. We expect fewer themes and firming correlations. More selective fund picking is required.
We downgrade L/S Equity to Neutral. Within the space, we selectively remain overweight deep fundamental U.S. funds. We remain overweight on European and Japanese long bias funds. We turn underweight on Quantitative funds, likely to be unsettled by factor rotations.
Event-Driven funds are well positioned to exploit fundamental opportunities. We remain overweight Special Situations. They actively rotate their portfolios toward less crowded turnaround opportunities. The M&A pulse is moderating but still provides an appealing carry for Merger funds, at neutral.
Macro dynamics are likely to take center stage as inflation, growth and monetary normalization stand at a crossroad. More fundamental pricing at a macro level and heterogeneous economic conditions would provide relative opportunities in FI and FX. These are risky as they remain driven by speculative monetary decisions and policy gyrations. We see more stable returns and carry for funds focusing on EM’s FX and FI markets. Overall we upgrade Macro funds to overweight.
We keep CTAs at underweight. The trend-following backdrop remains mixed. Medium-models are better positioned in our view.
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