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Asset Allocation Letter - “Confidence will be a key factor in 2017”


Asset allocation conditions have rarely been that favourable. Reflationary forces are now firmly in place, as reflected by the steep increase in inflation and commodities expectations -oil prices have risen by almost USD 10 despite the dollar rally. Interest rates have steepened as deflationary risks have abated, which had a dual impact on yields. Long term rates have risen and the yield curve has steepened. This, in turn, should have a favourable impact on credit supply and, as such, lead to an increase in final demand. Yields have become more attractive across the board, in, both developed and emerging bond markets. 

Investors are optimistic. Against this backdrop, equity and credit markets delivered strong returns, driven by more positive macroeconomic news flow. Furthermore, the election of Donald Trump on a promise to radically change tax policy in the US has enabled domestic growth outlook to be revised upwards. Markets are willing to believe that this positive shock could spread to Europe.

Caught between hope and uncertainty, market trends will not be linear. We are entering into a year full of hope. Beyond the political measures, which always have their share of difficulties in terms of implementation, confidence is a critical factor for performance. On this point, time is scarcely supportive for the simple reason that “market time” generally passes faster than “macroeconomic time”. Furthermore, risk factors are far from absent, particularly in Europe given the busy political agenda. Investors will have no other choice but to be flexible and reactive

The ability to adapt investment strategy is going to be critical. Investors will need to be reactive, being able to switch to safe-havens as well as to return to risky assets if volatility was to increase. The good news, in this early part of the year, resides in the potential diversification provided by the recent in interest rates rise. US government bonds, the ultimate safe-haven asset, are now offering some yield. Similarly, equity volatility is stable at all-time lows, which represents a cheap hedging opportunity.

As was the case in 2016, performance in 2017 is likely to be generated during a few key periods, which must not be missed. We are convinced that multi-asset management investment strategies provide the opportunity to capitalize fully on their diversity.


Laurent Tignard

Global Head of Multi-Asset, Institutional Clients


Investment scenarios

  • Our central scenario, based on a limited but stabilized global growth remains valid - around 3% per year in 2016-2017 – with a 70% probability of occurrence (stable). US growth should be slightly higher than expected for 2018 (2.2% vs 1.7%) and Developed Economies globally driven by domestic demand (Europe, US, Japan). Emerging Markets should improve benefiting from the stabilization of oil prices. This environment should favor risky assets and also QE friendly assets (Euro Corporate and Equities, Peripheral Sovereign Debt).
  • Our first alternative scenario(stable at 15% probability) assumes an acceleration of US growth as well as US inflation expectations thanks to fiscal expansion leading markets to reprice rates higher and USD stronger, with the Fed eventually more aggressive than initially anticipated. It would create a widening gap between disappointing growth expectations and sustained inflation expectations.
  • Our second alternative scenario sees a global growth slowdown with 15% probability of occurrence (stable). The trigger could be a deterioration of the US economy, a disappointment from the Chinese data or the consequences of the Brexit vote.


Positioning under our central scenario

The intermediate risk budget is stable at 5/10.

  • On equity markets, we increase our geographical bias while remaining neutral in directional.

- Geographically, we favor Developed Markets as the relative attractiveness of Emerging Markets is fading over the short-term. We cut the overweight on Emerging Markets to fund the long exposure on EMU and Japan. We also maintain a neutral exposure on US and the underweight on Europe ex-EMU.

- Sectors/factors: we still have a preference on US Value and remain balanced between Value and Quality in Eurozone. In terms of sectors, we keep our bias on cyclicals and pharma.

  • In the fixed income space, we stay underweight in nominal duration and maintain our long exposure to Credit.

- Rates: We maintain a short duration exposure to Core Eurozone and a moderate long exposure to Peripherals. We took our profit on US Breakeven and turn long US duration via a long exposure to US 2Y. We also keep a long exposure to Euro Breakeven.

- Credit: We are globally positive on the asset class. We balance our overweight exposure between Industrials and Financials and increase our position on High Yield in Eurozone. We maintain a long position on US Investment Grade.

  • Currencies: we do not implement significant currencies strategies, although we build a long position on JPY and maintain a low risk budget on Emerging Markets Forex.
  • Macro Hedging: we prefer equity volatility to other macro hedges. We are ready to reinforce the exposure to US treasuries after a potential overshoot over the short-term.


Cross asset views and portfolio positioning

RISK LEVEL: 5 / 10

Asset Allocation Letter 201701_img1



2017: What if something goes wrong?

This year starts on a much better footing than 2016 and deflation/recession risks are off the radar leading to a higher probability of orderly execution of our central macro scenario: Decent growth in the US sustained, among others, by fiscal boost (positive impact on capex), modest improvement in Europe, improvement in Emerging countries leading to narrower growth differential between Emerging Markets and Developed Markets, China’s orderly transition under way and rangy commodities prices (45-55 per barrel).

That said, markets are fully in line with us and opportunities that we correctly saw last year (long value stocks in the US, short core duration, long inflation breakeven) have had a very good run and seem to offer less at the beginning of this year, leaving us with some comfort from a macro point of view and some discomfort from a market point of view.

In the central view, commodities prices will be less of a market driver compared to 2016 (fantastic catch up of commodities related assets probably fully priced at those price levels). Inflation remains globally contained but, because of business cycle positioning (late in the US with possible wage inflation in the pipe) and Forex depreciation (UK, Mexico..), inflation will likely be a bigger market driver in 2017 as market participants are now only considering the “good story” of inflation. Central scenario assumes 2 hikes in the US, QE will be maintained in EMU in a form or another, BoJ will continue to be creative. Forex volatility needs to remain contained to have this scenario confirmed: rangy USD vs DM at current levels (opportunistic trading), selectively positive for some Emerging currencies. Emerging Markets assets should outperform (EM equities, local rates) with better growth prospects (if Mr Trump does not ruin the party), Developed Markets equities enjoy some upside with outperformance of Japan and Europe vs US.

Our Multi-Scenario process leads us to scrutinize markets beliefs and try to see what could go wrong. Having a clear mind about the positive and negative risks factors is a pre-requisite to build resilient portfolios and be quick in adjusting portfolios should some of those risks start to materialize. Our central scenario can probably be considered as the rosy outlook from a macro and market point of view, this is the reason why we believe most of the alternative outcomes are negative, except probably one of a coordinated fiscal boost. Most of the risks can be summarized in a few words: higher US real rates, prohibitive USD, unpleasant inflation numbers, US and European political risks.

1. Positive risk factor

A coordinated fiscal boost in the main regions (those who do not face potential balance of payment issues and continue to suffer from negative output gaps), as this would comfort global growth numbers, increase the winner’s lists (US fiscal policy is supposed to benefit quasi exclusively to the US) and reduce the potential negative impact on Emerging Markets (via Emerging currencies depreciation and Trump’s protectionism risk). This would also guarantee some alignment of interest (higher rates because of higher growth, not because of contagion effects coming from higher UST) and offer markets the wished transition from monetary to fiscal support. This would be a catalyst to reinforce equity exposure globally.

2. Jump in UST real rates

Q4 markets moves (higher interest rates yields, USD bull run and equities sector rotation) reflect a cleaning position and a change in the balance of risks: Adjustment of inflation and growth expectations. Markets want to give growth a chance. Should the bond sell-off continue, it will eventually bite on risk assets: Investment Grade credit and Emerging Markets Bond Index spreads will likely take a hit as the next domino. On equities, convergence will likely be on the downside if UST continues to fly as valuations are stretched. This probability is reinforced if we see a bear flattening (US) as the “positive steepening” for financials will be questioned. Same for Emerging Markets assets (starting from Forex to hard currency bonds). In Europe, ECB is happy with recent market developments as risk assets perform and euro depreciates. Rates were too low, especially in Germany and this reduced QE’s efficiency and made execution harder (bond scarcity, impact on bank profitability, impact on savings). Having higher nominal rates and very stimulative real rates is a win/win for the ECB. Going forward, key indicator is monetary conditions index in Italy/Spain. ECB needs real rates below potential growth ( 0-1%). Above 2% nominal rates in Italy starts to be problematic, unless it is offset by other stimulating measures.

3. US TWI appreciation

The USD is key and has the potential to derail the “blue sky story”. It is very unsure the world is able to cope with an appreciating USD. The belief that the FED simply can set the fed funds targets based on US domestic factors (output gap and inflation gap) is unrealistic. Prohibitive dollar is jeopardizing the Emerging Markets fragile recovery and will also negatively impact US growth, an element that is totally ignored by market participants. One should not forget that the positive macro momentum that we currently enjoy is largely due to the very easy financial conditions brought by USD depreciation, low real rates, low credit spreads, higher commodity prices in 2016 H2. We are in a positive manufacturing cycle that could reverse should financial conditions continue to tighten.

4. US inflation: late cycle issues

Before the fiscal easing being felt in the US (end of 2017), US growth may face some unpleasant growth/inflation mix: higher oil prices and tight labor market (wages are up), closed output gap push could put some upward pressure on inflation numbers. As Ms Yellen pointed out in the last Fed minutes, a boost in inflation coming from high fiscal spending will need to be addressed by higher fed funds.

5. Good Trump vs Bad Trump and macro momentum

Markets currently focused on the good Trump (fiscal boost) rather than on the bad Trump (negative for Global Trade, protectionism and bull USD). Additionally, the planned fiscal measures on corporates (higher import prices, lower corporate taxes) do not seem obviously growth friendly (higher inflation, higher USD, lower exports etc.). Any silly talk regarding Emerging countries, China will also be highly detrimental to foreign risk assets and make the risk-on mood short lived. This will lead to high Forex volatility, strong Emerging Markets underperformance etc. Moreover, the current positive impact of Trump’s election will likely fade away as markets participants will have to fact-check the reality of growth momentum before the allegedly positive impact being actually felt. Economic surprises are mean-reverting by nature and currently at high levels in the US.

6. China

Markets are relaxed as CNY devaluation/capital outflows are better understood and macro momentum is solid. China has the retaliation power in case Trump goes unfriendly and will not remain silent if USD appreciation and capital outflows continue to intensify.

7. European political risks

Brexit’s impact will be slowly felt and risk premium will continue to weigh on UK’s assets. News flows will matter a lot and likely create some contrarian opportunities (it will not be black or white agreement). In France, Marine Le Pen is very unlikely to win the elections but one should expect a very efficient campaign. Due to multiple candidates, it seems highly possible that she arrives in lead position in the first round before being defeated. It is much too early to fight against market fears of her winning. It will get much worse (Spring) before it gets better (having two rounds is the best shield to avoid an extreme winning).


Key takeways

  • Markets are too focused on Trump’s elections. Platform execution remains highly uncertain and one should not confuse positive impact of last year’s stimulative conditions and expectations regarding an uncertain political platform.
  • US real rates, USD, commodities and NFP/ISM are the ones to watch. Too high payrolls are not good (too high real rates), rapid slowdown is not good either (back to late cycle issues). USD scenario is crucial to build a portfolio: making clear choices between “long USD “ and “short USD” assets with positive asymmetry is the right question to ask ourselves.
  • The system is highly leveraged: credit spreads widening is the real threat to the system.
  • China is systemic. Mind macro momentum and financial outflows.




Amélie Derambure

Multi-Asset Portfolio Manager




Gross performances of our strategies (December 30, 2016)

Amundi, data as at end of December 2016. Gross performance of “Balanced Institutional Absolute Return Low volatility “, Multimanager Multi-Asset Fund of Funds (Bonds)“ GIPS composites in euro. Their respective benchmarks are: Eonia capitalized and a composite benchmark: 50% JPM EMU Government Bond Index, 30% JPM Government Bond, 20% Exane ECI – Europe Convertible. Past performance is not a reliable indicator of future results or a guarantee of future returns.


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TIGNARD Laurent , Global Head of Multi-Asset, Institutional Clients
PASCAL Frédéric , Deputy Head of Multi-Asset, Institutional Clients
TAZE-BERNARD Eric , Chief Allocation Advisor
BEN ABDALLAH Marc-Ali , Senior Analyst, Investment Solutions
NETO Florian , Client Portfolio Manager
LEVY Dan , Head of Multi-Asset Investment Specialists
GUILLEMOT Bénédicte , Investment Specialist
DEBOUT Leslie , Investment Specialist
DERAMBURE Amélie , Global Multi-Asset Portfolio Manager

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Asset Allocation Letter - “Confidence will be a key factor in 2017”
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