The Goldilocks context should still prevail in the coming months

Executive summary

Visibility

• We have clear visibility on growth, at least for 1H 2018, with contained inflation. The Goldilocks context should therefore still prevail in the coming months.
• Central banks are more predictable and monetary tightening is progressive.
• The recent rise in forex volatility is a new factor of uncertainty.

 Valuations

• Valuations are high for some equity regions but, so far, we have not detected a bubble. Earnings growth will nevertheless be crucial. The start of the Q4 earnings season has been strong.
• Credit is expensive but reflects solid fundamentals.

 Volatility

• Volatility had reached a historically low level in 2017. However, since the beginning of February, it has increased significantly.
• The evolving US trade policy seems a major policy unknown that is increasing market volatility.
• Momentum in bond yields and the price of oil are also under watch. 

Général overview: Equities vs. Bonds

February 2018 started with uncertainty around inflation and the pursuit of a pro-cyclical view in a context of rising interest rates and volatility. However, there is no reason to question our fundamental scenario for the time being. Candriam still expects the Goldilocks environment to prevail throughout 2018 and fundamentals to remain supportive.

The current expansion is still accelerating, but at a slower pace, and economic growth expectations are still being revised upwards. Furthermore, the 4Q (2017) earnings season has started on a very positive note. We expect double-digit growth in the US and the same in Europe (supported mainly by banks).

In this context, equities have become more attractive, following the recent correction, even in the US, where equity markets are now trading at 17x 2018 earnings, while their forward price-earnings was still above 20x one week ago. In addition, strong earnings growth should remain supportive of equity market performance.

Regional equity strategy

Regional convictions are concentred on EMU, Japan and Emerging Markets

EMU equities: there has been economic expansion in the region, with even 2.7% year-on-year growth in 4Q 2017. Meanwhile, the ECB remains accommodative, with a monetary policy horizon beyond 2018, while decent corporate earnings momentum is underpinning the attractiveness of the region’s risky assets.

Japanese equities: the Bank of Japan confirmed that it would not join other central banks in tightening its monetary policy anytime soon. A weaker Yen, which is supportive of the attractively valued Japanese equities, should follow.

Emerging market equities: emerging market equities have performed well, thanks to improving fundamentals and US Dollar weakness. The local and global fundamental backdrop remains supportive.

In the meantime, we remain neutral on US equities, while maintaining a negative view on Europe ex-EMU equities. The hawkish Bank of England monetary policy stance has put a barrier to GBP depreciation, challenging overseas profit growth. Despite the agreement after the first round of Brexit negotiations, the region is having difficulties setting up new trade relations. Moreover, expected returns remain low in this region.

Fixed income strategy

Negative on government bonds

We are negative on bonds and have an even lower duration now. As the momentum in rising bond yields accelerated, we further reduced our duration in the US and Germany by around 0.25.

With a tightening Fed and expected upcoming inflation pressures, we assume rates and bond yields should continue their uptrend. We thus continue to diversify out of low-yielding government bonds. Our strongest conviction is emerging debt, as the ongoing monetary easing represents an important support for this asset class. Also, emerging debt is benefiting from strong global economic growth and the increase in commodity prices. Meanwhile, fundamentals remain solid, with low public debt, an improving current account and a carry that remains attractive.