Asset Allocation June 2016

02 Jun 2016


  • Growth in developed economies set to converge
  • Bank of Japan does not give in to expectations
  • We prefer US and Japanese equities over Europe
  • Overweight in US credit now closed


At first sight, May was a fairly quiet month for financial markets. Equities, real estate and commodities were practically flat over the month and only gained in euro terms as the common currency weakened versus the US dollar. Bonds lost some ground in US dollar terms, but the slippage was driven more by currency movements than by yields. However, during the month, risky assets first retreated and then recovered briefly before running out of steam. So what were the drivers? Firstly, weak company earnings globally. Secondly, the outlook for US growth and monetary policy and thirdly, the assessment of the risks coming from China. With these themes still well alive, we have remained defensive in our asset allocation. We are underweight equities, emerging market debt in hard currency and commodities. We have shifted some of our duration exposure from broad eurozone government bonds to US Treasuries.

A weak earnings season

Not much had been expected from the first-quarter earnings numbers. So, as usual, most US companies managed to exceed the analysts’ expectations. At 76%, the ‘beat rate’ of companies that released better-thanexpected results was slightly above the rates of the previous five quarters. Even though more companies managed to beat the sales forecasts, this quarter’s rate fell short of the longer-term average. In Europe, where beat numbers have always been lower than in the US, earnings and sales beats were low, even for European standards.

But even in the US, we would not call this a strong earnings season. Earnings fell by 8.3% YoY for S&P500 companies and sales were off by 2.2% YoY. And this was not just due to under-pressure energy companies. Earnings also fell in the basic materials, industrials, utilities, financial and information technology sectors. The sectors geared towards the consumer stood out positively. In Europe, only basic materials, healthcare and telecommunications saw earnings growth. Probably a more important difference between the US and Europe is that the drop in earnings expectations has bottomed out in the US, while it has continued in Europe (and in Japan).
We regard the outlook for corporate profits as challenging. GDP growth and inflation are generally low, which curtails sales growth. Business sales in the US fell by 1.7% YoY in March in nominal terms. Low inflation is a bigger issue in Europe and Japan. In the US, companies are starting to see upward pressure on labour costs: unit labour costs, albeit typically volatile, rose by 4.1% QoQ annualised in the first quarter. This is not just due to rising wages, but also to very weak productivity growth. With margins still relatively high and limited pricing power, rising wage costs are a risk for US corporate earnings
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