Equity Letter - “We were on the edge of the abyss and we have taken a big step forward”

EDITORIAL

If we stay rational, we must admit that at first glance equity markets appear to have limited upside. We can even say that we are currently facing an asymmetrical situation where the downside is probably twice as big as the upside. That said, who cares about rationality after a 2016 marked by a succession of unexpected events and still more unexpected market reactions?

Currently markets are definitely determined to see the glass half full rather than half empty and there is at least one good reason for that: when inflation is exposed to upward pressure worldwide, this should feed through to a brighter outlook for nominal growth and more specifically for earnings growth. This element will be key given that we are facing stretched valuations and badly need support from earnings dynamics.

In the US we are slightly sceptical about profit growth but cannot exclude higher earnings generated by lower tax rates and still very aggressive buybacks. In Europe on the contrary we are much more optimistic on the earnings outlook. Europe is probably one of the regions most sensitive to higher inflation. Given the more rigid cost structure, it is inflation which will be key for a recovery in margins. In addition, latest economic data have been encouraging and confirm that the recovery is well in place, while the historical drag from sectors such as Energy and Banks is abating or even reversing. In Japan and in Emerging Markets we are reasonably constructive on this front but with the caveat that the story remains currency-dependent.

This leads us to favour Europe. More than specific themes or sectors, at this stage we believe it is stock picking that offers that biggest opportunities, alongside a likely booming M&A cycle.

Romain Boscher, Global Head of Equities

CONVICTIONS

2017: The year of the earnings rebound?

For the past six years, earnings anticipations at the start of each year have turned out to be too optimistic. How are we situated this year? The accompanying chart plots consensus and Amundi forecasts for 2017 over the past twelve months. It is interesting to note that:

• The two lines intersect in December 2016 when Amundi became –and still is- more optimistic than the consensus on the earnings outlook for this year.
• Earnings momentum according to us remained positive at the end of January, which should translate into further earnings upgrades for 2017.

Amundi’s more positive view can be explained by the following factors:

• Higher earnings forecasts for all resource-related sectors, in parallel with (Energy) or in anticipation of (Metals and Mining) the rebound in commodity prices (Amundi is currently anticipating 65 to 105% earnings growth in energy and natural resources sectors in 2017).
• The end of downgrades in all financial sectors since October 2016 (steeper yield curve, upward revision of leading indicators, more supportive market environment)

At this stage, we don’t expect any downgrade of consensus forecasts for the following reasons:

• Consensus expectations ex natural resources (i.e energy and materials) are at 9.7% which looks reasonable given the macro-economic environment
• Consensus forecasts for financials (10% for banks and diversified financials, 4% for insurance) seem realistic in the current interest rate environment
• Only the construction materials sector, which accounts for only 1% of market capitalisation, can disappoint in the short term.

2017 should be the year when earnings growth expectations are confirmed by actual earnings reports, with in our opinion low risk of downside surprises barring exogenous shocks (decline in commodity prices, geopolitical risk, unexpected currency movements).

Stéphane Taillepied, Head of Equities Research

Equity markets are focusing on the pro-business measures of the Trump administration and are shrugging away the risk of disappointment due to possible implementation difficulties. Other indicators of market stress, such as the GFSI (Global Financial Stress index), the MOVE (bond volatility index) and the CVIX (currency volatility index) reflect higher levels of investor concern.

It is highly likely that a spike in bond and currency market volatility would spill over to contagion on equity markets, where the current attractive level of volatility makes it possible to buy protection at a relatively low cost.

Eric Hermitte & Gilbert Keskin
Co-Heads of Volatility and Convertibles