On the US markets, Donald Trump’s election triggered a rise across the equity markets, long-term rates and the dollar, as well as a tightening in swap spreads. The markets have bought a resolutely Keynesian twist in US fiscal policy as well as a positive impact of this shift on real economic growth. But is this optimism justified? Firstly, we ought to bear in mind that there is a great deal of uncertainty on the shape of the new administration’s economic policy. The most surprising aspect is that euphoria on Wall Street completely ignores the possibility that certain campaign promises will be implemented – promises that would have an incredibly damaging impact on the US cycle, particularly the major shift towards protectionism (trade barriers) and massive deportations of undocumented residents. These moves would clearly have a stagflationary impact on the US economy. Secondly, we may well raise questions on the extent and timeframe for economic stimulus. The infrastructure and defense investment programs look likely to have a virtually neutral cyclical impact on an economy that is close to full employment. To add to this, any increase in spending cannot take place until 2018 as the infrastructure program relies on a hefty portion of private investment, which will take some time to be organized. However, for the markets, the most important aspect of Trump’s program is his

corporate tax break policy. The prospect of a drastic cut in corporation tax automatically has an obvious positive effect on companies’ future profits and hence their share price. Furthermore, the likely vote to apply a tax amnesty on the repatriation of overseas corporate funds would lead to inflows into the capital account, which would bolster the dollar against foreign currencies. However, we think that the White House will have to come to an agreement with Congress on a broader and much more austere review to US fiscal policy. Trump’s election did not convert the Republican majority to budgetary Keynesianism overnight. Any extensive Republican budget programs in the past have always taken place against recessionary backdrops. It is hard to image the GOP embarking on a massive stimulus program when the economy boasts virtually full employment, and with public debt already at all-time highs. Trump will no doubt have to considerably water down his program and dissolve it in a wider reform where tax cuts are offset by the elimination of various tax niches and other tax breaks. Overall, the markets are confidently buying the power-holding Republican party’s conversion to budgetary Keynesianism, while playing down the campaign’s omnipresent protectionist rhetoric. Trump will have to choose between pleasing the markets

and pleasing his voters.

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Asset allocation: summary of our global outlook

With a cyclical acceleration in China and the US, rising oil prices and monetary tightening in G7 countries, the main drivers for reflationary rotation remain. The Fed swiftly confirmed its hawkish monetary stance after continued solid job creation in 3Q (FOMC participants expect to make three rates hikes in 2017) and despite fiscal uncertainty. China is ending the year with an acceleration in industry and retail sales. OPEC meanwhile kept its promise to implement an important agreement to curb output, covering more than half the oil market. Lastly, the ECB made an initial reduction to its asset purchase program. The markets’ hopes of a recovery in growth and world inflation were borne out by these latest developments. Yield curves steepened across the board, pushing up bank valuations. Break-even inflation rates soared. Sector rotation from growth into value stocks continued on the equity markets, and the dollar marched on with its rally against gold and other G10 currencies.

So the real question for 2017 is whether the real economy
will live up to the promises that the markets are buying
into as 2016 comes to an end. US business confidence is
soaring as a result of hopes of massive tax cuts. Will
Congress agree to increase public deficits in order to
finance its tax cuts at the peak of the cycle and with public
debt on the rise? Can job creation, real estate and
consumer spending momentum hold up against a
backdrop of fast-rising long-term rates and a strong
dollar? A fresh increase in the US trade deficit could bring
Trump’s protectionist campaign rhetoric against China
back to the fore, with the risk of unsettling the complex
US-Chinese relationship, which is key for both
macroeconomic and geopolitical balance worldwide. Lastly,
in Europe, consumer resilience will be put to the test by
increasing oil prices, rising interest rates and a slew of
political events. The world recovery since 2008 had thus
far been able to rely on central banks’ goodwill. Bond
markets’ expectations of a swift rise in inflation no longer leave them with this option of cautiously sitting tight and waiting.

At this stage, we play a positive scenario on the markets, at least for the first half of 2017. Equities are set to outperform bonds. We remain underexposed in duration on sovereign bonds. We remain long on credit and extend this stance to include US high yield. However, we remain cautious on emerging market assets due to the risk of potential monetary and fiscal tightening in China (overheating of economy, capital outflows) and the negative impact on emerging issuers in strong currencies of the increase in the cost of liquidity in dollars. We go neutral on commodities, as current levels already seem to price in a lot of the good news on the world cycle.

Tactical views

GLOBAL

--

-

++

●◊

++

●◊

●◊

●◊

=

+

Equities

●◊

◊●

Fixed Income

Money Market

--

-

=

+

EQUITIES

US

Europe

Japan

Asia ex Japan

EM

●◊

◊●

◊●

◊●

◊● ◊●

++

--

-

=

+

FIXED INCOME

Sovereign

Euro IG

Euro HY

EM Debt

◊ : monthly views
● : views of the previous month

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Equities

"Overweight Eurozone, US and Japan vs. emerging"

•   Statistics in the Eurozone remain on a positive trend, particularly on the outlook for consumer spending (consumer confidence surveys) and exports (recovery in industrial export orders, weak euro). We will have to keep an eye on these consumer and business confidence levels in view of the various political events that lie ahead in the Netherlands (elections in March), France (elections in May-June) and Italy (elections likely to take place in Spring). In the meantime, the ECB remains cautious in its moves on the bond markets (continued QE right through 2017). Equity market valuations remain close to neutral. We therefore overweight the Eurozone.

•   US equities are still buoyed by promises of tax breaks by the future Trump administration. Earnings revisions remain on a positive trend, as do inflows into equity mutual funds. We continue to overweight and favor small caps, which will benefit the most from tax cuts and are relatively immune to the negative effects of a rising dollar.

•   We maintain our overweight stance on the Australian market, which is a pure reflation play due to its commodities and banking focus (steepening yield curves good for banking transformation).

•   We have adopted a positive stance on Japanese equities. The domestic outlook should improve due to full employment and the uptick in world trade. The sharp drop in the yen provides a profitability boost for Japanese corporates, which also have a hefty production base in the US. The yen is set to remain weak due to the Bank of Japan’s cap on long-term rates.

•   We remain underweight on emerging equities. In our view, valuations do not seem to factor in political risks (Turkey, South Korea, South Arica, etc.) or cyclical risks (uncertainties on the outlook for Chinese economic policy in 2017). As regards emerging markets, we overweight Mexico and Taiwan.

Source : Datastream

Share price/future profits, adjusted for sector composition

Tactical views

EQUITIES	--	-	=	+	++
Developed markets
US	●◊
Europe	◊●
Japan	●◊
Asia ex Japan	◊●
Emerging markets
Asia	●◊
Europe	◊●
Latam	●◊

◊ : monthly views
● : views of the previous month

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Fixed income

"Long European and US credit vs. G4 sovereign debt"

•   We remain heavily underweight in duration on the Eurozone. In December, the ECB took concrete action on the need to reduce monthly purchases to their March 2016 level, cutting back from €80bn to €60bn per month. However, the minimum length for the program was extended to the full year 2017, and this met with a positive welcome from the markets. Draghi’s resolutely cautious tone, particularly as regards political risk in 2017 ("uncertainty prevails everywhere") limited the increase in long-term sovereign rates. However, we think that the cutback in monthly purchases will focus on sovereigns, and not affect IG credit, ABS and covered bond purchases. The easing in technical constraints on sovereign bond purchases focused on the short end, extending to one-year maturities and allowing purchases below the ECB deposit rate. The weak euro and the rebound in oil prices promote an increase in inflation expectations. The yield curve should continue to steepen.

•   We maintain our stance on Eurozone Investment Grade credit following the ECB’s decision to continue its asset purchase program in 2017.

•   We overweight US inflation-linked products: the increase in long-term rates was too severe and this trend should turn around as the most exposed sectors to debt flows weaken (real estate, automotive). We maintain our exposure to US IG credit and round it out with a play on US High Yield, which has a duration close to 5 years and benefits from the improvement in the energy sector.

Euro area : increase in inflation due to oil prices

Tactical views

Source : Datastream

FIXED INCOME	--	-	=	+	++
Sovereign bonds
Euro Core	◊●
Euro Periph	◊●
UK	◊●
US	◊●
Japan	◊●
Inflation	◊●
Credit
Euro IG	●◊
US IG	●◊
€High Yield	◊●
$High Yield	●◊
EM Debt	◊●

◊ : monthly views
● : views of the previous month

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Commodities

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-

=

+

++

Oil

◊ ●

Industrial metals

●

◊

Gold

◊●