Asset Allocation Monthly

Transcription

1 For professional investors Asset Allocation Monthly October 2016 Joost van Leenders, CFA, Chief economist, Multi Asset Solutions SUMMARY INVESTMENT CLIMATE Growth improves, but not strong Fed to hike in December, gradual in 2017 Bank of Japan will target 0% ten-year yield Asset allocation: limited upside for oil prices SUMMARY ASSET ALLOCATION Last month we mentioned the risk of two interest-rate rises in the US still to come this year. With the Federal Reserve leaving key rates on hold in September, clearly that risk has faded. While many macroeconomic growth indicators have improved, we expect central bank policy generally to stay highly accommodative for the time being. This should be positive for risky assets, yet on balance, equities barely moved in September. Government bond yields spiked around the middle of the month, but dropped back quickly. We think risky assets now amply discount the improvement in the economic growth outlook. Given the challenging environment for company profits, we have maintained a cautious stance in our asset allocation. Global economy: from weakness back to modest growth Multi-asset Duration Investment grade High yield Emerging market debt Real estate Commodities Sep-16 Oct-16 After the weakness in the first half of the year, macroeconomic indicators have started to improve. Confidence in the manufacturing sector, as shown by manufacturing PMIs, has increased in a range of countries. The global GDP-ed average rose to 51.2 in September, which is not much stronger than in previous months, but the average for emerging markets reached its highest level since February In the eurozone, the Economic Sentiment Index jumped in September, as did the German Ifo index. In the US, the

2 Asset Allocation Monthly October 2 ISM manufacturing index moved back to above 50, the level which separates growth from contraction, after a brief dip to below that level in August. Consumer confidence has improved in the eurozone and Japan. Global trade data has also started to recover from the weakness in the first half Manufacturing PMI (index, GDP-ed) Global Developed economies Emerging markets Source: Markit, BNPP IP We do not expect the global economy to escape from modest growth though since we do not see any drivers for such a positive move. Globally, company profit growth is weak to modest and companies have been reluctant to engage in capital spending. Especially in the US, profit margins have been under pressure from weak productivity growth and rising unit labour costs. The risk is that companies will start rationalising on labour. The eurozone economy has been driven more by consumption in the past year, but with the tailwind of falling oil prices fading, one could have doubts about its sustainability. The unemployment rate has stalled at 10.1% for five straight months. Credit growth is marginally positive, but the risks in the banking sector remain. Massive monetary and fiscal stimulus in China has stabilised the economy, but no more than that. Overcapacity, rising leverage and an unproductive use of capital remain risks for the Chinese economy. In Japan, current growth looks too low to generate any inflation. Bank of Japan: blueprint for others? Despite hawkish comments beforehand, the Fed s policy-setting committee left interest rates unchanged in September. However, no fewer than three dissenters voted in favour of a rate rise and Fed chair Yellen reiterated that the case for higher rates had strengthened. One could wonder what the Fed is waiting for. We think it did not want to surprise the markets after weak macroeconomic data had lowered the marketimplied probability of a rate rise. The lack of consensus on the Federal Open Market Committee was also clear from the individual members forecasts. Three members foresee no rate rise this year, three see rates 50bp higher than the current level and two even expect rates to go 75bp higher. The majority (10 committee members) foresee one 25bp rate rise. So one could see this as a fairly hawkish hold : no rate hike now, but one later this year. However, the downward revisions to expected rates in 2017, 2018 and in the longer run show that the Fed will likely move only very gradually. In September, Bank of Japan governor Kuroda had a new trick up his sleeve. Kuroda had announced a broad reassessment of the BoJ s monetary policy, but had ruled out any scaling back of the central bank s asset purchases or its purchases of foreign bonds. In fact, he had signalled that he was satisfied with what had been achieved so far and blamed low inflation expectations on low oil prices, the strong Japanese yen and the adaptive nature of inflation expectations in Japan. The main issue to address though was the scarcity of government bonds. The BoJ s asset purchase programme is so massive that even with a huge government debt and large deficits, the bank will at some point run out of bonds to buy. By formally keeping the volume of the asset purchase programme at JPY 80 trillion per year, we think the BoJ has effectively moved the policy focus from buying a fixed quantity of bonds to buying bonds at a fixed price, more specifically 10-year bonds whose yields the BoJ has pledged to keep at zero (with some flexibility in the amount of bonds to be purchased) Japan interest rates Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 BoJ call rate 10-year government bond yield This should effectively solve the scarcity issue. If private sector selling put upside pressure on yields, the BoJ could step up its asset purchases. Conversely, it could slow them when yields were drifting lower. Of course, this would make the BoJ s policy potentially highly pro-

3 Asset Allocation Monthly October 3 cyclical. The BoJ also said it aimed to overshoot its 2% inflation target, but that did not impress markets. Japan CPI (% YoY) Headline CPI Core CPI were driven higher by financials on the expectation that the latest BoJ measures could alleviate some of the downward pressure on banks interest margins. The yen actually strengthened right after the decision. In our view, it is relatively easy to step up the promises on inflation, but not backing this up with clear action does not boost one s credibility. Admittedly, keeping 10-year yields at zero in combination with flexibility on the pace of the necessary asset purchases may essentially solve the asset scarcity problem, allowing the BoJ to continue with quantitative easing for longer, but possibly at a slower pace. Will the BoJ s new Quantitative Easing with Yield Curve Control policy be a blueprint for other central banks? It could work in the US, which also has a homogeneous government bond market, or in the UK. But not in the eurozone as the ECB would have to set explicit target yields for (the bonds of) different countries and should be willing to buy (or sell) any amount of bonds per country as required to keep yields at the target. In September, the ECB did not change its asset purchase programme, leaving the scarcity issue on the table. But the assignment to special committees to address a smooth functioning of the asset purchases hints at changes in the future. We expect the selfimposed limits to what the ECB can buy in the markets to be relaxed, so that in December, the bank would be able to announce the extension of the programme beyond March Quiet markets Financial markets have been quiet lately. There was a spike in volatility in the middle of September in the US amid talk of the Fed raising rates in a weak economy. The steepening of yield curves, driven by expectations that central banks were looking for steeper curves to alleviate the pressures on banks, added to the volatility in equity markets by the middle of the month. This all proved to be mild and short-lived though. The warm blanket of monetary policy suppressing bond yields quickly calmed equity markets. However, US equities had a good run earlier this year, even though company earnings have struggled. Thus, the valuations of US equities have deteriorated. Earnings trends in Europe have been even weaker. Meanwhile, there are political risks in the US and the eurozone, but in the latter, they are accompanied by low growth and low inflation as well as lingering risks in the financial sector. In this climate, we have remained cautious towards equities (local currencies, index, 1 January 2016 = 100) 70 Jan-16 Mar-16 May-16 Jul-16 Sep-16 S&P 500 DJ Eurostox Nikkei 225 MSCI EM in $ Bond yields briefly moved higher in the US and Germany by mid-september, but the spike was short-lived. With the Fed expected to raise rates gradually, if at all, the ECB probably extending its asset purchase programme and rate cuts and the re-start of asset purchases by the Bank of England, the upside on yields has been capped. The new BoJ target of 0% for 10-year yields prevented yields from drifting to their July lows. Obviously, the main risk for bonds is that central banks fall behind the curve and have to remove policy accommodation if inflation returns. However, there are hardly any signs of sustainable inflationary pressures in the global economy. Within fixed income, we prefer US Treasuries over eurozone government bonds due to the higher carry in the US and the political risks in the eurozone which could lead to wider spreads on peripheral government bonds. For emerging market bonds in hard currency, we

4 Asset Allocation Monthly October 4 do not think that spreads properly reflect underlying fundamentals, hence our under year government bond yields -0.5 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 US Germany Japan Energy markets were rocked by the intention of some oil-producing countries to cut production. While Brent oil prices jumped by almost 10% in a couple of days to close to USD 50 per barrel, this level is just slightly below the peaks in June and August. Production cuts are no done deal yet. Several countries have recently increased production or are in the process of doing so and Russia, which is not an OPEC member, has yet to cooperate. We think that any deal may be undermined by the reluctance of major producers to give up market share, especially with low oil prices causing governments in many oil-producing countries to struggle to sustain their financial commitments. And of course, higher oil prices could bring US shale producers back to the market more quickly. With a stiff negative carry on this asset class, we have kept our under in commodities. 70 Oil (Brent, USD per parrel) Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16

5 Asset Allocation Monthly October 5 Asset allocation 1 Multi-asset Duration Investment grade High yield Emerging market debt Real estate Commodities Fixed income Euro Govies Euro Short Dated US Govies Investment Grade (EUR) Investment Grade (US) Euro Inflation Linked High Yield (EUR) High Yield (USD) Emerging Bonds USD Emerging Bonds Local Ccy European large caps European small caps US large caps US small caps Japan Emerging markets Real estate European Real Estate US Real Estate Asian Real Estate Foreign exchange AUD CAD CHF DKK EUR GBP HKD JPY NOK NZD SEK SGD USD EM FX KEY Over: Neutral: Under: Increase: No change: Decrease: 1 The tables reflect net positions versus the benchmark within the Multi Asset Solutions strategy model portfolio. Views on a particular asset class should not be seen in isolation but in the context of the overall portfolio. * Duration risk is managed independently of the underlying fixed income allocation using government bond futures.

6 Asset Allocation Monthly October 6 Under Changed. Equity market volatility briefly increased in September after bond yields in the US and the eurozone spiked. This shows where the risks for equities lie: stretched valuations, driven higher by low yields and high earnings expectations. Company earnings may disappoint in the current environment of low growth and low inflation. Even with slightly higher inflation in the US, margins have come under pressure as labour costs rise faster than productivity. A further concern for us are the political risks in the eurozone and the US. We have hedged our under through attractively valued out-of-the-money call options on the US S&P500. Small-cap equities: Over Unchanged. Fundamental factors such as relative valuations, the US economic cycle and the earnings outlook are neutral in our view, although the earnings outlook has improved from a couple of months ago. We are over as we believe that large amounts of cash on bigger companies balance sheets and a generally low appetite for capital expenditure will drive mergers and acquisitions, which in turn should support small-cap stocks. We also see this over as positive exposure to market risk and thus as a partial hedge against our generally cautious asset allocation. Government bonds: Neutral duration Unchanged. Our overall duration exposure is neutral since we see upside risks for yields coming from (eventually tighter) US monetary policy. Global growth and inflation, while modest, also warrant higher yields, but asset purchases by the ECB and the Bank of Japan are providing powerful counters. We expect higher total returns in the US due to higher carry and a steeper yield curve. European political risks should primarily affect selected peripheral government bond markets. Investment-grade corporate bonds: Neutral Unchanged. We view the macroeconomic fundamentals as generally positive for this asset class. Defaults are low, credit conditions continue to improve and yields remain historically low in general. In the eurozone, we think the carry is too low to justify an over position. With the ECB for now hesitating to provide additional stimulus, risk spreads have widened in the eurozone. Further widening is a risk going forward. High-yield bonds Neutral Unchanged. Up to early September, spreads narrowed after the spike in the wake of the EU membership referendum in the UK, even though some fundamental factors have deteriorated marginally: rating downgrades have recently outnumbered upgrades and default rates have risen. Spreads diverged in the US and Europe as the European credit market suffered from the ECB s hesitance to provide more stimulus. We think yields are currently too low to compensate for the risks of an over position. Emerging market bonds Under Unchanged. Emerging market growth indicators have hardly picked up and political changes and reforms are making little progress. The rebound in commodity prices has been supportive, but we are concerned that this may have come too early and is overdone. Our crossasset valuation tools indicate that emerging equities and currencies discount more negativity than bonds. Given the upward momentum in currencies, we prefer to be under in hard currency debt versus US Treasuries.

7 Asset Allocation Monthly October 7 Real estate securities: Neutral Unchanged. We are seeing positive real estate fundamentals such as attractive dividend yields, positive supply factors and low funding costs, but high valuations and interest-rate volatility are risks. Commodities Under Unchanged. The OPEC announcement that the cartel wants to cut production sent oil prices higher. But given that several of the main producers have recently increased production or are in the process of doing so and in view of the incentive for governments to keep up production to plug fiscal deficits, we are sceptical that there will be an actual agreement. Moreover, non-opec member Russia has yet to cooperate and US shale producers could come back to the market if prices rise further. The negative carry further limits the attractiveness of the asset class, in our view.

8 Asset Allocation Monthly October 8 Disclaimer This material is issued and has been prepared by BNP Paribas Asset Management S.A.S. ( BNPP AM )* a member of BNP Paribas Investment Partners (BNPP IP) **. This material is produced for information purposes only and does not constitute: 1. An offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. Any investment advice. Opinions included in this material constitute the judgment of BNPP AM at the time specified and may be subject to change without notice. BNPP AM is not obliged to update or alter the information or opinions contained within this material. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the Financial Instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for a client or prospective client s investment portfolio. Given the economic and market risks, there can be no assurance that any investment strategy or strategies mentioned herein will achieve its/their investment objectives. Returns may be affected by, amongst other things, investment strategies or objectives of the Financial Instrument(s) and material market and economic conditions, including interest rates, market terms and general market conditions. The different strategies applied to the Financial Instruments may have a significant effect on the results portrayed in this material. The value of an investment account may decline as well as rise. Investors may not get back the amount they originally invested. The performance data, as applicable, reflected in this material, do not take into account the commissions, costs incurred on the issue and redemption and taxes. *BNPP AM is an investment manager registered with the Autorité des marchés financiers in France under number 96002, a simplified joint stock company with a capital of 67,373,920 euros with its registered office at 1, boulevard Haussmann Paris, France, RCS Paris ** BNP Paribas Investment Partners is the global brand name of the BNP Paribas group s asset management services. The individual asset management entities within BNP Paribas Investment Partners if specified herein, are specified for information only and do not necessarily carry on business in your jurisdiction. For further information, please contact your locally licensed Investment Partner.