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Xavier Chapard, strategist at LBP AM, shares his insights in a context marked by numerous uncertainties.
As Christine Lagarde put it, we are facing "phenomenal uncertainty". This concerns energy prices, US customs duties and retaliation by other countries, as well as the massive investment projects that will be undertaken in Europe, particularly for defence...
Faced with this volatility, the markets are fairly optimistic, with European equities at an all-time high and US equities only 5% below their mid-February high.
The European economy has the potential to surprise in the medium term. Germany's historic turnaround on fiscal policy and the boost of more than 1pt of GDP in public investment over the next few years should enable the country to finally emerge from stagnation. This is very promising for European risky assets.
But the economic risk remains bearish in the short term, due to the slowdown in the US economy since the start of the year and the risk of an escalation in the trade war. Investment spending in Europe will take time to pick up.
After the sharp rise in the markets since the start of the year, we believe that this justifies a degree of caution in the short term. Above all, we need to be agile and responsive over the coming months.
Our equities positioning is slightly defensive, with a preference for Japanese and emerging equities over US and European equities.
Equities are expensive overall. The valuation of US equities remains close to its highs, while that of European equities has risen well above its historical average. Corporate earnings are well on the way up, but this has already been factored into prices.
Above all, we are particularly selective between sectors, as political and geopolitical changes are encouraging wide dispersion. Chinese equities could provide stability for once.
The fundamentals remain very favourable for corporate debt, given the solidity of corporate finances and monetary easing, which limits the risk of default. And the yields on offer are still attractive.
But changes in economic policy could put some companies in difficulty, which is not really reflected in the average credit premium, which remains historically low.
This leads us to be rather defensive, favouring solid companies and being very selective in terms of sectors.
Interest rates on government bonds have risen sharply in the Eurozone since the announcement of the increases in public investment. This is justified, given that the already high deficits are set to increase by 1pt of GDP over the next few years.
That said, the ECB is continuing to cut interest rates, inflation should continue to fall over the coming months, and the increase in government borrowing requirements should be very gradual at first. Despite the uncertainties, we therefore believe that the level reached by rates is attractive. And government bonds offer protection against negative short-term risks.
Overall, we are overweight sovereign debt, diversifying our exposure between the various European countries and the United States.