#Market Strategy — 08.06.2016

We Remain Positive On The Main Developed Equity Markets In The Medium Term

Florent Bronès

Sustained economic growth will help lift profits, albeit at a very slow pace. Equities remain the preferred asset over the long run, fundamentally justified by higher profits and dividends.

The rally in the markets that began in mid-February continued in April and May.  A transition phase with more volatility could begin in the short term. The markets lack catalysts to fuel their rise, while central banks are taking a breather and key political deadlines are approaching.

Financial markets are extremely sensitive to the Fed

The US Federal Reserve surprised the markets by publishing its minutes hinting of a possible rise in official rates this summer. Several Fed officials even suggested that another hike in June was likely, but would depend on economic data.

In May, US data were solid, and leading indicators (ISM and PMI) even recovered, so much so that before the employment report was published on Friday 3 June, a rate increase in June/July was considered as highly probable.

Employment figures reshuffled the cards: coming in a considerably below expectations, they triggered a strong fall in bond rates and In the dollar, and now make any move by the Fed in June unlikely. We are sticking to our scenario of one increase in Fed rates this year (we think December): too early in the summer, particularly given the risk linked to the referendum in the UK, not in September because it is too close to the US presidential elections. But we still foresee a rate increase because the US economy is solid, wages are rising by 2.5% year-on-year and the Fed needs to normalise its monetary policy.

A packed political agenda

Several important elections are taking place in the coming weeks and months, fuelling uncertainty for the financial markets. Financial variables are reacting quickly to the various surveys. The UK referendum on Brexit on 23 June will be the first vote. It will be followed by the general elections in Spain taking place a week later, on 26 June. The Italian prime minister, Mr Renzi announced that a referendum on constitutional changes would be held in October. He threw all his weight behind the plan by announcing that he would resign if the vote was negative. And finally, the US presidential elections are scheduled for 8 November.

Markets lack short-term catalysts

The markets rebounded nicely in May. Risk appetite returned due to Fed comments, bringing confidence in the strength of the US economy, and better economic data, particularly in Europe where we have marginally raised our economic growth forecasts.

The markets should remain timid in the short term. They lack catalysts to pursue their upside trend, while the debate on the Fed remains open and political deadlines are fast approaching.

But later in the year, earnings growth prospects will improve: the consensus for a 2% to 3% rise in profits in 2016 appears very conservative and over cautious given the recovery in the price of oil. In 2017, earnings should increase at a faster rate than corporate sales thanks to higher margins (except  in the US where margins are at a high and will struggle to remain at this level).

In this context of a moderate rise in profits and in the markets, dividends continue to represent a sizeable share of total profitability of equity investments.