Will Trumponomics extend or shorten the economic cycle?


Fund Commentary
19 Jan 2017


In December, markets were driven by the two major Central banks meetings, the FOMC and the ECB. In the US, the Fed raised its Fed Funds rate to 0.5%-0.75%. This decision was unanimous for the first time since July and was in response to the strength of the labour market and economic growth.

In addition, the Fed mentioned that inflation expectations have risen “considerably”. In Europe, the ECB extended its QE program until (at least) the end of 2017 but will reduce its asset purchases from 80 to 60 billion EUR per month after March. Sovereign bonds yielding below -0.4% and bonds maturing within two years will be included in the purchase list. This was clearly an increase of the QE (60 x 9 months = 540 billion EUR, instead of 80 x 6 months = 480 expected) but markets did not particularly like the decrease of the monthly purchase amount.

During the month, US economic indicators showed that growth is rising from modest to moderate, employment is still expanding and the housing sector continues to show signs of improvement. On the other hand, consumption indicators were disappointing and the strength of the US Dollar was mentioned as a threat by the Fed in its beige book. The European economy is still improving as consumption, business confidence, consumer confidence and unemployment suggested an improvement in the pace of the recovery. But inflation remains too low.

Following November which was dominated by the outcome of the Presidential election in the US, all eyes were focused on Europe this month. As expected, in Italy, Matteo Renzi lost his referendum and resigned. In France, Mr Hollande decided not to stand again for election as President in May. In terms of rescue plans, the Greek short-term debt relief has been frozen by the Eurogroup Finance Ministers and the ECB announced that the amount of capital needed by Monte dei Paschi to avoid bankruptcy was 8.8 billion EUR instead of 5! Outside Europe, the main event was the OPEC agreement on 30th November to cut output (up to 1.8 million barrels/day), leading to a jump in oil prices from $45 to $55 in December.

In this context, the 2y US Treasury yield increased from 1.11% to 1.19% (+8bps), the 5y yield from 1.84% to 1.93% (+9bps), the 10y from 2.38% to 2.44% (+6bps) and the 30y long bond from 3.03% to 3.07% (+4bps). At the same time, the 30y inflation-linked Treasury yield climbed from 0.92% to 0.99%, leading to a stabilisation of the inflation breakeven rate (from 2.11% to 2.08%) after a huge increase in November due to the reflation arm of Trumponomics. In Europe, Government bonds behaved differently, reflecting the difference in behaviour between the Fed and ECB. The 2y German yield decreased from -0.73% to -0.77% (-4bps), the 5y yield from -0.43% to -0.53% (-10bps) and the 10y Bund from 0.28% to 0.21% (-7bps). At the same time, the Italian 10y yield decreased from 1.99% to 1.81% (-18bps) while the Spanish 10y bond yield declined from 1.55% to 1.38% (-17bps). On the credit side, the European iTraxx Main decreased from 80 to 72bps while the US corporate CDX index decreased from 73 to 68bps. In Emerging Markets, the CDX 10y EM index rallied substantially after the widening experienced in November after Mr Trump’s victory. The Emerging Market spread tightened from 308 to 286bps (-22bps). As the widening had only reached +18bps in November, the EM index finished the year 2016 tighter than on the eve of the Presidential election!


During the month, the Investment Adviser did not modify his strategy which has been in place since October, favouring investments in Floating Rate corporates (non-Financials), i.e. bonds with low duration (between 0 and 0.3) and coupons indexed to the 3 month Euribor. As usual in December, trading activity was lower due to low liquidity. The Portfolio Manager sold KfW 2020, decreased the weight of Nederlandse WaterschapsBank 2019, Terna 2018 and Snam 2019. He also bought 1 million EUR of Bund 2026 at 96.478 and sold it at 97.133 in order to take advantage of the volatility of 10y German yields. The duration was maintained around 2.5. In terms of portfolio diversification, the Fund held 34 issues from 33 different issuers.


As with the Strategic Euro Bond Fund, the Investment Adviser did not modify his strategy during the month, favouring investments in Floating Rate Notes, i.e. bonds with low duration (between 0 and 0.3) and coupons indexed on the 3 month USD Libor (which reached 1% at month end). The weight of Floaters (6.7% on 30th November) climbed above 10% in December. The weight of the following FRN bonds was increased: Ford Motor Credit 2018, Apple 2018, Cisco 2018, Siemens 2018, Exxon Mobil 2018 and Nissan 2019. Regarding the sell-off in the 30y Treasury market, the Investment Adviser had identified a second major stoploss level at 3.13% (after 2.81% in November). Once the yield climbed above this level, he sold the remaining position in 30y bonds at 3.16%. As a result, the position in 30y Treasuries which had already decreased substantially from $8 to $3.5 million in November was totally sold in December. The investments in TIPS (inflation-linked) have been slightly decreased (from $6 to $5.5 million). The proceeds of these sales have been reinvested in short term corporates by increasing the positions in Tesco 2017 and Honda 2018. In addition, due to a weight approaching 5% of the portfolio, positions in Engie 2017, Linde 2018 and Enel 2019 were reduced. Sanofi 2021 was sold due to uncertainties around the purchase of Actelion (initially taken over by Johnson & Johnson) and a possible litigation risk after the Dépakine scandal in France. Finally, the investment Adviser initiated a position in US Treasury 2026 at 2.38% as the evolution of 10y Treasury yields looks more clear than the behaviour of 30y long bonds. The modified duration decreased from 4.8 to 3.8. In terms of portfolio diversification, the Fund held 42 issues from 37 different issuers.


In November, the Investment Adviser sold the remaining position in 30y TIPS and slightly decreased the positions in two Russian issuers, Gazprom and VnesheconomBank as their weight reached 5%. In terms of geographical breakdown, the top 3 countries were Russia (19.2%), Brazil (10.8%) and India (8.2%). The rating allocation was 50.4% Investment Grade and 47.3% Crossover (BB+ and BB). The breakdown of the portfolio in terms of market allocation was 97.7% Emerging Markets and 2.3% cash. In terms of sector allocation, the Investment Adviser favoured Governments (32.7%) followed by Materials (18.3%) and Energy (18.0%). The modified duration increased slightly from 5.8 to 5.9 during the month. In terms of portfolio diversification, the Fund held 35 issues from 35 different issuers. OUTLOOK The Investment Adviser’s global outlook has not changed for the moment. Mr Trump is not a magician and during his 4-year mandate, the US will not avoid a recession or at least a significant slowdown. In terms of growth, the trend will remain broadly the same. Regarding inflation, a significant reflation is, in his opinion unlikely. The Investment Adviser believes that the current behaviour of the US Treasury bond market looks like the Taper tantrum in June 2013. The sell-off in the Treasury market could continue in Q1 2017 but the Treasury yield curve is probably already normalised at the current levels. Regarding Europe, the ECB must maintain its policy (massive QE) as we will see the first real consequences of Brexit within one year (probably Q4 2017 / Q1 2018). Emerging Markets will stay volatile but technical factors such as low net issuance, negative or low yields environment in most Developed Markets, higher commodities and oil prices (OPEC’s behaviour is bullish for Emerging bonds), stabilisation of emerging currencies and a “not-too-hawkish” Fed suggest that the environment will remain supportive for further spread tightening. Any correction would be a buying opportunity.


The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 12/01/17 and are based on internal research and modelling.