Key takeaways
• 2017 - Reflation, Reversal, Rotation, Relief or Revolt. EPS to turn +ve but politics to remain a valuation overhang in H1.
• Defensive vs Cyclical rotation at extreme levels. More balanced approach needed but look for another leg to cyclical trades.
• O/w Media as quality cyclical and Oil. Stay cautious on UK domestic (Retail, Travel). Health, Utilities over Food & Bev.
2017 – A year of cross currents, nimble investors required
Recovery (positive but moderate in our view) and Rotation go hand in hand - we think
that the pace of the rotation has to moderate. ECB reversal on QE is a risk and tapering
because the ability or willingness to do QE fades would likely cause a setback. Investors
will demand a premium for political risk until we get clarity on populist Revolt or policy
Relief in France and elsewhere. Like 2016 investors will need to trade the ranges.
High single digit upside - politics likely to weigh near term
A valuation overhang remains in Europe vs other DM. We see a return to positive EPS
growth (+7%) in Europe for the first time since 2014, driven by higher global GDP
growth Resources recovery, capex discipline and FX. +7% growth implies less
downgrades than usual (10% is the average). Base case upside in high single digits (c9%
total return) but politics may mean market highs are more likely achieved in H2.
Modestly higher yields and higher equities compatible
Equities can continue to perform with rising rates – the key is that inflation breakevens
are not falling. However, a more aggressive bond sell-off taking Treasury yields to 3% or
higher would undermine EM, the growth outlook, peripheral spreads and risky assets.
Reflation rotation stretched – refining our approach
Rotation has been extreme (>6SD move in Def vs Cyclicals). Argues for a moderation in
returns and a more balanced approach to sector allocation. Look for another leg to
cyclical trades in the New Year. Sector valuations have also moved a long way already.
Cautious on domestic UK exposure – Brexit still to bite
The full impact of sterling weakness on the UK consumer environment is yet to be felt
and Brexit negotiations are likely to drive further uncertainty and FX volatility. Structural
issues add to our concerns in Retail and Travel & Leisure (both underweight).
O/w Oil, Health, Utilities, Media; u/w Food & Beverage
An OPEC cut and higher oil would make Oil’s high DY sustainable. Healthcare is too
cheap vs an improving sector growth outlook and 2017 is a key year for pipeline news.
Food & Beverage still seems the least attractive Defensive on valuation, positioning. We
move overweight Media, a quality cyclical that has lagged and seen valuations de-rate.