Con la vista puesta en la primavera política

Laurence Boone, AXA IM - Lunes, 27 de Febrero

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Keeping an eye on the political spring With uncertainty growing, plans are needed for both before and after    The path to recovery for the global economy looks as firm as it has been since the financial crisis, but high uncertainty looms heavily both in Europe and the US. As a result, our strategy focuses on two periods - before and after a politically-laden Spring.

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Keeping an eye on the political spring

With uncertainty growing, plans are needed for both before and after

The path to recovery for the global economy looks as firm as it has been since the financial crisis, but high uncertainty looms heavily both in Europe and the US. As a result, our strategy focuses on two periods - before and after a politically-laden Spring. In this note, we review a number of factors. We examine the (good) global economic momentum and the political risks coming from the US, chiefly in the shape of tax and financial regulation reforms. We also present our French polls aggregator (suggesting at this stage a close race between François Fillon and Emmanuel Macron to reach the second round) and spreads – where we believe French-specific risk is lower than analysts report. In the near-term we remain cautious and will look to protect against the on-going near term political risk, leveraging off the very low levels of volatility to hedge portfolios. But, once the French election has passed and we have more clarity on US policy around tax, trade and financial deregulation, we expect a risk-on appetite to return, albeit with a level of caution, which is appropriate for a cycle that is reaching its peak.

The economy hasn’t been this good for a long time!

The US recovery is approaching its peak. Indicators are all pointing to the upside – the labour market continues to gain momentum, discouraged workers are getting back into the workforce and wages are growing at a brisk 3% or so. Inventories are low and investment continues to rise. Inflation is past the 2% target, supported by healthy core inflation of 2.3%. In the euro area, economic growth has averaged a robust 1.8% for the past two years, while unemployment has declined by more than 3.6 million over the past four years. Inflation rose to a healthy 1.8% in January and keeps surprising on the upside. Japan also displays a more comfortable growth momentum, while China and emerging markets (EM) continue to drive global growth with 4.4% expected for 2017.

Against this backdrop, central banks continue to send signals of normalisation. In the US we expect two Fed fund rate hikes this year and four in 2018, as some of the budgetary stimulus and relaxation of financial rules should prolong the US cycle. The European Central Bank (ECB) will likely amend its introductory statement before the summer to confirm that signs of deflation have vanished, even though the accommodative stance is likely to stay until year end. EM central banks stand ready to address inflationary pressure. Overall, this will see market rates rise slowly, resulting into a soft tightening in financial conditions while sizeable central bank balance sheets are likely to prevent any brutal rate adjustment.

Too good to be true?

In spite of this healthy and comforting picture, we remain wary of forthcoming political risks. In Europe, the French election looms large and will continue to dominate the stage until June. Markets have already demonstrated how swiftly they can respond to political uncertainty. In the US we will get little clarity before the summer on the policies the new US President is able to effectively implement. These policies will shape the US cycle and financial markets outcome in three areas:

− Trade: Where any amendments to trade relations should take place over the next six months, although President Trump has offered a more conciliatory tone with China recently.

− Budget: The shape of tax reform will not be known for another month or so, as the lost revenues from the reforms to Obamacare will condition the extent to which corporate taxation can be modified. While we can be pretty confident that there will be a lower income tax rate (to 20% or 25%), the end of interest payment deductibility, and some taxation of un-repatriated tax profits, the destiny of the border adjustment to tax receipts is uncertain.

− Financial deregulation: The US Treasury Secretary has opened a 120-day period of consultation with the industry, where the usual demands will surface (modification of retention rules, consumer protection, bank capital and some aspects of Volcker rule), but we will know little of the government position before the end of this period.

Overall, these certainly have the potential to support growth and inflation but the magnitude of the impact may be very variable, and can lead to market distortions, for the structure of the nonfinancial industry and corresponding asset allocations.

On the French side

It would be an understatement to characterise this election cycle as a roller coaster. At present the polls are moving in tandem with incoming news. By 17 March, at least, we will have certainty on the candidates. Once this happens, the real electoral campaign can hit full speed. In our view, two key indicators should drive our understanding of both this election and market movements during the period:

− First, we have constructed a polls aggregator that allows us to incorporate the past accuracy of these polls and the size of their sample into our model1, and smooth them with the distance to election day. Currently the aggregator gives François Fillon the highest probability of winning but Emmanuel Macron is so close that we are reluctant to draw any conclusions (Exhibit 1).

− Second, we have broken down the evolution of the French spread into three components: the influence of monetary conditions, European political risk at large and a more French-specific risk. Our modelling suggests that the 45-basis point increase in the French spread at this date can be broken down as 10bps of European risk, 15bps of domestic risk and 20bps to other market conditions. Overall, the French specific risk is lower than market comments imply.

30% Asset allocation 20%

Against this background, our focus is on managing risk in the run-up to summer and 10%

how to protect against potential downsides.

We recommend protecting against a continuation
of the political risk in the near term, taking a more
neutral stance on Bund yields and remaining
negative on peripheral spreads. We also like
additional protection to mitigate risks of euro depreciation or financial sector risks. Given the very low levels of volatility, we believe this asset class is an attractive way of hedging portfolios. Once the election is over, we believe risk appetite will recover and so look to keep a moderately risk-on stance through exposure to low-grade credit, as well as a short duration bias as global interest rates rise gradually.

Download the full slide deck of our February Investment Strategy

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1 Clavel, L. and Kuhanathan, A., « French Presidential elections: monitoring the evolution of the polls », AXA IM Research, 14 February 2017

Exhibit 1

Tight race in the upcoming French election

Probabilities of winning the election 70%

60%

70% 60%

50% F. Fillon (38%) 50% 40% E. Macron (33%) 40%

0%
4-Jan 18-Jan 1-Feb 15-Feb 1-Mar 15-Mar 29-Mar 12-Apr 26-Apr

Source: Diverse pollsters and AXA IM Research – As of 24/02/17

30% M. Le Pen (22%) 20%

B. Hamon (5%) 10% 

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