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Equity Letter - Cautiously optimistic

The essential

There are good reasons to envisage a constructive scenario for equities going into 2017, albeit associated with an obvious list of caveats

In this first issue of the year, we present the market views and outlook of the Heads of the Global Equity, European Stock Picking and Emerging Market teams.


Cautiously optimistic

We wish you the best for this “expected” Happy New Year. There are good reasons to envisage a constructive scenario for equities going into 2017, albeit associated with an obvious list of caveats. To make a long story short, yes, earnings, inflation, growth, interest rates and the USD are all modestly but by all appearances heading in the right direction. However,

  1. the good news has already been partially discounted in the last months of 2016 and what has already been gained cannot be regained a second time
  2. upward inflationary pressure is good news only if – and this is a big if- inflation remains in the region of 2%;
  3. what is true of inflation is also true of interest rates. Modestly higher interest rates are a relief but only as long as long-term rates stay below 3%;
  4. a stronger USD is welcome for Europe but would be perceived as a threat to the emerging market recovery if the upward movement goes too far or too fast;




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At the end of the day, we are tempted to opt for a scenario based on gentle reflation associated with a sluggish but nevertheless real recovery delivering global GDP growth of slightly more than 3%. This leads us to project positive but modest expected returns for 2017 with a hierarchy consisting of (1) Japan and the Euro zone, (2) emerging markets, (3) the US, but with very little dispersion in performance. The main condition required for markets to do significantly better than our forecasts would be to see the earnings forecast upgrades confirmed by actual earnings reports. Lastly, we can easily understand that some investors may choose to hedge part of their exposure through options, because one financial asset continues to be excessively cheap, i.e. volatility.

There is indeed a path to a happy end in 2017, and this features less global trade growth, slightly less financial repression, more fiscal dominance and more internal growth driven by domestic demand.



Romain Boscher, Global Head of Equities


Global Equities Outlook 2017 – a view from the coalface

Markets have entered 2017 with an unusual amount of momentum. Despite all of the challenges in 2016, returns were reasonable with global equities delivering an 11.2% total return in Euro terms. Where from here?

On the positive side fundamentals continue to improve: economic leading indicators are moving up to cycle high levels and there are signs that both revenues and profits are accelerating in major markets as we move into 2017. The US has been through a protracted period of low EPS growth in 2015-6 and with elevated valuations we need to see earnings growth resume. With the dollar at levels not seen since 2002 a robust global growth environment and probably some fiscal relief on top of this will be required to offset the currency headwind. So the US has its work cut out in 2017. Europe starts the year with lower valuations and a better currency backdrop, so there is a good chance of Europe delivering double digit EPS growth in 2017, which would be the first meaningful growth for 6 years. Japan and EM will also benefit from the stronger dollar and a better global growth outlook. Valuation opportunities are still available in some sectors but overall valuation spreads (a proxy for opportunity) are beginning to look somewhat narrow


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The main risk seems to be the optimism currently surging through equity markets: we have been quick to price the positives of a stronger dollar and fiscal stimulus, but so far there hasn’t been much focus on the accompanying economic and political risks. The Pollyanna view would be that the Trump Administration will be the reforming Democratic presidency that Obama failed to deliver (will Trump be the best Democratic President the Party never had?) but the reality is that many policies are either unknown, untested or both. Border Adjustability is a case in point. Whilst seized upon by the Republicans as a radical solution to the deindustrialisation that has come with Bretton Woods II, it will be complex to put in place, would force a resurgent dollar further upwards and would fall foul of WTO rules. Whilst we doubt this kind of complete re-ordering of the fiscal framework in the USA would ever pass Congress, it has caused volatility in those sectors it most obviously impacts. Expect more of this in 2017

So overall, we think that the outlook for 2017 is mixed. There are risks politically and from – at least in the short term – inflation expectations moving further upwards, but on the positive side there are some signs of stirring animal spirits and accelerating earnings growth. Europe continues to look the most attractive of the regions, followed by Japan and EM (although the risks to EM from the Trump White House are material). From a sector perspective we see the best value opportunities in Healthcare, Energy, and to a lesser extent, Consumer and Financials where stocks are already assuming an ongoing steepening of the yield curve


Nicholas Melhuish, Head of Global Equities


European Equities in 2017: worth revisting ?

After massive outflows from this asset class against a backdrop of better numbers, we think this is a valid question to ask. If we go back to previous years and make a comparaison between the US and the European Equities, beyond the massive difference in terms of performance (+235% for S&P 500 since 2009 and +89% for the Euro Stoxx 50) we immediately pinpoint the difference in terms of EPS with the US making new highs and Europe far behind.


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The massive buybacks in the US explain roughly a quarter of the difference. We have a very similar picture when it comes to margins : in Europe we are currently around 4%-4.5% vs a peak around 9% and in the US we are close to 8% with a peak at 9.5%.

Let’s have a look and try to see how we could explain this discrepancy. We know that this is not a question of top line (see chart) as the EZ recovered from the previous crisis. This is not a question of cost control either. Indeed, since 2012 unit labour costs and the cost of goods sold over sales have not grown. So what’s the issue then ? Pricing.



European companies have maintained sales by sacrificing pricing. -Euro Area corporate pricing has been lower than developed market inflation since the Great Financial Crisis. This point is of utter importance when we exit a regime of deflation as it could trigger some willingness for corporates to increase pricing. Keep in mind that Euro Area corporate pricing is much more linked to global CPI than to Euro Area CPI due to international revenue exposure (see chart). Knowing that margins expand when pricing exceeds labour cost growth (see chart), we could therefore conclude that Europeans margins will expand if global CPI is well oriented.

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What does it mean for the European equity market?

The starting point is that the multiples are not cheap anymore. Consequently we need earnings to grow. The consensus, as usual, starts the year with a double digit to mid-teens EPS growth. The bears would rightly argue that since 2011 we had at best 4% growth at the best and at worst -4%. Always difficult to argue that this year could be different. But this is the call we are making based on the assumption from our economist that the global CPI could grow 3.0% in 2017 vs 2.6% in 2016 and 2.4% in 2015. Looking at the sectors we would like to highlight the following :
- The oil price has a positive base effect which is positive for the Energy sector. So the energy sector EPS could grow more than 50%
- Commodity prices ex energy are also very well oriented (+20% EPS growth for the Materials sector)
- Banks and Diversified Financials EPS could also grow 20% + thanks to rising interest rates .

In the environment where we are exiting an ultra-low interest rates environment to go to a low interest rate one, surely European Equities are to be considered especially after a strong de-risking exercise from the financial community away from the EZ (on the backdrop of Brexit and the Italian referendum).


Laurent Ducoin, Head of Europe Stock Picking



Trump, Trade and Emerging Markets


The election of Donald Trump has added a degree of uncertainty to emerging equities. Donald Trump has rewritten the way to run electoral campaigns and may very well put his personal spin in sensitive diplomatic matters. His phone call to the prime minister of Taiwan shows his willingness to go the unconventional way and reminds everyone that on this earth, we are far from living the end of history. Trump’s nominations outside of the traditional Republican crowd also show that he is not going to follow the consensual Washingtonian way and that relations with Congress, although dominated by Republicans, may very well become confrontational at some point.

As written in the Wall Street Journal, “Trump’s economic agenda fuses traditional Republican principles of lower taxes and regulation with a more populist approach on trade, immigration and manufacturing.“ For emerging markets, the second part of the agenda will be the most disturbing. A project seems to be currently analysed by Republicans that would completely overhaul the US corporate tax system. One of the envisaged key changes would be to deprive imports from tax-deductibility. This would be equivalent to an import tax that would apply indiscriminately against all countries.

If adopted, this decision would be negative for emerging market currencies as they would bear part of the necessary adjustment. By making imports more expensive, it would encourage investments in the USA in areas where this country has a clear competitive advantage, such as in technology and oil. Potentially, this could not only affect Mexico and Asian export-manufacturing countries but also currency-pegged oil-exporters if a large increase of US shale oil production were to pressure the price of the barrel. Even if not eventually adopted, the fact that the new Administration might envisage adopting tough trade policies could continue to weigh on emerging market equities in the short term and make investors wary of delving too fast into emerging markets. While medium term fundamentals have improved in many emerging countries, and valuation attractiveness of currencies and equities continue to make emerging countries an attractive medium term story, inflows into this asset class may be delayed until the extent of Trump’s new trade policies has become clearer.

There is no doubt that emerging equities have already discounted some negative outcome. For example, an additional tax of 5% applicable on all imports is, in our view, already priced in at this stage. However, a deep change in US corporate tax law that would render non-deductible any import from any country (an hypothetical but possible outcome at this stage) is only partially priced-in by emerging markets.


Patrice Lemonnier, Head of Emerging Market Equities




BOSCHER Romain , Co-Head of Equities
MELHUISH Nicholas , Chief Investment Officer, Equities – Amundi London
IWANAGA Yasunori , CFA, CIO Amundi Japan
HO Anthony , Chief Investment Officer - Asia ex Japan
DRABOWICZ Alexandre , Head of Development and Investment Specialists, Equity Strategies
ANDRE Sudeshna , Investment Specialist, Equity Strategies
DUCOIN Laurent , Head of Europe Stock Picking
LEMONNIER Patrice , Head of Emerging Markets Equities

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Equity Letter - Cautiously optimistic
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