Accentuate the positive

Transcription

1 AS S E T AL L O C AT I O N Accentuate the positive Barometer April 2017 Pictet Asset Management Strategy Unit Rising business and consumer confidence supports a broadbased, synchronised global economic recovery which reinforces our pro-equity stance. Table of contents 01 Asset allocation: broad-based growth favours equities 02 Regions and sectors: blue skies with a chance of storms 03 Fixed Income: pockets of relative value 04 Global markets overview: equities recover from Trump disappointment 05 In Brief

2 01 Asset allocation: broad-based growth favours equities The global economy is extending its broad-based, synchronised recovery, supported by surging business and consumer confidence in both developed and emerging markets. This, combined with favourable technical signals and a very slow process of interest rate normalisation, reinforces our bullish stance on equities. We maintain our neutral position on bonds overall, but retain an overweight in US Treasuries as insurance against political upheaval. The French presidential election with the first round due on April 23 has potential to deliver a market-negative, Brexit-like surprise in the shape of a win for the far-right National Front candidate Marine Le Pen. In the US, the failure of Donald Trump s administration to pass legislation to overhaul the healthcare system fanned concerns over his ability to implement his other election pledges to cut taxes and boost infrastructure spending.

3 MONTHLY ASSET ALLOCATION GRID April Pictet Asset Management Business cycle indicators back up our view that a synchronised global economic expansion is taking place. Our proprietary leading indicators are near their December 2013 peak, while the world purchasing managers index (PMI) hit the highest since April Global consumption, which has been the main driver of the recovery, is growing at an annualised 3.3 per cent and has been expanding at a rate above its long-term average for more than three years. Even more encouragingly, global private investment appears to be surging after years of weak growth. Companies feel confident about levels of final demand and they have plenty of cash available to invest. With global capital expenditure on course to grow at a 4-5 per cent yearly clip, accounting for about per cent of global GDP, it could lift global growth rates by as much as 1 percentage point. In the US, some indicators show that consumer and business confidence has been running at all-time highs. However, the rosy view of sentiment indicators is not fully backed up by hard economic data, a phenomenon that is at odds with the historical trend. This opens up the possibility of some disappointment in the US economy in the medium term, especially if inflation remains at a 3 per cent plus annualised rate, which will in turn reduce the spending power of consumers.

4 The euro zone economic recovery remains resilient despite political risks. With growth running at an above-trend rate of per cent, conditions are ripe for the European Central Bank to scale back its bond buying or raise deposit rates as early as the first quarter of Japan s growth momentum is likely to pick up further thanks to strong external demand, an improving labour market and persistent monetary easing by the Bank of Japan. China s economic recovery has been led by improving external demand, with nominal global exports growing at an aboveaverage rate of 12 per cent a year. Industrial profits, meanwhile, are surging at a rate of about 30 per cent as producer price inflation boosts profit margins. Capital outflows have eased, in part because of a recent rise in short-term interbank rates stabilised the yuan currency. Foreign currency reserves rebounded above a key USD3 trillion threshold in February. Rising exports are also supporting other emerging economies, where real economic growth bottomed out in December PRIVATE INVESTMENT PICKING UP World private investment (volume) and new orders* *24 Manufacturing PMIs - new orders components GDP weighted. Source: Pictet Asset Management, BIS, CEIC, Thomson Reuters Datastream Our liquidity indicators remain steady at a neutral level. Major central banks continue to provide ample monetary support, offsetting tighter liquidity conditions in the private sector US commercial and industrial loan growth has fallen in real terms to less than 3 per cent per annum versus 10 per cent a year ago. Looking ahead, however, liquidity conditions are set to tighten towards the second half of 2017 as the US Federal Reserve is likely to raise interest rates again. Central banks in China, the euro zone and the UK are also making hawkish noises. Valuation readings continue to show that US equities are expensive. Various measures, such as stock market capitalisation relative to GDP (now at 132 per cent) and the cyclically-adjusted price-earnings ratio (now at 30), have risen to levels last seen in Among sectors, the industrials remain the most expensive, while telecoms are the cheapest. Equities still remain attractive relative to bonds, even though equity risk premium has narrowed slightly and falling excess liquidity may generate some headwinds. Corporate earnings prospects are also positive as our models suggest global profit growth could easily beat the consensus forecast of 12 per cent this year, for the first time since Historically, equities outperform significantly in years when earnings are upgraded, such as in 1988, and 2010.

5 Our technical signals continue to be positive for equities. Some of the metrics such as the US Investors Intelligence Advisors' sentiment indicator and the ratio of the 12-month forward PE to the VIX index have eased after hitting most bullish levels in 30 years last month.

6 02 Regions and sectors: blue skies with a chance of storms Accelerating export growth, resilient private consumption and signs that private sector investment is rebounding from cyclical lows all underpin our view that the synchronised global economic expansion continues to gain momentum. This optimism, however, comes with a couple of caveats. First, consumer and corporate confidence readings, particularly in the US, are so strong that there is the risk expectations will be disappointed. Unlike other major markets, US corporate earnings forecasts have been on a downtrend (see chart). And second, it would be dangerous to ignore political risks, especially those surrounding the French Presidential election. EXPECTATIONS FOR US CORPORATE EARNINGS FALLING IBES 2017 consensus earnings forecasts for S and P 500, MSCI Emerging, MSCI EMU and MSCI Japan indices. Source: Thomson Reuters Datastream We continue to keep a maximum underweight on US shares. They remain relatively overvalued by 30 per cent on an aggregate basis and by 15 per cent once adjusted for factors such as sector weighting and seem to have priced in plenty of good news, as well as ever rising margins. Even setting aside valuations (which, by some yardsticks, are at their highest since 2000), consumer and corporate sentiment is at a worryingly bullish extreme. These factors suggest the market might not take disappointment well though the Trump effect on US equities shouldn t be overstated, shares are likely to have been driven by global growth more than hopes of what Trump might do for the US corporate sector. Overall, it s worth bearing in mind that analysts have been revising down their earnings forecasts on US corporates for the current year. The European economy looks particularly strong, as even peripherals like Portugal are posting bullish economic data. This good news reinforces our overweight stance on European equities. With Europe lagging the global economic and credit cycle, the region s equities have plenty of catching up to do on margins and earnings.

7 We would be even more positive were it not for the upcoming French presidential election. We think investors have become complacent about the likely outcome and are underestimating the risk that Le Pen could win. Even a good showing by the National Front candidate in the first round of the polls could shake up the markets. India s economic stumble, triggered by last November s demonetisation, is behind some of the deterioration in emerging market leading indicators, but we expect this to be relatively short-lived. Our economists think that the positive differential between emerging market and developed economy growth will widen again over the coming years. This should support EM currencies and it leads us to retain our overweight stance on emerging market shares their gains have been double those of developed market equities so far this year and we expect the segment to remain strong. On price-to-earnings, price-to-book and price-to-sales metrics, EM equities are at a 20 per cent discount to their 10-year averages. At the same time the gap between emerging and developed economy inflation is the lowest in memory, which should reduce the inflation premium investors demand of EM assets. The Bank of Japan, meanwhile, is the only major central bank we don t expect to turn hawkish this year. We expect it to keep buying domestic equities. That, together with a upbeat outlook for Japanese corporate profits and the strong historical correlation of Japanese equities with US bond yields, means that we are sticking to a full overweight on Tokyolisted shares. Among sectors, we remain neutral on industrials, which are expensive and are unlikely to benefit from a Trump infrastructure package anytime soon, given his recent political setback of having failed to repeal Obamacare. Financials, on the other hand, remain an overweight. They benefit from cheap valuations while rising bond yields should help support margins. At the same time, stronger collateral values should keep default rates in check. Technology stocks continue to outperform, driven by solid earnings momentum and product cycle. We see more upside potential as valuation is not abnormally high, with a 12-month PE of 18 times.

8 03 Fixed Income: pockets of relative value Global bonds are still trading at some of the most expensive valuations of the past 20 years. This is particularly worrying given the upbeat outlook for global growth, which has historically displayed a negative correlation with fixed income. A correction seems likely, and there are early signs of it starting in US high yield debt, from which investors have withdrawn USD10 billion over the past three weeks, or 1.9 per cent of net assets. We believe there is more to come, and are taking the opportunity to lock in recent profits by downgrading US high yield to neutral. This view is supported by deteriorating fundamentals, including rising charge-off rates for bad debts on corporate balance sheets and increased leverage levels. A large amount of short term debt has been issued in recent years, which makes the asset class more susceptible to rate rises than has been the case historically. US CREDIT CYCLE MATURING Source: Thomson Reuters Datastream Notably, the yield spread between high yield bonds and US Treasuries continued to tighten throughout the past year, even as leverage climbed to its highest levels in around a decade (see chart). Its risk premium at just 397 basis points above US Treasuries is well below the 10-year average of 583 bps, and a correction now seems warranted. Within corporate credit, we are also neutral on European high yield and emerging corporate debt. Our broadly cautious stance on bonds, however, does not preclude relative value trades. We see one such opportunity in investment grade debt, where US (overweight) looks markedly cheaper than Europe (underweight).

9 The US also offers much better value than Europe in the government debt market. Benchmark 10-year US Treasuries are yielding some 200 bps more than the equivalent German Bunds one of the widest spreads seen since the fall of the Berlin Wall. The valuation gap looks even more difficult to justify given the risk of heightened political uncertainty and market jitters in Europe linked to Brexit negotiations and the French presidential vote. We believe US Treasuries are wellplaced to offer protection in case of electoral success by Le Pen, or indeed disappointment with regards to the implementation of Trump s growth agenda. We therefore retain our overweight stance on US government debt based both on its relative valuation and on its potential to act as a hedge against any potential market turbulence, whether that is caused by political upheaval or an unexpected deterioration in economic conditions. To complement this trade, we are downgrading European government debt and UK gilts to underweight from neutral. Both are flashing red on technical indicators, particularly in terms of seasonality and market breadth. In the foreign exchange, we believe the dollar has peaked, and see solid appreciation potential in the euro, sterling and Swiss franc, with all three helped by attractive valuations. We also see a scope for emerging currencies to rebound in the near term given their strong, six-month lagged correlation with real GDP growth.

10 04 Global markets overview: equities recover from Trump disappointment Equities finished March with a gain of over 1 per cent, recovering from a mid-month sell-off triggered by Trump s defeat over healthcare reform, which raised concerns about whether he could deliver on other campaign pledges, in particular tax cuts. Europe was the biggest gainer in equity markets, rising over 5 per cent in local currency terms and hitting a 16-month high as upbeat corporate results and buoyant merger deals brightened the region's economic prospects and helped investors shrug off Britain s formal triggering of its departure from the European Union. Within sectors, IT stocks were the best performing, while real estate was the only group that fell on the month. US DOLLAR COMING UNDER PRESSURE Source: Thomson Reuters Datastream Disappointment over Trump s healthcare setback briefly pushed the dollar to a 4-1/2 month low against a basket of major currencies. But the US currency finished the month only slightly lower, as it was shored up by expectations that the economy is strong enough to justify two further Fed rate hikes following March's 25 basis points increase. The Mexican peso rose over 6 per cent amid growing optimism that the country may forge a trade deal with the United States. The South African rand was the biggest loser, falling more than 2 per cent in the aftermath of a cabinet reshuffle that included the departure of the country's finance minister. Bonds ended the month slightly higher, with a weaker dollar and strong external demand bolstering emerging local currency debt by more than 2 per cent, making it the best performing segment in the fixed income market.

11 Oil fell nearly 6 per cent after uncertainty grew whether an OPEC-led production cut will be extended beyond June to ease a global supply glut.

12 05 In Brief APRIL 2017 Asset allocation Global economic strength reinforces our overweight stance on equities and neutral view on bonds. Regions and sectors US equities look very expensive. Europe offers better relative value, but this is in part overshadowed by political risk. Fixed Income We take profits on US high yield, but retain overweight on Treasuries as a hedge against potential growth disappointment or political upheaval. Important legal information Past performance is no guarantee of future performance. Performance data does not include commission and fees charged at the time of subscribing to or redeeming shares. NAVs relating to dates on which shares are not issued or redeemed ("non-trading NAVs ) may be published here. They can only be used for statistical performance measurements and calculations or commission calculations and cannot under any circumstances be used as a basis for subscription or redemption orders. International fund management entails investments denominated in different currencies. Changes in the exchange rate may have a negative impact on the value or price of securities. The value of investments may go down as well as up. Investors may not recover their entire initial investment upon selling. Risk factors are listed in the fund's prospectus and it is not the intention to reproduce them in full in this document. Pictet AM 2017 All rights reserved.