Draghinomics

Still the ECB surprised positively and especially the currency responded strongly to the further increase in “easiness” of the policy stance. The details of the rate cut and asset purchasing program have been discussed previously in the economics part, but probably most important for markets was that words (by Draghi) were followed by action (of the ECB).

Key is that this reflects an ongoing “whatever it takes”- mentality at the leadership of the ECB that keeps both the cyclical recovery and sovereign QE hopes alive.

Moreover, it inspires daydreaming about a European version of the Japanese regime shift in policy setting that took place late 2012, known as Abenomics (after then elected Japanese Prime Minister Abe), that could create an even more significant asset price reflation in Europe than seen since the peak of the Euro crisis.

The inspiring speech that Draghi gave in Jackson Hole did indeed hint at a more wide-ranging shift in the European policy agenda. He not only emphasised that eroding inflation expectations justify further policy easing, but also pressed for the need of a more comprehensive policy impulse and effective reform package that balances near-term demand support (both fiscal and monetary) and enhancement of the economy’s long-term growth potential.

By further emphasising that the risk of doing too little currently outweighs the risk of doing too much, both the urgency and composition of the message from the ECB President sounds remarkably similar to that of Japanese Prime Minister Abe. However, whether Draghinomics will make a similar impact on European asset prices as Abenomics did on asset prices in Japan remains to be seen. Draghi’s progressive thinking is certainly off to a reasonable start in terms of market impact, as bond yields and the Euro are lower and equity prices are up in recent weeks.

Still, it should not be overlooked that the size of the moves seen so far remains far smaller than what was seen in Japan after the start of Abenomics.

For example, the Euro is only down 4% in trade-weighted terms from its peak for the year, while the Japanese Yen dropped around 25% as a result of the shift in policy settings in 2013. It remains early days, however, to judge the impact Draghinomics as it took 4-5 months in Japan to generate the full impact on bond, equity and currency prices.

The political hurdles for some of Draghi’s ideas remain formidable so a repeat of the Japan experience in Europe still seems a stretch, but further steps on a more cautious reflation path cannot be excluded.

The implications for our asset allocation stance are currently mainly regionally of nature (closing our underweight in European equities, staying overweight in European credits), but if the impact of Draghinomics where to grow so will its impact on our allocation stance. It is not yet a reason to increase our overall risk-on stance, but has contributed to eliminating the concerns we had on disappointing growth numbers in Europe as a potential driver of future risk aversion amongst investors (and yes, the better German and French data releases also helped here). If further traction in especially the currency market becomes visible, a renewed increase in risky asset exposure will certainly be considered.

Fixed Income

We are neutral on fixed income spread products. Visibility on the economic recovery has improved and emerging market tail risks have faded (although not disappeared). Also, in an environment of easy monetary policy stances and low return expectations, the search for yield remains an important driver of investor flows. However, technical factors are now less positive and liquidity and gap risk have increased recently.

Within fixed income spread products, we closed the underweight high yield. High Yield’s relative valuation and momentum have improved after the sell-off while flows have returned. Liquidity within high yield nevertheless remains a concern. Euro Investment Grade Credits are neutral.

We are neutral EMD HC and upgraded EMD local rates to overweight. Investor flows returned to EMD as did momentum in local bonds. Search for yield and reform potential (Indonesia, Brasil) may provide further support. We keep Eurozone Peripherals at a medium overweight as further ECB action is increasingly likely and underlying fundamental improvement is expected.

Equities

Equities are a medium overweight. A moderate cyclical sector allocation remains in place as we believe much of the data disappointment is weather-related and expect a growth re-acceleration in the second half. We prefer Financials, Discretionary, Energy and Materials. Elsewhere, the stable growth sectors remain underweight as they are still too popular and expensive. Earnings are also providing welcome support both in the US as well as in Europe.

After the ECB measures we upgraded Europe from a medium underweight to neutral. The monetary policy cycle and the earnings cycle may offer support for European equities. However, we continue to prefer the non-European markets.

Regionally we prefer Japan. The country remains attractive due to lowered expectations, high earnings growth, attractive valuations and investor positioning. US is a small overweight following better than expected earnings and improving economic surprise indicators. Finally, we upgraded emerging markets on fading cyclical risks for the region, attractive valuations and strong flow momentum. At the same time lingering growth and system risks in China remain an important risk factor.

Real Estate

Real estate was reduced from a strong to a medium overweight. Globally, fundamentals remain firm almost everywhere in DM space and non-residential real estate starts to pick up in the light of a better economic outlook. The recovery started in the US but today also the UK, Germany, Japan and, more recently, other parts of core and peripheral Europe are improving in terms of house prices, home sales and unemployment dynamics. Chinese real estate on the other hand sees his prospects deteriorating.

Commodities

Commodities are on a small overweight. Global cyclical indicators and some improvement in selective Chinese data provide support. Meanwhile, El Nino probability has come down but could flare up again and some supply side squeezes in (non-US) agri and metals components might arise on the back of this. Also, geopolitical risks remain omnipresent while non-commercial positioning in key segments (Energy, Agriculture) came down substantially. At the same time, uncertainty with respect to the outlook for both growth and stability of the financial system in China offers a potential headwind for commodities.