#Market Strategy — 09.05.2016

Towards A Transition Phase With More Volatility?

Florent Bronès

The rise in markets which began in mid-February thanks to the recovery in oil prices and the combined efforts of central banks continued in April.

A transition phase with more volatility could begin in the short term. Markets lack catalysts to continue their rise at a time when central banks are taking a break and significant political deadlines are drawing near.

Central banks on hold

After taking important decisions over the past months, central banks are now waiting to see what impact they will have before taking new initiatives.

The Fed didn't make any announcements at its April meeting. It acknowledged that the American employment market is improving and that inflation is significantly below its 2% target, partially as a result of falling oil prices. We believe that it will only increase rates once this year, probably in December, that is, after the presidential elections. This will provide support for the dollar. The ECB didn't decide on any new measures, as expected. It first wants to see what impact its latest announcements will have.

It noted that inflation remains below its target. Mr Draghi reiterated that European rates will remain low for a long time to come, at least through the end of the bond purchasing programme. (March 2017). The same holds true for the Chinese central bank which has been waiting since the currency stabilised.

The biggest surprise came from Japan: the BOJ took no decisions, while expectations favoured a new activist phase. As a result, the yen has re-appreciated.

A busy political agenda

Several important elections will take place over the coming months, generating uncertainty in the financial markets. First up is the British referendum on Brexit on 22 June. This will be followed by general elections in Spain one week later, on 26 June. The Italian prime minister Mr Renzi has announced that a referendum on constitutional changes will be held in October. He has put all of his weight behind the plan and announced that he will resign if it is defeated. The American presidential elections will then be held on 8 November. In addition, the French presidential election will be held in 2017 and the German parliamentary elections in September.

Markets in a transition period

Markets have experienced a significant recovery since their low points on 11 February, leading global indexes to important resistances, i.e., a moving average of 200 days. The latter is now trending downwards, which means that a transition period will be necessary before a sustainable increase can break through.

Equitiy markets will be short of catalysts to ensure their continued rise. We are entering a less favourable seasonal period: central banks in a holding pattern, significant political deadlines and the end of the earnings season. All of these reasons point to continued high volatility.

The fundamental trend will depend on corporate results. Current market valuations imply that economic growth and profits need to remain well-oriented. That's our scenario. We are expecting an increase in global results of about 3% in 2016. This growth could accelerate in 2017, notably if the financial sector, which is important in the indexes, extends the rebound in profitability. The improvement in margins will potentially be large in Europe and in Japan, although less so in the United States since margins are currently high there. This is not the case at all in Europe. However, the consensus expectation for a 13% increase in global earnings in 2017 is too optimistic.

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