EQUITIES

Janet Yellen rebuffs pressure to hike

While agreeing that the case for a rate rise had strengthened, Federal Reserve Chair Janet Yellen braved mountingopposition inside and outside the U.S. central bank and delayed an interest rate increase again to give the economymore room to run.

The decision to stand pat drew dissents from three voting members of the Federal Open Market Committee (FOMC) -the first time that has happened since December 2014.It also comes on the heels of an accusation by Republican Party presidential nominee Donald Trump that Janet Yellenis deliberately keeping rates low to help make President Barack Obama look good in his final year in office.There are also concerns that the Fed’s easy monetary stance is fuelling bubbles in the financial markets.

Not only did the Fed put off a rate increase, it also scaled back the number of hikes it expects next year, to two fromthree, according to the median forecast of FOMC participants. Currently, the median forecast for the Fed funds rate expects50 basis points of rate tightening in 2017 and 75 basis points in both 2018 and 2019. This should enable the Fed to achieve aneutral fed funds rate (2.9%) sometime in 2020.

In the same time, the Bank of Japan’s (BoJ) decided to shift from his “whatever-it-takes” approach of the pastthree-plus years to a steepening of the yield curve (more comments in the Bonds section).

As a result, stocks advance in unison with bonds as Fed and BoJ inspired a global rally. Loose monetary policies inthe U.S., Europe and Asia have helped drive gains in risk assets this year and the latest signals from central bankers suggestthe era of cheap money has further to run. Global equities have risen 2.5% (in euro), while a gauge of bonds is up 5.6% in2016.

The problem is that all the speeches, forecasts, meeting minutes, press conferences and media interviews given

SEPTEMBER 2016

The analysis of Thierry MassetJanet Yellen rebuffs pressure to hikeMarkets held hostage to rateSeasonality is going againstcommoditiesThe peso as U.S. election barometerDebt alarm keeps ringing louder forChinaAn oil gamble that has no precedent

by Fed officials is muddying, not clarifying, the outlook for almost two years. Fed officials have repeatedly complainedthat financial markets are under-pricing the chance of rate increases only to then refrain from raising rates. This is a Fed thatseems to be saying that the only time they are going to raise rates in a meaningful way is when they have no other choice…And when they have no other choice, they are by definition behind the curve (overly easy) if the activity keeps growing (the USeconomy grew at a 2.4% pace last quarter)!

All year bulls have pointed to an element missing from market psychology and said it would prevent a correction:overconfidence. But signs of exuberance have been multiplying in the market, including record high levels of bullishholdings by hedge funds in index futures contracts and unrepresented short positions in VIX futures. In this context, anyunforeseen risks has the potential to send stocks, bonds and currencies into a tailspin.

With MSCI World All-Country profit in the worst decline since 2009, US presidential elections looming and apotential Italian crisis, the list of reasons for the second-longest US bull market to strengthen is getting shorter.While improved economic data helped fuel the S&P 500’s 20% (in euro) rally from a February low, signs of weakness areemerging and we prefer to keep our cautious stance.

We also believe a bond shock remains a key destabilizing risk to markets, particularly if catalysed by a loss ofconfidence in central banks. While there is no immediate danger of a strong global spike in long-term yields amid tepidinflation worldwide, any shift in the Fed, ECB & BoJ’s unprecedented asset-purchase plan would have a ripple effect.

The risk-on sentiment and hunt for yield that prevailed in the past few months, benefiting risk assets was based on abelief that central banks were going to provide more stimulus. But there has been last month, before the meeting of theU.S. and Japanese central banks, a reassessment by the markets about how much more stimulus may beforthcoming. Traders were favouring shorter maturities as central banks on hold were seen as potentiallystoking inflation, which erodes the value of debt maturing decades in the future.There was also another reason those maturities were lagging behind: international central banks are showingreluctance to extend the expansionary monetary policies that drove yields to record lows and stoked demand forlong bonds.As a consequence, the spread between 5-year and 30-year yields has rebounded after contracting in Augustto the narrowest since the first quarter of 2015. It was at 1.17% in the U.S. and 1.04% in Germany, up from as littleas 1.03% and 0.87% in August. The last time the yield curve steepened this quickly, in August 2012, primary dealerswere offloading billions in 30-year bonds to the Fed as part of its debt-buying program.

Investors spent much of 2016 loading up on longer-dated bonds because they yield more than shortermaturities. They were rewarded with gains of almost 20% through the end of August. But now they are left holding thesecurities most vulnerable to a potential selloff on concern central bankers globally are contemplating the limits of theirrecord monetary policy measures.Given the elevated level of cross-asset correlations (equities, credit, currencies and commodities are influencingeach other at a higher rate that any time since the measure was invented in 2008) this situation highlights thedanger of simultaneous selloffs should rates tighten. Massive central bank stimulus with below zero rates andquantitative easing has led to increasingly dysfunctional markets, with even the negative correlation between stocksand bonds breaking down. They are now largely moving in the same direction as markets have become more driven bycentral banks, leaving investors with no place to hide. Everyone is thinking about managing risk through diversification,a little bit in bonds, a little bit in stocks. But if the correlation increases between those two then that risk managementbased on diversification doesn’t help. Because everyone is doing that.

But what’s more troubling is the potential for violent swings in the inter-market relationship that could make itharder for quantitative funds to adjust. Computerized traders whose behaviour is triggered by market signals like volatilityor price trends rather than earnings or the economy have been contending with record fluctuations in cross-assetrelationships. For instance, the correlation between the euro/dollar and the S&P 500 500 index jumped to 75% when the U.K.voted to secede, and has since reversed to -60%, data from JPMorgan showed. The average stock correlation plunged toonly 10% in August after exceeding 70% earlier.

These record swings in the levels of cross-asset correlation illustrate the interconnections among global markets andthe growing impact of central bank policy on prices and point to a high level of macro and political uncertainties whichmakes asset allocation difficult. This large instability of correlations makes it harder to forecast and hedge risk fora multi-asset portfolio and strategies.

The problem for investors is as follows. If they think that government bonds are likely to produce negative returns in future,they should accept that the same will be true of equities at least in the early transition phase. Since equities are more volatile,it is also likely that they will go down by more than bonds. In this context, we keep for the moment our global defensivestance by staying underweight on equities, by increasing our underweight positioning on sovereign bonds and byincreasing our overweight on cash. Holding cash is the best protection against bond and stock markets inflated by recordmonetary stimulus.

1.1 Regional call

1.1.1 Euro-Area: underweight

The “Brexit” vote, the political instability, the earnings contraction and a less effective monetary policy are fuelinguncertainty, complicating decisions for policy makers as well as businesses and investors:

The U.K.’s exit may damage trade and encourage other members to renegotiate their relationship with theEU, signalling scope for further losses in the Euro-Area (seven of the U.K.’s nine biggest trading partners are in theEU).The European Central Bank (ECB) is approaching the limits of its monetary policy, and further expansion of itsasset-purchase program could give rise to legal and financial stability concerns, Governing Council member &president of the Dutch central bank Klaas Knot said. According to him, “the marginal benefit of taking more measures isdiminishing” and quantitative easing leads to “higher risks of undesirable side effects like bubbles, an unhealthy searchfor yield, a rolling over of problematic loans, increasing wealth inequality and an addiction to low interest rates”. Anotherpotential consequence is that governments become less inclined to work on structural reforms and reduce debt, giventhe generosity of monetary policy. “The ball is now clearly in the court of the politicians”, Knot added.ECB’s currency challenge is underlined by Kuroda’s yen whiplash. When the Bank of Japan (BoJ) governorsurprised investors by adopting negative interest rates on January 29, he spurred only a brief drop in the yen. Then,demand for havens surged on concern a slowdown in China will stunt global growth and BOJ’s move itself added to therisk-off mood. Since the ECB announced an extension of its QE we observed counter-intuitively the same pattern withthe euro which is relatively stable against the 10 major currencies.

In this context, investors remain skeptical of the region’s recovery despite central bank stimulus. Analysts areforecasting profit at European companies will be under pressure this year, reversing earlier calls for growth. SinceAugust 2015, earnings per share for companies in the Euro Stoxx 50 index fell 25%.

Despite central banks doing just about everything bar throwing money from helicopters, companies still don'tdeploy cash. Global capex fell about 10% in 2015, according to Standard & Poor's, and could shrink another 4% thisyear. That's driven by the ailing commodities sector. But if energy and materials are excluded capex still shrank 2% lastyear. What's gone wrong? In a world marred by low growth and industrial overcapacity it's hard for companies togenerate a return exceeding their cost of capital and this is clearly slowing investment. Furthermore, the high cost ofequity has other unhappy consequences. Debt-market investors who have had to switch to equities as central banksgobble up bonds are demanding large dividends to hold stocks. This risk-averse class of shareholder penalizescompanies that prioritize long-term investments over cash returns.

Despite increased fears of quantitative easing failure, the cash reward for owning European stocks is about eighttimes larger than for bonds: corporate dividends exceed yields on fixed-income assets by the most ever (14.8%).

With President Mario Draghi signalling that ECB stimulus is here to stay, traders have been flocking to the debtmarket. The average yield for securities on the Bloomberg Eurozone Sovereign Bond index fell to about 0.28%, and morethan $2.5 trillion - or one-third of the bonds - offer negative yields. Shorter-maturity debt for nations including Germany,

France, Italy, Spain and Belgium have touched record, sub-zero levels.

At the same time, concerns of a Chinese slowdown and instability in the banking industry have sent the Euro Stoxx50 index down 22% from its April high last year. That has pushed the dividend yield for members of the gauge to anestimated annual 4%, up from 3.7% at the end of 2015. If you believe that we will avoid a global recession and thatfears about deflation are overdone, there is a lot of attractively-priced assets out there.

1.1.2 Japan: underweight

The more Haruhiko Kuroda does, the more convinced traders become that the yen’s appreciation is out of hiscontrol. The Bank of Japan’s (BoJ) decision, to shift from his “whatever-it-takes” approach of the past three-plus years to asteepening of the yield curve, marked the fifth straight meeting that saw the yen gain by the end of the trading day. The yenslipped as much as 1.1% to a one-week low of 102.79 per dollar soon after the BoJ’s decision, only to recover all thoselosses to end the day higher. The Japanese currency has surged 20% this year, the best performer among 10 majordeveloped peers, set for its biggest annual advance since 2008.

Making its policy menu more complex only led markets to believe the BoJ faces limits.Strategists questioned whether the BoJ can control the so-called yield curve (particularly at the longer endof the curve) as it envisions. Kuroda already faced scepticism that the yield curve strategy is a smoke screen forparing bond purchases. While the BoJ may be able to contain yields from an overshoot and guide them towards zerofor 10-year notes using the new operations, it is unclear how the bank can cope if yields drop to lower levels than thosepolicy makers deem appropriate. The BoJ has only two options - sell long-term government bonds or forgo buying

operations - when doubts about inflation and the economy raise speculation about more BoJ stimulus and push downyields. If the first option is unrealistic, it seems difficult to lift yields just using the second option.

Skepticism about the odds of success for “Abenomics”, Prime Minister Shinzo Abe’s economic revivalprogram, may rise if the BoJ is judged to be struggling with the limits of the aggressiveness that marked the firstyears of Governor Haruhiko Kuroda’s tenure.While Governor Kuroda denied any intention of scaling back the amount of bonds the BoJ buys, or tapering, thecurrency market’s reaction shows traders saw it as a tightening step rather than an easing one. Whether it’stapering or not, aiming to peg 10-year yields around zero means a reduction in bond purchases will become inevitable.Many market players associated more bond buying with a weaker yen, so scrapping that would naturally mean for thema yen buying factor.

However, after a long run of disappointing investors, Haruhiko Kuroda got it right, if the Japanese stock market isany guide. Shares in Tokyo posted last month their biggest gain (+1.6% in euro) since July after the Bank of Japan (BoJ)adjusted its monetary policy, while their year-to-date performance is still negative (-11.7% in yen and +1.5% in euro).

Banks surged as Kuroda’s board refrained from making deeper cuts to negative interest rates. A steeper yield curvewould make lending more profitable for banks.Exporters advanced as the yen weakened.The Topix index outperformed the Nikkei 225 index as the central bank said it was going to buy more exchange-tradedfunds (ETF) tracking the broader gauge. Instead of an overemphasis on larger shares on the Nikkei 225, the BoJ will bebuying ETFs in a more balanced manner that’s in line with market capitalization. The heavy presence of the BoJ in theNikkei 225 has raised concern among some investors. The central bank owned about 62% of Japan’s domestic ETFsat the end of July and is on course to become the No. 1 shareholder of 55 companies in Japan’s Nikkei 225 by the endof 2017.

The equity market looks at it with relief with no further negative deposit rate cuts. But generally the market willtake it as there having been monetary tightening because the yield curve moved up.

1.1.3 Emerging Markets (versus Developed Markets): overweight

It is become all too common to attribute the surge in Emerging Market (EM) assets this year to the cheap cash sloshingaround the world courtesy of central banks. But that is only half the story. Sure, faced with negative debt yields in manydeveloped countries, investors have cast their nets far and wide to bolster returns, often pouring money into thebonds, stocks or currencies of nations mired in recession.

While yields on developing-nation bonds in hard currency have plunged 1.10% since January to 4.35% as investorsscooped up the debt, they’re still well above much of what you get in places such as the U.S., the Eurozone and Japan.There are about $9 trillion worth of bonds with negative yields globally. Investors in hard-currency EM debt have reapedaverage returns of 10% (in euro) this year.Meanwhile, an index of 20 developing nation currencies has jumped 7% in 2016, on pace for the biggest surge in sevenyears.MSCI’s EM stock gauge is up 13.5% (in euro) this year, almost four times as much as the broader MSCI World index ofdeveloped-nation stocks, but that should be seen in the context of the group still down as much as 40% relativesince’11.

Some of the most troubled emerging economies and companies in recent years are actually giving moneymanagers reasons to pile in.

China is now on pace to hit its growth target, while Brazil and Russia are poised to emerge from their slumps.Developing nations have also boosted their foreign reserves by $144 billion to $9.9 trillion after they sank to a three-yearlow in March.The more than 800 companies in MSCI’s Emerging Markets index posted average growth in earnings-per-share of 47%in the latest quarter, while profit for members of the Standard & Poor’s 500 index fell.Companies and households in developing nations are starting to reduce borrowing as a percentage of their economies.Excluding China, the credit-to-gross-domestic-product ratio has dropped to 127%, from 128% at the end of last year,marking the first decline since the global financial crisis. Emerging-market companies in particular are slashing debtlevels that had become increasingly worrisome amid a tumble in currencies in recent years.

Furthermore, EM equities are looking cheap in the long term context.While developing countries are more vulnerable to the threat of policy missteps in times of economic weakness thantheir more advanced counterparts because they lack institutional strength, there equities are cheap in relative term: theprice/book differential between EM and the DM is now 30% below their long-run mean.The earnings yield on the MSCI Emerging Markets index has risen to one of the highest level (1%) since 2014relative to junk bond yields, meaning investors get a bigger return on investment from equities. Analysts’ increasingprojections for company earnings and a rally in higher yielding debt in an era of negative interest rates are behind thedivergence between stocks and bonds.

Lower-than-expected U.S. rates sap the dollar’s strength and reduce the risk that investors will pull money fromless developed economies as they did at the start of the year (they took around $735 billion out of developing countries in2015, the first net capital outflow since 1988). The combined gross domestic product of the so-called BRICS economies —Brazil, Russia, India, China and South Africa — has dropped steadily since the U.S. dollar rally began to take hold. While theDollar index has climbed about 34% between mid-2011 and end 2015, the BRICS nations' year on year growth in GDP fellfrom 7.5% to 4.5%. Since the end of 2015, we observe the opposite phenomenon.

Finally, China seems to have (for now) avert a hard landing scenario. Chinese leaders appear to have stabilized their$10 trillion-plus economy by relying on a tried and true playbook: unleash a torrent of credit to power a borrowing surge andspending splurge.

The flood of money has helped house prices rebound, spurred investment, stabilized markets and buoyed consumers.It also ensured that gross domestic product (GDP) in the second quarter came in at a 6.7% gain from a year earlier,matching expectations and well within the government’s 2016 target of 6.5% to 7%.Yet behind China’s improved GDP performance lurk some long tail risks. Credit growth exploded in the firstquarter, in an economy already awash in debt and industrial overcapacity. The China’s credit-to-gross domesticproduct “gap” (the difference between the credit-to-GDP ratio and its long-term trend) stood at 30.1%, thehighest for the nation in data stretching back to 1995, according to the Basel-based Bank for InternationalSettlements. Readings above 10% signal elevated risks of banking strains. A blow-out in the number can signal thatcredit growth is excessive and a financial bust may be looming.

The borrowing binge spurs questions about sustainability, and may create thornier challenges later unlessPresident Xi Jinping’s government follows through on its goals of restructuring bloated state-owned enterprises andcleaning up a bad-debt encumbered banking sector. Some analysts argue that China will need to recapitalise its banksin coming years because of bad loans that may be higher than the official numbers.

1.1.4 United States: underweight

Little by little, the corporate cushion is shrinking. Pressured by a year-and-a-half of weakening profits and splurges onbuybacks and dividends, the once-towering piles of money at American companies have started to topple. Cash andequivalents slipped to a median $860 million at S&P 500 index members last quarter, touching levels not seen for threeyears, according to data compiled by Bloomberg.

While hardly a portent of mass insolvency, the slippage complicates the balancing act for chief executive officers trying tokeep shareholders appeased while earnings drop. Spending on share repurchases, which inoculated investors from thesputtering economy for seven years, is getting harder just as the Federal Reserve weighs raising interest rates.

At first glance, S&P 500 companies look flush, with cash outside the financial sector at $825 billion at the end of the secondquarter, near the highest of the bull market. The catch is that the money is concentrated in just a sliver of the market:the top 50 richest companies in the benchmark index account for more than half the total. For the other 90%,balances are being reduced at the fastest rate since the start of the bull market. Total cash for that group was $385 billion inthe second quarter, compared with $447 billion at the end of 2015 and down 10% from the year before, on pace with an 11%dip at the end of 2014 that was the biggest since 2009.

Money is getting less abundant across industries as some of the biggest companies see reductions. Cash fell 26% atGoogle parent Alphabet from a year ago, while it dropped 66% at AT&T. The largest losses are in oil companies likeChesapeake Energy, where reserves of $2.1 billion plunged to $4 million over the past year. A handful of tech companies alsosaw their reserves shrink: EBay and NetApp’s cash slid by at least 24%.

The crux of the issue is deteriorating earnings. S&P 500 companies have posted negative growth for six straightquarters, a stretch that’s been exceeded only once since 1936, during the financial crisis. Earnings before interest and taxesat S&P 500 companies totaled $1.1 trillion in the year ended last quarter, the lowest since 2011, according to data compiledby Bloomberg.

Pressure is building at U.S. corporations that have chosen to return money to shareholders instead of spending iton plants and equipment. Investor priorities are shifting: companies with the highest capital expenditures are beating thosewith the most share buybacks in the stock market.

Signs that companies are already growing weary of keeping up current levels of cash outlays are cropping up, with newbuyback announcements down $115 billion since 2015 and dividend growth on pace for the worst year since 2010,according to Barclays. As total buybacks and dividends in the S&P 500 equal about 128% of annual earnings this year, themost on record outside the financial crisis, that slowdown in payouts is a concern. A lack of improvement in earnings will limitdividend growth, and in turn, is likely to slow the ascent of the stock market.

Persistent low interest rates and a lack of clarity from Janet Yellen’s Federal Reserve means U.S. companies arecapitalizing on the same near-zero borrowing costs that fueled the debt boom throughout the bull market. Mediantotal debt in the S&P 500 climbed to $5.43 billion in the second quarter, the highest ever, according to Bloomberg. Borrowingat these incredibly low levels to use that capital elsewhere, even for dividends and buybacks, could be the appropriate thing todo, but there’s a limit to how much companies can take on. Weakening profits could one day halt the binge. Debt at globalcompanies rated by S&P is already reached three times earnings before interest, tax, depreciation and amortization in 2015,the highest in data going back to 2003 and up from 2.8 times last year, according to the ratings company.

In this context, we can understand that the stock market’s message for Fed Chair Janet Yellen is that slow andsteady on interest rates is preferable to fast and furious. History not only backs that up, it also shows the margin ofvictory can be wide. U.S. stocks have gained an average of 11% over a year’s time when the Federal Reserve takes agradual approach to raising lending rates. That compares with a 2.7% average decrease during faster rate cycles. Movingslowly after liftoff would give policy makers time to assess the impact of higher rates on the economy and reduce thechances they would overshoot and raise rates too high. Our economists remain of the view that U.S. policy makers willeffectively neutralize the impact of the December rate increase by signaling a slower pace of tightening in the future: 50 basispoints in 2016 and 50 basis points in 2017.

1.2 Style call

1.1.2 Cyclical versus Defensive: underweight

Global macro surprises, which tend to lead global manufacturing activity (PMI), are too volatile to be consistent witha stable increase in global PMI. In other words, it is difficult to say macro momentum could improve and risk asset price couldpositively react to this upside. Our economists keep their forecast for the global GDP growth below 3% (2.3% in 2016 and2.7% in 2017). That should not help cyclical stocks to reduce their underperformance compared to defensive ones.

While we think that rates should go a little bit up in the medium term and while we know that such a bearish bond environmenthurts defensives equities and bond-like stocks (the direction of the movement in bond yields was in the past a verygood indicator of the relative performance between cyclical and defensive sectors), the outperformance of cyclicalshares doesn’t seem to be yet in the cards.

1.2.2 “Value” stocks (with lowest price/book ratio): overweight (versus “growth” stocks)

“Value over growth” could be an emerging theme. The Federal Reserve’s first rate increase since 2006 (inDecember 2015) shoul contribute to the shift, because the companies in the value-stock category have more to gain froman increase of interest rates. Rising bond yields are supportive of value stocks as there is typically a strong positivecorrelation between the relative performance of value versus growth stocks and the direction of bond yields.

The macro environment is still slightly biased toward Value on the basis that global growth is improving (while onlyslightly) and that bond yields should trend higher over time.

On the long run, value stocks perform better than growth stocks. While it is true that relative performance is reversedduring contractions, the duration of expansionary periods tends to be greater. Therefore, investors can profitably adopt a

passive holding in which, for example, they buy only value.

Growth stocks, which we define as those with the highest price/book value ratio (P/B), are still trading with a valuationpremium to value stocks.

1.2.3 Big capitalisations: overweight (versus small caps) in the U.S. and neutral in Europe

The cycle for big caps relative to small caps could again turn bullish in the U.S. and in the Euro-Area when the riskaversion will increase again on the financial markets as, in this case, there is generally a bias toward the safer side ofequities (or a “flight to liquidity”). The ratio of the S&P 100 index, consisting of 100 of the S&P 500’s largest companies bymarket value, with the small caps (Russell 2000 index) rose to 0.8 from a near record low (0.7) during the past four decades.

A rift is emerging in the U.S. stock market between companies whose sales are expanding and those whose aren’t.Until recently, investors preferred the latter. Revenue at the biggest U.S. companies is in retreat even as prices hover near all-time highs, making large-cap shares the most expensive in more than a decade, measured against sales. The Russell 1000index, which tracks the largest stocks by market value, trades for 1.8 times sales, compared with a ratio of 1.3 in the Russell2000 index of small-caps, the widest gap since 2003.

To be sure, valuations measured by revenue paint a more extreme picture than those tied to earnings. The S&P500 trades at a price/sales ratio of 1.8, about 20% below the peak in 2000, data compiled by Bloomberg and S&P show. Atthe same time, the index’s price/earnings ratio of 20.1 is about 30% lower than the highest level of the dot-com bubble, datashow. Price/sales ratios of large cap companies began to take off in the first quarter of 2014, as the Russell 1000 indexbegan beating its small-cap counterpart for the first time since the start of the bull market. The gauge has climbed 18% (inUSD) since then, compared with a 7% gain in the Russell 2000.

The decline in sales growth hasn’t been as severe for members of the Russell 2000. While the pace of revenuegrowth in small caps peaked in 2014, sales have still risen in each quarter since. With the exception of telecommunicationcompanies, sales growth in small companies has been stronger than those for large-caps in every industry of the stockmarket.

One reason larger stocks have risen recently is due to their ubiquity in exchange-traded funds that make themeasier to purchase for buyers looking to invest large sums of money in U.S. stocks. If you are a global allocator or sovereignwealth fund and you want to move capital to the U.S., you want do it in the most liquid names. Even if small caps have betterfundamentals, small caps will always lose out in that environment.

Part of the valuation gap is also a result of the greater impact weak oil prices have on the large-cap universe:energy companies make up 6.8% of the Russell 1000, compared with 2.4% in the Russell 2000.

1.2.4 Focus on high dividend and dividend growth:

In this cycle, the yield advantage of equities versus credit is larger than in previous cycles and might take longer to normalize,and the search for yield remains strong, especially if dividends go on growing.

Usually credit yields tend to be below dividend and earnings yields as equities provide a claim on future growth and dividendscan grow whereas the coupon will not. But this time the yield of the aggregate Bloomberg Euro investment gradecorporate bond index (0.5%) would have to increase by 3.2% in order to return the average yield of the StoxxEurope 600 index.

We continue to like stocks with high yields that are also growing dividends: they outperform the MSCI World AllCountries index by 2% (in euro) since end 2015. The search for yield theme is a positive only for stocks that can deliversustained high yield. Dividend yields and dividend growth make up the primary return from equities over the longterm:

European equities offer a higher dividend yield (4%) than other equity regions (2.6% in the U.S or 1.9% in Japan).High dividend yielding stocks outperform low dividend yielding stocks and the market over the long term.