Since Donald Trump was elected, investors have gradually been reassured on their fears on deflation, growth in emerging markets, and uncertainties on the euro area, which had dented appetite for risk between end-October 2015 and mid-February 2016. They therefore played the global reflation theme.
World growth is clearly accelerating and resynchronizing, and the threat of deflation is dwindling.
This combination of an upturn in real growth and a rise in inflation is broadly favorable for the overall earnings per share growth trend, which should come out at close to 13% this year.
The phase of acceleration in inflation now seems to be behind us and leading indicators are beginning to turn around in some areas, particularly the US and China. The expected corporation tax reform in the US should further shore up corporate profitability in 2018, even if the implementation of other reforms is looking much less likely in view of Donald Trump’s dwindling political credibility. Lastly, the main central banks should start cutting back their balance sheets out to end-2017, and some have already started to rein in liquidity or are preparing to announce this type of move (ECB). The end to US monetary expansion actually dates back to spring 2014 and has been gathering pace since then.
Looking to emergings, improved global financial conditions and a good showing from commodities have been positive. But the gradual normalization of monetary policy, the progressive reduction in liquidity in dollars and the slowdown in Chinese growth (which drove commodities) could drag down these economies.
While long positions on dollars, commodities and emerging equities look vulnerable among the reflation trades that have been driving the markets, others still seem to harbor potential in our view, such as euro area equities, which still benefit from accommodative financial conditions, solid economic fundamentals (PMI at a 6-year high) and increased competitiveness due to the weak euro, which buoys corporate profitability. The real “justice of the peace” will be the recovery in household consumer spending, which should be bolstered by more accommodative fiscal policy and the decline in jobless numbers.
In the euro area, we are still positive on themes such as small caps, which are more exposed to the acceleration in the economic cycle, as well as banking stocks and Italy, which are set to benefit from the gradual increase in interest rates.
We also maintain our positive stance on Japanese equities and the emerging debt markets in local currencies.
