monthly strategy report june 2017 - banca · pdf filethe image of louis xvi beheaded by ......

Monthly Strategy Report June 2017

Alejandro Vidal CrespoDirector of Market Strategies

Austerlitz: Empires come and empires go

Monthly Strategy Report. June 2017

Austerlitz: Empires come and empires go

The success of the French Revolution in 1789 had profoundly disrupted the balance of power in Europe, not so much from a strictly military perspective, but from the concept of war itself and its consequences. Whereas under the Ancien Régime, the consequence of battle was a realignment of forces between various closely-related royal families, the emergence of the French Republic gave way to a new scenario in which it faced the need to wipe out a novel political system on the one hand and the absolute need to survive on the other. The image of Louis XVI beheaded by guillotine had sown terror in the masses and now the rules were simply kill or be killed.

The intrinsic mission of the Revolution and the Republic was to expand to the rest of the population, oppressed by masters, who naturally wanted not only to keep the Revolution at bay but sought to eradicate it from France entirely and restore the monarchy. Thus, the scenario shifted from one of more or less tactical alliances devised to place a given relative at the head of a kindred kingdom to one of absolute ideological conflict, an all-against-one scenario to which France had grown accustomed and to which it adapted by way of a very powerful army of devoted soldiers, dogged and competent officers, and generals chosen by merit, when not directly by guillotine-based natural selection. During the rule of Robespierre and the Jacobins, failure was simply not an option, nor was it under the subsequent Directorate. Confronting them were armies of subjects commanded by mediocre, randomly appointed officers and generals.

The situation in 1803 was complex; in 1801 the Peace of Amiens was signed, ending hostilities wherein a Second Coalition (1798-1801) against France and led by the British had been defeated after a promising start, with Napoleon abandoned without a fleet in the shadow of the pyramids in Egypt. But France’s subsequent victories in the battles of Marengo and Hohenlinden definitively handed dominance to Napoleon, who had risen in the ranks to First Consul and de facto ruler after overthrowing the Directorate in the Coup of 18 Brumaire.

The Peace of Amiens imposed harsh conditions on the United Kingdom, including the return of many American colonies to France, and the island of Minorca, my beloved home, to Spain. Minorca had been in the hands of the English, virtually without interruption, since its invasion in 1708. A refusal to evacuate Malta and the French repression of the Haitian Revolution (duly supported by the British) led the United Kingdom to declare war against France in 1803.

The British Prime Minister at the time, William Pitt the Younger, in his second term as head of the government, had made the fight against Revolutionary France his raison d’état by adopting several legislative and non-legislative measures to combat the Republic. England’s policy toward the rest of the European powers was essentially to badger France and Spain in the American colonies by imposing its increasingly evident dominion of the seas and exhausting France on the continent by financing and indirectly participating in all kinds of alliances and armed conflicts. This is precisely what Pitt the Younger did in 1804, when he organised a Third Coalition against Bonaparte, who, in turn, assembled 150,000 men off the coast of the English Channel in a clear threat to the United Kingdom, after crowning himself Emperor before an astonished Pope Pius VII.

England first allied with Sweden, then with Russia and Austria to counter Napoleon, whose plan was to invade the British Isles. In order to keep the English fleet away from the Channel, he devised a complicated plan: he enlisted the Spanish fleet and formed a combined armada that made Lord Nelson believe they were launching an attack in the Caribbean. But the whole house of cards collapsed at Cape Finisterre, and the combined fleet had to seek refuge in Cádiz, only to be defeated later by Nelson at Cape Trafalgar.


Napoleon abandoned his invasion plans and turned his sites toward the continent and combat on land. He quickly mustered the 150,000 troops stationed in Britain and crossed the Rhine to face the Austrian battalions under General Karl Mack, whom he roundly defeated at the Battle of Ulm. After this loss, the Austrian army was savagely pushed eastward by the Grande Armée, which—two months later, in November 1805—took Vienna. Next, Napoleon crossed the Danube where, on the other side, a third emperor awaited, the Russian Tsar Alexander I.

Because the Tsar’s army was still some distance away, Austrian forces withdrew east to present-day Czech Republic to meet its allies. The Tsar appointed a Russian veteran and renowned strategist, General Mijaíl Kutúzov, as head of the combined Russian-Austrian forces. Kutúzov was decisive from the outset, and Napoleon was in a difficult position despite having advanced so much; he was far from home, which made his extended logistical lines an obvious risk. Moreover, the Prussians, who shared the Holy Roman Empire with the Austrians and who had remained on the sidelines, could enter the conflict at any moment, with the massive French army prowling around their backyard. Napoleon was perfectly aware of this and was eager to quash the campaign as swiftly as possible. But Kutúzov did not advance, rather, he continued to retreat toward the east to the Carpathians in an effort to force a negotiation with the French, who could not and should not proceed further.

Napoleon then deployed all of his strategic genius. He advanced 53,000 soldiers to Austerlitz, a strategic position on a hill within the range of 90,000 Russo-Austrian soldiers. In addition, he began to dispatch his generals to the chanceries, giving the impression that the French army was weak and sought a negotiated peace. As a final test, the Austrian Emperor, Francis I, offered Napoleon an armistice, which the Corsican accepted enthusiastically. That same day, Bonaparte again showed ineptitude before an emissary of the Tsar, Count Dolgorouki, and then he proceeded to abandon the hills of Austerlitz, leaving the most strategic enclaves of the battlefield unprotected and displaying tremendous weakness and disorganisation on the right flank, which defended the route back to Vienna, his natural retreat.

But it was all pretence, a simple strategy to lure the enemy into a confrontation. Napoleon had another 20,000 troops within a day’s march to reinforce the supposedly weak right flank, which, moreover, stood among a swarm of streams and lakes, making an attack difficult. Napoleon also planned for his left flank and cavalry to close in on the enemy like a vice if they took the bait and decided to attack on the right.

And that is precisely what happened. The Austrian and Russian generals were persuaded and convinced the Tsar that they had a unique opportunity to destroy the right flank and send Napoleon back to France, if not further. Kutúzov stood alone in his opposition to the plan, and was consequently relieved of his command.

On 2 December 1805, the Allied army took the Pratzen Heights, a strategic position in the centre of the battlefield purposely abandoned by Napoleon, and viciously attacked the French right flank. That flank, already reinforced with the arrival of reserve troops, withstood the onslaught while General Vandamme’s 16,000 bayonets charged furiously to recover the Pratzen Heights, and two divisions of cuirassiers under Marshall Murat (who would become King of Spain in 1808) crushed the combined cavalry of the Tsar and the Prince of Liechtenstein from the left flank. Finding themselves surrounded, the Allies fled haphazardly into the tangle of frozen lakes and rivers. According to chronicles of the event, the French bombarded the ice, shattering it under the feet of the Allies and causing heavy human and material losses to the Russians in the icy waters.

As a result, the Austrians and Russians lost 37% of their men; the French lost only 13%. Peace was reached in Pressburg, ushering in a decade of French domination on the continent. Austria bore the brunt of the agreement, suffering heavy territorial losses and compensations. Napoleon mandated the creation of the Confederation of the Rhine, a political formation of German states under the aegis of


France that would last until 1813, when Napoleon was defeated at Leipzig. Such was Prussia’s opposition to the formation of this confederation that it declared war in 1806.

In Austria, the Emperor’s position of absolute impotence led to the dissolution of the Holy Roman Empire, a supranational union between Austria and Prussia dating from Charlemagne. Unable to maintain the Empire and fearing that Napoleon would impose his reign, Francis I preferred to abolish the title, and thus an Empire that had endured for nearly a millennium passed definitively into history.

Napoleon, meanwhile, returned to France in triumph with hundreds of cannons confiscated from his enemies, which he ordered to be melted down and used to build the Vendôme Column. It is said that his success at the Battle of Austerlitz convinced him of is invincibility and unassailable genius. He would later arrive at Bailén, Leipzig and Waterloo to prove otherwise, paving his way to the islands of Elba and Saint Helena.

Monthly Strategy Report June 2017

Equipo de Estrategia de Mercados de Banca March:

Alejandro Vidal, Unit Director, Market Strategies

Rose Marie Boudeguer, Service Director, Research Services

Pedro Sastre, Service Director, Market Strategies

Sebastián Larraza, Director, Discretionary Management Services

Paulo Gonçalves, Specialist Technician, Research Services

Miriam Ordinas Sanjuán, Specialist Technican, Market Strategies

Joseba Granero, Specialist Technican, Research Services

The positive tone of markets persists


The positive tone of markets persists

Improvement in the business cycle and corporate profits drive markets.

As we approach the middle of the year, the world’s major stock markets continue to exhibit positive results. In macroeconomic terms, the activity data released reaffirms our scenario that global growth is rebounding. Still more positive is the fact that increased economic dynamism has translated into higher corporate profits. At the conclusion of the Q1 corporate earnings season, results were favourable with profit growth of +14.5% among S&P 500 companies and a ratio of positive surprises of 78%—a clear indication that companies have far exceeded previous expectations.

The outcome of the French election means support for the European project…

In light of the good tone in fundamentals, market uncertainty remains concentrated in economic policy. In May, however, we witnessed a shift as uncertainty drifted out of the eurozone toward other regions. One of the reasons for this was the result of the French presidential election: the victory of the independent, pro-European candidate, Emmanuel Macron—who won 66% of the votes versus 33.9% for the extremist candidate, Marine Le Pen—is expected to provide greater stability to the European project in the near future.

…but political uncertainty remains high worldwide: the US and UK are the focus of attention.

In the United Kingdom, as the 8 June elections approach, polls indicate that the current PM, Theresa May, could fail to achieve her objective of strengthening the majority and may even lose seats. Meanwhile, in the United States, the investigation into the current administration’s alleged obstruction of justice—given its ties to Russia—triggers concern about the stability of sitting president, Donald Trump, and could hamper agreements to adopt fiscal stimulus measures and annual budgets.

The data support a scenario of accelerating growth.

With regard to macroeconomics, as we mentioned, the data remain positive, especially in the eurozone. The region maintained steady growth in Q1, with GDP advancing +0.5% q-o-q. Moreover, with rebounding investment and business confidence indicators at historical highs, the composite PMI reached 56.8 in May, its highest level since 2011.

In the United States, activity data was mixed: Q1 GDP grew +1.2% annualised quarterly and some leading indicators of consumer spending curbed their upswings. In Q1, growth also slowed in the United Kingdom, with GDP advancing a mere +0.2% q-o-q.

The euro appreciates as political tensions recede and activity improves.

The most apparent impact of the trends described—receding political tension in the eurozone and improved growth forecasts for the region—on financial assets was the appreciation of the euro in its main crossovers. The currency market was the first barometer of changing expectations, prompting the euro to appreciate +3.1% against the dollar to exceed 1.12 EUR/USD and +3.7% against the pound sterling to 0.87 EUR/GBP.

The extension of production cuts failed to boost oil prices.

On the commodities market, as expected, OPEC and a dozen non-cartel countries, including Russia and Mexico, agreed to extend the curtailment of crude oil production until March 2018. Despite the announcement, the price of a barrel of Brent fell -2.7% in May because this decision


had already been partially taken into consideration.

Easing inflation and…

Bond markets continue to appreciate further. Inflation expectations have slowed their recovery with the stabilisation of energy costs. As an example, in the eurozone, CPI eased to +1.4% y-o-y in May from +1.9% previously, with the core rate dipping to +0.9%.

…a cautious approach from the central banks bolsters bonds.

Serving as additional support for bonds is the cautious approach of the main central banks. In the eurozone, the ECB president confirmed a message of greater optimism about economic growth, but reiterated the fact that because core inflation remains low, the economy still needs an accommodative monetary policy to bring inflation closer to ECB targets. In the United States, the Fed minutes indicate that an additional interest-rate hike may loom in June, but the authority has yet to toughen its discourse and has said it would not begin to reduce the balance sheet in the short term.

In this context, the required yields on public debt declined in May: in the United States, the 10-year bond rate fell -5 b.p. to 2.2% and in Germany to 0.3% (-2 b.p.). Peripheral sovereign debt also performed well and in the case of Spain the required 10-year yield fell -10 b.p. to 1.55%, prompting Spain’s government bond index to gain +0.9% in the month.

Credit market gains accelerated...

On the credit market, the global high-yield corporate bond index posted major gains (+0.95%), while the investment-grade equivalent also appreciated +0.2%. For its part, emerging sovereign debt experienced volatility throughout the month, due to the political crisis in Brazil with the launch of a judicial inquiry into sitting president, Michel Temer, after an entrepreneur placed him at the centre of an alleged bribery scandal. Nevertheless, improved activity data in all emerging economies lessened uncertainty and sovereign debt in local currency closed the month with gains of +2%, while the foreign-currency denominated counterpart gained +0.8%.

…and stocks also performed well.

To conclude with equities, the month was positive overall for global stock markets, though performance was mixed according to region: emerging markets saw the biggest gains with the MSCI Emerging Markets index climbing +2.8%, led by Asia (+4.3%), while Latin America lagged behind given declines in the Brazilian stock market (-5.2% in dollars). Among developed countries, the United States performed better, with the S&P 500 up +1.2%, while the Eurostoxx50 closed unchanged. Domestically, the Ibex35 continued its strong appreciation and rose +1.5% in May.


Strategy for June 2017

ASSET ALLOCATION

Overweighting Neutral Underweight

Shares Cash Bonds

Alternatives

ASSET ALLOCATION

Overweighting Neutral Underweight

EquitiesEurozone Asia

Emerging

Bonds

Emerging debt High-yield corporate debt

Investment-grade corporate debt

Convertible Bonds Sovereign bonds

Alternatives Multi-strategy absolute return Mixed absolute return

Growth accelerates but inflation eases.

Expectations of acceleration in global growth remain intact, but inflation forecasts are easing as energy prices stabilise.

Monetary policy will continue to be more expansionary than expected a few months ago…

In this context, the central banks have reassessed their policies somewhat. According to recent statements, these policies will be more expansionary than expected a few months ago. The Federal Reserve will continue to raise rates, but at a more gradual pace, given that, thus far, leading US economic indicators suggest a growth rate nearer to 2% than the 3% that was estimated after the promise of a substantial fiscal stimulus package from the new US administration. In the eurozone, growth is accelerating, though risks persist—elections in the UK, Brexit negotiations, the possibility of snap elections in Italy—that may increase uncertainty. As such, the ECB has stated that it is necessary to continue stimulating credit to bring inflation closer to target levels and that, for the moment, it has no plans to address the matter of further reducing its bond-buying program or implementing eventual rate hikes.

…which prompts us to make certain changes to the portfolios.

This context of upward growth and easing inflation expectations slightly alters the perception of asset performance in the short and medium term, which leads us to make certain changes to the portfolios.

We have slightly reduced the underweighting of bonds at the expense of monetary assets.

We continue to adhere to the recommendation of overweighting equities, remaining neutral in monetary assets, and underweighting bonds, though we have minimised the underweighting of the latter by increasing exposure to credit at the expense of a slight reduction in monetary assets. The move to reduce liquidity is based on the fact that we do not expect eurozone rate hikes until well into 2018, which will ensure that monetary assets continue to yield near-zero returns.

We continue to recommend investing in short-term bonds…

Along the same lines, short-term rates on the European curve will remain anchored thanks to ECB


policy, and therefore no significant increases in the yields required on debt are expected, which could reduce the value of the bonds, especially those with short-term maturities, with durations of close to two years.

At the same time, we are in a scenario of yield fluctuations within certain ranges on both the European and US curves, which can be used tactically to increase the advantage of active, flexible bond management.

…and increasing exposure to credit risk.

This context of near-potential growth and moderate inflation also favours credit since it allows companies to retain low financing costs and benefit from higher sales and rising profits, which also drives the credit status of companies upward, prompting upward rating revisions and lowering default rates. Though valuations are very demanding, credit adds extra profitability to bond portfolios.

In short, within the fixed income category, there is potential in short-term high-yield credit, emerging debt, convertible bonds and global fixed income managed actively and flexibly.

After an excellent corporate earnings season, equities have begun to move laterally, awaiting a catalyst to drive them upward again.

After an excellent corporate earnings season, equities have moved laterally in recent weeks as positive factors (good macroeconomics, low rates) are weighed against negative factors (very demanding valuations and few indications of a rebound in the US economy that will reinvigorate other regions). In contrast, there is no risk of strong corrections since investors buy after downswings. This implies that stock markets are waiting for a catalyst to drive them upward again, which could come from additional clarity about the US fiscal and trade policy, the stabilisation of China, and a boost in global trade.

Given the uptrend in corporate profits, we remain optimistic about equities.

In light of the uptrend in corporate profits, we remain optimistic about equities despite less attractive valuations. We continue to prefer European stocks, and with regard to emerging markets, the context is positive for Asian, Emerging European, and Latin American shares, despite political uncertainties, such as those in Brazil.

The risks to this scenario are political and geopolitical.

However, politics remains one of the key risks to markets: the delay of US stimulus, difficult Brexit negotiations, and the uncertainty of Italian politics, coupled with geopolitical tensions in the Middle East and the Korean Peninsula, may discourage investors.

The dollar may strengthen as the FED raises rates, but its potential is waning.

On the currency market, the dollar was hit by setbacks in macroeconomic data, the absence of the announced stimulus measures, easing inflation, and expectations of a further rate hike. Nevertheless, as the Fed raises rates, we expect the dollar to return to the 1.05-1.10 EUR/USD range. Although the upside potential is not excessive, we still recommend keeping dollars in the portfolio for diversification purposes.

We expect oil to remain around $50/barrel.

As for oil, we expect prices will remain near $50/barrel of Brent in the short-medium term, a level that generates stability for both exporting countries and consumers.


Equity Indices IBEX35 (3 years)

Euribor Euribor 12 months (3 years)

EUR/USD (3 years)

10 years government yields

Currencies

Government Bonds

Corporate Bonds (1 year spread)

Commodities

Data: Bloomberg


Equity Indices performance (3 years)


Important Remark:

This contents of this document are merely illustrative and do not pretend, are not and cannot be considered under any circumstances as an investment recommendation towards the contracting of financial products.

This document has only been prepared to help the customer make an independent and individual decision but does not intend to replace any type of advice needed for the contracting of such products.

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Consequently, March Gestión de Fondos, S.G.I.I.C., S.A.U. and its customers are not bound by this conditions concerning the final documents to be approved. March Gestión de Fondos, S.G.I.I.C., S.A.U. does not offer any guarantee, expressly or implicitly, in relation with the information shown in this document.

All terms, conditions and prices contained in this document are merely informative and subject to modifications depending on the market circumstances, changes in laws, jurisprudence, administrative procedures or any other issue which may affect them. The customer should be aware that the products mentioned in this document may not be appropriate for his/her specific investment targets, financial situation or risk profile. For this reason the customer must make his/her own decisions by taking into account such circumstances and by obtaining specialized advice in tax, legal, financial, regulatoy, accounting issues or any other type of information required.

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Please note this document has been translated for your information only. In case of any errors or misinterpretations, the Spanish text will always prevail.

monthly strategy report june 2017 - banca · pdf filethe image of louis xvi beheaded by ......

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