Philippe Roset, Head of SPDR ETF's Netherlands at State Street Global Advisors
The last fortnight has featured two items of particular interest: 1) a returned focus on the US Federal Reserve (Fed); and 2) (at last) some market reaction to the impending parliamentary elections in Europe.
Attention to the Fed jumped after President Trump’s speech to Congress on 28 February, which confirmed hopes of boosting fiscal spending and cutting taxes. Whilst there was a distinct lack of specific detail on policies it was enough to drive expectations of higher US GDP and, a rate hike in March, rallying from nearly a 30 percent to around a 90 percent likelihood.
In late February, European sovereign markets started to price in political risk, particularly the possibility of anti-EU candidates winning the elections in the Netherlands, France and perhaps Italy. Investors rushed into short-duration German bunds in a quest for safe, cash-like assets. At the same time, French and Italian bond yields widened against German ones across all durations.
The continued strength of UK equities and gilts belies the increasing chatter on Brexit, which occurred as the Lords voted against the government on plans for Brexit.
Despite political uncertainty, fundamentals for equities and credit generally look positive and a diversified portfolio would appear to be the best approach for investors.
The strongest returns across all sectors came from more defensive areas of the equity market, namely Consumer Staples , Health Care REIT , Telecommunications and Utilities; prompted by increased political uncertainty, despite volatility remaining very low.
Whilst US Financials continue to see inflows, as prospects for US bank deregulation re-establish themselves; on this side of the Atlantic there was a pause for breath, as markets considerthe potential implications of more populist political regimes.
As reflected by moves across the market, defensive styles outperformed. Low volatility shares have been out of favour for nearly six months since becoming highly expensive in the wake of post-Brexit vote turbulence.
The demand for lower risk options has been prompted by heightened European political uncertainty. The popularity of high dividend equities is consistent with this theme, as is the sell-off in smaller companies, often seen as more risky.
Strong US economic data and a more hawkish Fed saw the US Treasury index yield climb 20 bps, pushing performance down last week and putting pressure on fixed income exposures. Corporate bonds performed better — as expected — but the best position was in high yield with a short duration bias. Emerging market debt underperformed but the case for the asset class remains, given that yield-carry can weather a moderate strengthening in 2017.
German bunds sold off in sympathy with US Treasuries, correcting some of the move in French government bond spreads. The skew remains to the downside for French Government Bonds, OATs (Obligations Assimilables du Trésor), though, in the run-up to the presidential elections. Overall, investors would do well to consider an exposure to credit over treasuries.