#Market Strategy — 12.12.2016

Growth And Inflation Forecasts Raised

Florent Bronès

In view of the reflation policy via fiscal measures put in place in the US, we have revised up our forecasts for economic growth, inflation and long bond yields, first of all for this country and then in Europe and Japan.

The Trump administration’s reflation policy via tax cuts and infrastructure spending will have a significant impact on US economic growth. The other mature economies will also benefit. We have revised up our 2017 growth forecasts for the US.  In 2018 the positive impact will gradually feed through to Europe and Japan, because these stimulus policies will progressively spread, translating into a positive impact on the global economy, including the emerging markets. The downside of these reflation policies is the effect on inflation, which will accelerate in 2017, automatically due to the rise in oil prices, and more structurally, due to the likely increase in wages in economies close to full employment. Consequently, the rise in bond yields, which started before the US election, has accelerated and is set to continue: we have revised up our bond yield targets to 2.75% for the 10Y Treasury and to 0.75% for the 10Y German bund.

The ECB has announced an extension of its Quantitative Easing programme until December 2017 and a reduction in the amount of its monthly purchases from €80bn to €60bn as from March.

The Fed is expected to hike rates during its meeting on 14 December and then twice more by 25bp in 2017. This general context of a Keynesian stimulus policy in a still expansive monetary policy environment (US Fed fund rates remain historically very low) and an acceleration in inflation will be a very important subject in 2017.

Take advantage of these reflation policies

The acceleration in global economic growth above +3% in 2017 and 2018 will favour stock markets thanks to the positive impact on company profits. Moreover, equity valuations are fair, except in the US where they are now in expensive territory. We have not changed our preferences for mature stock markets which are the most exposed to the economic cycle (Eurozone and Japan). The fall in the euro and the yen will boost profits of exporting companies. Profit forecasts in the US are following a good trend, hence we are not negative on this market. But its high valuation is limiting upside potential.

We have made some major changes to our European sector recommendations, with a new preference for Financials and Energy. On the other hand, we have downgraded our opinion on several defensive sectors to Neutral (Telecoms, Real Estate), and have turned negative on Consumer Staples and Utilities.

The emerging market economies will react differently to the US stimulus policy, but more or less positively. Above all, the risk of protectionist measures that Donald Trump constantly spoke of during his election campaign must disappear to improve visibility on this segment of the financial markets.

Oil prices

OPEC has reached an agreement to cut production by 1.2mb/d to 32.5mb/d. If this accord is fully respected, it will help to rebalance the oil market faster than expected. We have therefore raised our oil price forecast from $45-55 to $50-60 per barrel, which is positive for the listed energy sector.

The political risk turns to Europe

The markets will focus on the general election in the Netherlands on 15 March, the presidential election in France (May 2017), and then the general election in Germany in autumn 2017. Other risks concern the US and the start of the Trump administration, particularly diplomatic issues and the risk of protectionism.