Time To Reduce Some Positions

We recently adopted a neutral stance on global equities. Stock markets are near a significant resistance zone. Fundamentals would need to improve if the rally is going to continue. The macroeconomic environment has deteriorated and corporate earnings forecasts have been revised downwards. Signs of an improvement will take some time to appear. Against this backdrop, the markets will be more vulnerable in the short term due to the lack of catalysts.  However, we maintain a favourable view in the medium term. Thanks to the stabilisation of the economic environment and geopolitical pressures, earnings will continue to grow in 2019. This potential is expected to materialise by the middle of the year.

We reduce our positions, not by region, but by industry/sector in view of their performance. Several of them are now close to (or even above) their 200-day moving average. We first focus on the pro-cyclical sectors. Our arguments are essentially technical and relate to valuations.

We modify our positions on the following sectors/industries:

Global Materials (mining, steel, etc.) have been downgraded to neutral. In Europe, the sector has rebounded strongly, particularly driven by mining.

In the medium term, we believe that the mining industry could be supported by a recovery in the Chinese economy, especially thanks to the impact of the stimulus (fiscal and monetary) measures that the public authorities have been implementing for several months in a bid to curb the economic slowdown.

Meanwhile, China's economic data remain weak and the lack of catalysts expected in the short term and the rebound in the 200-day moving averages prompt us to reduce our exposure to the mining sector. Mining stocks are trading at relatively high valuation levels in comparison to other sectors.

The steel industry has rebounded strongly in the United States, unlike European stocks, which have posted more modest gains. In Europe, the sector's challenges relate to the impact of the US-China conflict (shift of steel trade to Europe), the changes in end demand (in particular China) and the negative effect of the recent rise in iron ore prices (the collapse of a dam in Brazil) on profit margins which are usually under pressure at the end of the cycle (lower sales prices, higher costs). Even though (European) steel companies have not yet reached their 200-day moving average, we still downgrade the industry to neutral.

Chemicals (which have not reached their 200-day moving average) have also been downgraded to neutral. We believe they lack short-term catalysts, particularly for driving demand. China and Autos are a risk for the industry. Despite the positive impact of lower oil prices on margins, DowDuPont's profit warning and some disappointing results have hurt the sector. Companies remain cautious about their second quarter 2019 forecasts.  On the other hand, the second half of 2019 could be better.

We are now neutral on Semiconductors in Europe. We were buyers of the industry in the fourth quarter of 2018, when it was heavily under pressure amid an extremely challenging context (US-China trade war, transformations in the automotive sector, fears about the sales cycle, concerns over Apple's value chain). At the time, the industry was excessively penalised by the markets. The sector is undervalued, especially certain diversified companies in varied activities (automobile, but also robotics, artificial intelligence, etc.). Today, the sector has rebounded strongly with hopes of a trade compromise between China and the US, and to date it has been one of the best performers in the recent rally. Corporate results: although reassuring, they remain fragile in the context of an economic slowdown. Stocks are high. In their communications, sector players remain cautious for 1H19 (low growth) but are more optimistic for 2H19. The sector will remain heavily dependent on the outcome of the trade negotiations between China and the United States. The sector has reached its 200-day moving average. At these levels, we prefer to take profits.

US industrials have been downgraded to neutral. The sector has rebounded strongly in recent weeks. Europe, however, is lagging due to a higher exposure to global demand (China, autos, semis). In the US, economic growth has remained robust. In 2018, it reached almost 3% thanks to the tax cuts implemented by President Trump. In such environment, industrial sales have been boosted and the sector has outperformed, underpinned by low rates and the rollout of business investments at the end of the cycle.

Without envisaging an immediate end to the cycle, sector momentum could be less favourable in the short term. US economic growth is expected at 2.1% in 2019. Leading economic indicators are deteriorating in the US, implying less favourable organic growth at industrials than in 2018. In addition, the sector in the US is now above its 200-day moving average.

We move from neutral to negative on Food Retailing. The industry has been suffering from a challenging environment (deflation, heightened competition, low growth, squeezed margins). However, the European industry has been driven by restructuring, mergers & acquisitions, and an increase in food inflation in recent quarters. Cost controls and synergies have led to an outperformance of the industry. In February, the European index has hit a 3-year high.  Food retailing is now trading at a premium.

We adopt a buy recommendation on REITs (excluding the UK). The industry is favoured by still low interest rates and high dividends. In a context of uncertainty, investors are showing greater interest in this type of stock. We avoid stocks that are exposed to the UK given the Brexit risk (impact on London offices).