Sector Strategy : A Lack of Catalysts on the Equity Market

The markets have been supported by a number of positive factors in recent months: a more dovish US central bank, reassuring earnings results and hopes for favourable China-US trade negotiations. However, we believe the markets will probably lack catalysts in the near term.

In this difficult environment, we have tactically reduced risk by cutting our cyclical positions. In the context of no short-term market catalysts, our sector strategy is now more neutral, at least for the time being.

We maintain positions in more defensive sectors such as Energy and Pharmaceuticals. However, we keep some cyclical positions in Europe (Hardware, Industrials), which are still cheap.

Equity markets: Positive to neutral in the short term

Recently, we have reduced our holdings in cyclicals. After the rally at the beginning of the year, we felt it was time to cut our positions due to the lack of short-term catalysts. The markets have been driven in recent months by several positive factors:

- A more dovish US central bank. The market was reassured by the comments from the Fed chairman, consequently reducing the risk of a monetary policy error.

- Fourth-quarter corporate results were reassuring. Although analysts had revised down their forecasts, the results did not show any signs of an imminent recession.

- Progress on the US-China trade talks. Hopes of a compromise between the two powers kept the markets buoyant.

Consequently, equity markets rebounded, supported first by cyclical equities. Today, the aforementioned catalysts seem to have less power. The gap between the behaviour of stock market indices and forecasts, especially for beneficiaries, has closed. Shares are oversold.

Some of our sector bets are more defensive. The Pharmaceutical industry should benefit from its solid growth profile despite the risk on drug prices. Energy, which has recently underperformed, is not expensive. It benefits from an attractive dividend and solid cash flow in a context of rising oil prices. We are also positive on REITs (solid profitability in a low interest rate environment). This strategy seems to have paid off in March. The S&P500 index dropped slightly at the beginning of March to return to 2,800, buoyed up by Energy and Health Care. The Technology sector is also very resilient.

We nevertheless maintain some cyclical positions in Europe (Hardware, Industrials). Despite the negative effect of the slowdown in car manufacturing, the Industrial sector should be supported by the stabilisation of the Chinese economy (ongoing stimulus).

The painful recovery of the banking industry

We are also positive on banks and insurance companies. While the latter benefitted from their defensive nature (less volatility, less regulatory risk), banks have suffered greatly in recent months from a difficult economic and financial environment: poor profitability in a context of low interest rates, strict regulation, political uncertainty (Brexit, Italy) and downward revisions of economic prospects. In Europe, the announcements of money-laundering scandals in Scandinavian countries have been an additional risk for the industry (risk of fines).

Ahead of the European Central Bank’s (ECB) meeting on 7 March, investors were hoping for new announcements that could support bank stocks, notably a measure against the negative deposit rate (extremely negative on earnings) and hopes for a new TLTRO programme.

The ECB started to act this month - sooner than expected, and its actions were
positive- but did not fully meet market expectations:

• A new round of TLTRO has been announced, but some important details have not
been disclosed (What price? Which loans are eligible?). Without unveiling any more
information, the ECB announced that the TLTRO rate would be indexed to the Refi
rate (and not to the deposit rate in the previous version), which is apparently less
generous to banks.
• The deposit rate remains negative. No reference was made to the expected
adjustments (progressive rates).
• Furthermore, investor sentiment was dampened by Draghi's speech. A cautious
signal on the economic environment was sent out with the downward revision of
macroeconomic forecasts (GDP for 2019-20-21 to 1.1% 1.6% and 1.5% vs. 1.7%, 1.7%
and 1.5%. Inflation at 1.2%, 1.5%, 1.6% against 1.6% -1.7% and 1.8%). The ECB is
unlikely to raise rates in 2019.

The ECB's announcement thus created confusion on the markets. European banks
corrected (-4%) on Thursday 7 March after Draghi's press conference. At this stage, we
remain positive on banks. Although the environment remains very challenging for
them, the ECB's communication aimed to demonstrate that the ECB is leaving options
open depending on market upheavals. The sector is also extremely cheap. We continue
to believe that the current level of the German 10-year is an anomaly. The sector could
also be supported by mergers (in Germany, in particular). Deutsche Bank and
Commerzbank confirmed that they are in talks to envisage a merger, moving from
unofficial talks to official talks. We thus remain positive at this stage, although
profitability conditions remain challenging for the banking sector.

In conclusion, looking beyond our short-term neutral view, we maintain a favourable
view on equity markets in the medium term. With the economic backdrop stabilising
and political (geo) pressure easing, corporate earnings will continue to grow in 2019.
This potential for further growth should materialise by mid-year. After consolidation,
we might return to some equity themes (consumer, EM sensitive stocks).