Societe Generale advised re-distributing equity allocations out of U.S. markets, citing in part an “unpredictable administration, which seems to lack cohesion” as well as upcoming mid-term elections as headwinds to any positive outcomes.
“U.S. equities have already benefited from the one-off increase in expectations due to the effect of the tax reform at two levels — stronger earnings growth (around 8 percent on EPS) and corporate buybacks subsequent to offshore cash repatriation — and should benefit form a weaker U.S. dollar,” the investment bank said in a note last week. “This should hinder — for a little while at least — what we see as an overdue crash that would be justified by high valuations, the unpredictable administration and rapidly increasing twin deficits (already high) in a late-cycle economy.”
But it added, with flat returns expected for the S&P 500 this year, it advised shifting to markets with higher equity risk premiums, which are lower valuations and earlier in the economic cycle, and the prospect of economic reforms. That would be the euro area and Japan, it said.
“We increase our exposure to Japan equities after their ample correction, at the expense of euro area equities,” it said, noting Europe stocks are more vulnerable to currency appreciation.
Use U.S. dollar spikes higher to reallocate?
Societe Generale also advised reducing U.S. dollar exposure, despite a temptation to buy the greenback on expectations the U.S. Federal Reserve would be increasing interest rates.
The bank noted the Fed’s expected moves “should hardly be a surprise,” while at the same time, more policy tightening will be coming in the euro area and Japan over the next two to three years.
“Both the euro and the yen remain cheap,” it said. “Furthermore, twin deficits are growing very fast in the U.S., fertile territory for an attack on what is not yet a cheap currency.”
It also advised getting “portfolio protection” through increased exposure to the yen, while it said it was keeping a high exposure to emerging markets, the ruble and the Norwegian krone.
The bank said it liked the ruble and krone as oil-linked currencies appear attractive as oil should be supported by “global growth resynchronization,” and both these currencies tend to do well when the U.S. dollar is flat or weak, which is Societe Generale’s long-term assumption on the greenback.
Societe Generale said it expected the euro would move closer to its fair value, toward 1.30 against the U.S. dollar by year-end, with the common currency undervalued against the greenback on a purchasing power parity theory.