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Equity Letter - Earnings are back

The essential

Even though the political news flow is grabbing the headlines, from an economic and financial point of view this is the time to focus on earnings and earnings expectations.

The impact of politics on the equity market needs to be nuanced by two key indicators, namely interest rates and earnings. 




Since the 2008 crisis, more than politics it is central banks who have played the key role, helping markets over the last two years to regain valuations which are in line with if not significantly above their historical average. Going forward, for markets to continue to trend upwards – which is our baseline scenario - they will need the help of earnings

The good news is that after several years of disappointments earnings expectations today are showing signs of recovery and could move upwards, precisely because the massive headwinds from resource-linked sectors are abating and are even turning into tailwinds. At the same time, over the medium term political actions if confirmed could be a support factor, thanks to big tax cuts, especially in the US, combined with fiscal packages and infrastructure spending which could underpin order books in related sectors.





After having been obsessed for the last couple of years with the denominator, i.e; interest rates and associated QE, investors’ attention is turning back to the numerator. Earnings growth, we are happy to note, is back in the driving seat, while interest rates have been pushed to the back, without however becoming a threat, at least as long as their surge remains temporary and of limited magnitude, in line with our scenario.

Looking beyond the current political noise in Europe, the US and even in emerging countries, the coming reporting season will be the most critical moment for markets, with an uptick in earnings expectations justifying our reasonably constructive view on equities for 2017.



Romain Boscher, Global Head of Equities



Chinese Yuan: From Crisis to Normalisation

We believe the Chinese Yuan will be a currency stabiliser in 2017 something which is still underestimated by the market. Along with the stabilisation in the Chinese economy in 2017, we believe expectations for the Chinese Yuan’s depreciation have finally normalized from the previous crisis status. The combination of a stabilising economy and proactive government action will continue to bring a more gradual move in the RMB going forward..

Reasons for the normalisation of Yuan deprecation expectation are as below (1) The Chinese Yuan is proving its stability by moving in a smaller degree than dollar, which is evidenced both on the day of US election (Yuan -0.1% vs. Dollar +0.7%) and after the election till end of November (Yuan -1.4% vs. Dollar +3.1%). (2)  China’s central bank, the PBOC, is acting proactively and successfully to intervene in the FX market both onshore and offshore to stabilise the currency. (3) As we have projected at the beginning of the year, capital outflow and FX reserve depletion will take a breather after the repayment of foreign debt and hedging up done around 3Q this year. (4) More capital control measures are expected to be carried out, including individual US$50,000 exchange quota to be brought down in order to prevent potential new waves of capital outflow under the overall property tightening environment. We have already begun to see this last phenomenon as Policy makers have intensified capital control measures over the last week in November, including new restrictions on outward direct investment, tighter scrutiny over capital outflows via Shanghai free trade zone, and increased controls over RMB cross-border flows, in order to prevent new waves of capital outflow. 


Over the past few months, we have witnessed an increase in VIP gambling activity in Macau confirmed by multiple casino operators. This activity has signalled a loosening bias on liquidity as well as on capital controls. However, as the Chinese yuan continues to weaken, we expect the central government to step up tightening measures. We cite this example to point out that the central government has many tools at its disposal in order to take a more gradualist approach towards its currency. While RMB internationalisation and liberalisation are still on the cards, the managed capital account enables the Chinese authorities to do things on their own terms

Externally, whether and when the incoming Trump government will label China as a currency manipulator is still uncertain to the market at this point. In our view, the Trump government will delay picking up this currency manipulation topic with China as (1) The scenario that the Chinese Yuan moves in a narrower range than the dollar will continue to play out; (2) The Trump government is unlikely to prioritize its trade negotiations with China but tackling topics related to NAFTA and other trade partners first. Hence we expect the Chinese Yuan will be a global currency stabilizer in 2017, and the chances of Chinese Yuan to be named as currency manipulator are very low. 

We think one very interesting development in the global FX market in 2017 would be whether Oil-RMB has the potential to replace Oil-Dollar? And if so, how soon it will be achieved? If this becomes a reality it will bring fundamental changes to the global currency and trade system thus bringing about a new order in the world economy.

This is one area we shouldn't lose sight of whilst the markets are still relatively blind about it. If this happens quickly, dollar shortage wouldn't be the fundamental key reason to explain many of the current phenomena we see today


Mo Ji, Chief Economist, Asia ex-Japan

Kenrick Leung, Portfolio Manager, Greater China, Amundi Hong Kong



India: the impact of demonetisation

The few facts before we analyse the impact are as follows: 1) the World Bank estimates the size of the black economy in India at ~23% of GDP; 2) India’s currency in circulation, at 12% of GDP, compares with an international average of 7%; 3) cash consumer transactions in India are ~68% of the total; 4) only 1% of India’s population pays income tax. Some “unknowns” are : 1) the counterfeit currency in circulation; 2) the proportion of cash that would not be deposited/exchanged at all (~125bn USD or 56% exchanges over last three weeks), and 3) further policy actions to curb future black-money generation.

We see the following  implications. 1) while citizens is inconvenienced in the short term, this is a big medium-term positive in the government's effort to crack down on black money and corruption; 2) the old currency notes are deposited with banks, bank deposit growth will witness a pickup and currency in circulation will moderate - a positive for banking sector liquidity; 3) rural households open new bank accounts to deposit old notes, this may also end up giving a boost to the government's financial inclusion thrust.; 4) as some of the black money is brought under legitimate channels, the government's tax revenue collections will get a boost; 5) the move generally bodes well for the inflation outlook since black money was associated with higher inflation. However, it is likely to hurt near-term consumption demand; 6) the decision has hit terror funding and led to immediate halt in major terror operations..





The real reform involves risk and some disorder in the short term. The investors were anticipating for real reforms since present government won the elections with majority. The government has taken several steps to clamp down on black money and anti-corruption that include declaration schemes (~45% taxation), agreement with many countries to add provisions for sharing banking information, tightened standards for identifying high value transactions and ultimately it announced this surprise move. If such reform is managed with prudent execution, it can lead to structural changes such as increase in tax base and revenues on the back of formalization of the informal economy, lower fiscal deficit, likely lower inflation, decline in interest rates and sustainable growth due to financial inclusion. 

Fiscal: Higher disclosure should lead to increased tax collection but, if the economy slows markedly, then it could also hamper tax growth. We see no stress in meeting current year fiscal deficit target of 3.5% of GDP even as benefits are pushed out to FY18. This doesn’t include a potential  dividend/ transfer the permanent reduction in CIC liabilities  to government from RBI – a potential fiscal windfall.

Inflation (CPI): A sudden monetary shock is likely to be deflationary in the near term. With a bumper harvest likely this Kharif season, CPI is likely to fall in the short term to around  4%. India is also planning to implement GST with four different rates and it was expected to be inflationary. With this demonization move, it is likely that inflation may remain contained  around  4.5%  for FY18. 

Interest rate: Strong growth is likely in bank deposits in the Oct-Dec quarter, some of which could reverse in the Mar quarter. The liquidity rush could be rates-positive, esp. at the short end, and has triggered temporary sterilization measures by RBI (increase in CRR). We also maintain that RBI monetary committee will cut interest rate by 25bps if not 50bps. On the INR, while it benefits theoretically from demonetization, the DXY trends may dominate. 

Growth: The consumer-led recovery in 3Q and 4QFY17, esp. rural demand, looks less likely to materialize now. It will have a negative impact on FY17GDP  (five months left) and consensus numbers being brought down by ~50bps to around  7%. However, this may lead to modest recovery to above 7.0% in FY18 on policy stimulus, pent up demand for consumer discretionary and some % of the black economy gettng reported as official.



Sidharth Mahapatra, Lead Portfolio Manager, India Equities, Amundi Hong Kong

Viral Jhaveri, Research Analyst, Amundi Hong Kong

The Politics of Rage still dominates, the market is ready, are the Italian banks ?


Mr Renzi has lost his referendum in quite a meaningful way by roughly 60% to 40% with a strong participation rate.How worried should we be ? First the ECB stands ready to act. Second, because most expiring bonds still have a coupon above current Italian yields, interest in percentage of GDP will continue to fall even in the likehood of rise in the Italian spead. So no reason to be panicking today on the sovereign front. Do we have a chance to see M5S taking over and trigger a referendum on the Euro ? At this stage we would consider this scenario as unlikely as we favour a new government either of technocrats or a grand coalition. In addition, the Italicum which gives a premium to the leading party winning an election is likely to be reviewed. Lastly the NO of this referendum maintains the possibility for the Senate to block the parliament. So we exlude at this stage the worst case scenario of M5S forming the next government with full power.

Then comes 2 more fundamental questions : 1-Have we witnessed, for a while at least, the end of the implementation of further structural reforms in Italy ? Sadly yes we would argue, which means that the country is unlikely to fill rapidly the gap in terms of productivity vs the other European countries it had generated during the last 15 years or so. 2-The second fundamental question is more short term and is the one we should focus on when it comes to assess what should be the right risk premium for both the Italian and the European Equity markets. Will the Italians manage to finish the restructuring of the banking system ? On this question we think it is too early to position ourselves on particular on the case of Monte di Paschi, where the participation of anchor investors was rumored to be linked to the success of the referendum. On a more positive note, Unicredit (a systemic bank) seems to progress on its disposal program of assets and NPLs.


Laurent Ducoin, Head of Europe Stock Picking




Valuation of Conservative strategy is strictly monitored

Some investors are getting increasingly concerned with the current level of valuation of low volatility stocks. Over the last couple of years, some defensive stocks became indeed more expensive. In a low rates environment and in a higher risk aversion market context, investors bought significant amounts of defensive stocks (e.g. high quality and low vol stocks), pushing their valuation at higher levels. This phenomenon triggered some articles and managers’ comments that described a potential “overcrowding” behind low volatility strategies.


Even though we reckon that there is some rational behind this concern, we believe that our Conservative strategy is well positioned to address these issues:

  • Despite higher levels of valuation, investors have today a preference to invest in Equities at lower level of volatility and this will probably persist in the near future, given the uncertain outlook, especially in Europe.
  • Valuation is integrated in our investment process as one of the key risk dimensions we take into account:
  • At the stock level: During our stock selection step, we consider quality ratios as well as valuation indicators. The idea here is to favor Quality stocks but not to overpay for this quality. A number of valuation “sanity checks” are integrated in the process to ensure Quality will not be overpaid:

1. Using ”Unlevered” valuation  metric : EV/Sales vs. EBIT Margin analysis

We compute a regression line (in black) between the EV/Sales and the EBIT Margin of the companies in the investment universe, excluding Financials.

Stocks with a valuation 15% above the valuation implied by the regression are penalized.These stocks are plotted in red dots above the red line. Stocks with a valuation below the red line are not penalized by the stock selection process.


2. Using ”Levered” valuation  metric: The Free Cash-Flow Yield  has to be positive 

Stocks with a negative Free Cash-Flow or with a Free Cash-Flow yield that is too low are penalized


  • At the portfolio level: During our second step where we optimize list of eligible stocks to generate the Minimum Variance portfolio, some portfolio guidelines are integrated to ensure a good diversification (max per sector, max per country, etc …). Here again, the Valuation risk is integrated as we use a constraint to limit the P/E of the portfolio vs. the benchmark. As such, we monitor valuation metrics (PE) at the portfolio level with the optimizer putting a constraint of quasi neutrality versus the Equity reference.

As an output of our process, the valuation ratios of our Conservative strategies are in line with their market-cap indices. The table below shows the valuation metrics of our strategies vs. their respective indices as of November:



The Conservative Europe fund has roughly the same price to earning ratio as the MSCI Europe (15.5 vs. 14.7), while its EV to EBIT ratio is significantly lower (12.6 vs. 14.5 for the MSCI Europe). This comes from the fact that the leverage ratio of the Conservative fund is much lower than that of the MSCI Europe 2.7 vs. 6.9) because of the strong quality bias of the strategy.

Our risk-focused investment process takes into account a wide variety of risks, ranging from top-down macro factors to bottom-up governance issues. Valuation has been identified as one these risks and we will continue to ensure a strict valuation discipline going forward.



Bruno Taillardat, Head of Smart Beta

Melchior Dechelette, Head of Risk Efficient Solutions



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

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Equity Letter - Earnings are back
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