![\"graph1-united_states_-_implied_equity_volatility_vix_index_.jpg\"](\"http:\/\/beta.next-finance.net\/wp-content\/uploads\/2015\/09\/graph1-united_states_-_implied_equity_volatility_vix_index_.jpg\")
<\/p>\nThere were bouts of volatility in financial markets this summer: collapse in Chinese
\nequities, depreciation of the yuan dragging down emerging currencies, drastic
\nfluctuations in equity markets in developed countries, collapse in commodity prices, etc.
\nHow can we interpret this turmoil and what is its impact on our asset allocation?<\/p>\n
<\/p>\n
Macroeconomic figures for developed countries were more or less in line with expectations.
\nEurozone growth slowed down slightly in Q2 to 0.3% after 0.4%, but conditions remain
\nextremely favorable for a continuation of the recovery: cheap oil, a weak euro, low real interest
\nrates, constantly improving bank lending conditions. Moreover, in Greece, the parliament voted
\nthe first series of reforms without difficulties, paving the way for the disbursement of the first
\nphase of the European bailout package. In the United States, growth jumped markedly in Q2,
\nestimated at 3.7% at an annualized rate, after the disappointment in Q1.<\/p>\n
Investor concern is focused on emerging countries, where the macroeconomic risks combine
\nwith growing political problems in a vicious circle. In addition to domestic political risks
\n(Malaysia, Brazil) international affairs are at play (Russia, Turkey, Egypt). The impasse in the
\nChinese development model is the main factor behind the slowdown in emerging countries. The
\ngrowth regime based on urbanization is coming up against a number of constraints, be they real
\n(overproduction of housing, industrial overcapacity, bad investments), political (surge in
\ninequalities, corruption) or financial (excessive debt of property developers, heavy industries
\nand local governments) while external competitiveness is suffering from the rapid rise in wages
\nand the appreciation of the yuan in the wake of the dollar. In addition, economic policy has
\nsuddenly seemed muddle-headed and inconsistent, reflected by the authorities\u2019 erratic
\ninterventions in the equity market at the beginning of the crash, or the incomprehensible
\nannouncements made by the central bank, which decreed a virtually free float of the yuan in
\nAugust while resuming its interventions two days later, thereby restoring the status quo ante.
\nAlso, the use of a police crackdown to punish those “responsible” for the equity market crash
\nreminds us of the ideological rigidity that is typical for a regime under pressure.<\/p>\n
![\"graph2-china-manufacturing_pmi_index.jpg\"](\"http:\/\/beta.next-finance.net\/wp-content\/uploads\/2015\/09\/graph2-china-manufacturing_pmi_index.jpg\")
<\/p>\n
Whether or not the Chinese economy has a smooth landing is likely to haunt financial markets
\nfor many months to come. The authorities\u2019 erratic reactions seem to reflect a rare
\nindecisiveness at the highest level of the State, which is easily understandable as there are only
\n\u201cbad\u201d answers to a bursting of an over-investment bubble: stimulating real estate or
\ninfrastructure once again would only create further distortions; devaluing the yuan would
\ndampen consumption and create a dispersal of exchange rates throughout Asia. Meanwhile,
\nscattered half-measures to stimulate the economy (rate cuts, acceleration in existing
\ninfrastructure programs) can be expected to curb the slowdown in the economy without solving
\nthe underlying problem.<\/p>\n
The repercussions are felt worldwide, but have the heaviest impact on suppliers to China, in
\ncapital goods (Japan, Germany, South Korea, etc.) and on commodities, i.e. most emerging
\ncountries (Russia, Brazil, Chile, South Africa, etc.) but also some developed countries (Australia,
\nCanada). Moreover, some emerging countries are also building up monetary imbalances
\n(inflation in Brazil and Turkey, exacerbated by the currency depreciation) and external
\nimbalances (excessive current account deficits in Turkey, South Africa, etc.), which will be
\nexacerbated by the increased cost of imported capital once the Fed hikes its interest rates.<\/p>\n
![\"graph3-commodity_price_in_usd.jpg\"](\"http:\/\/beta.next-finance.net\/wp-content\/uploads\/2015\/09\/graph3-commodity_price_in_usd.jpg\")
<\/p>\n
What should be done? With the exception of Japan, equity markets in developed countries were
\nexpensive, but they have fallen. The Chinese risk should nevertheless continue to weigh on
\nvaluations, which remain fragile in the United States, caught between the Fed and faltering
\nmargins (wages, productivity). The credit market had already reacted to the deterioration in
\ncorporate balance sheets; its message should not be forgotten when analyzing PERs, which are
\ncurrently being boosted by the mechanism of share buybacks with borrowed money ($550bn in
\none year for the S&P 500). Monetary policies are already at full throttle (ECB, BoJ) or at a
\ndangerous turning point (Fed), so the support will hardly come from G7 central banks. Lastly,
\nthe disappearance of the recycling of petrodollars and the liquidation of foreign exchange
\nreserves by emerging central banks are limiting the ability of long-term interest rates to
\ndampen the risk of volatility in equities. The equity risk is therefore becoming more significant
\nand increasingly difficult to hedge through bonds in a diversified portfolio.<\/p>\n
We are therefore continuing our move to reduce risk in our multi-asset portfolios by changing
\nover to neutrality in the equity asset class while keeping a long bias in European and US bonds,
\nat the expense of liquidity. To this end, we are neutralizing our exposures to US and Japanese
\nequities, but we keep an overweight position in Eurozone equities and an underweight position
\nin emerging markets. We also maintain an underweight position in commodities with the
\nexception of gold (neutrality).
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