Staying Risk On in a Low Volatility Regime

Transcription

1 2018 Global Market Outlook Step Forward, Look Both Ways Portfolio Positioning Staying Risk On in a Low Volatility Regime Lorne Johnson, Ph.D. Senior Portfolio Manager, Investment Solutions Group Overall RiskOn Positioning Backdrop for growth assets remains favorable as economic expansion likely to strengthen around the world Overweight Global Equities Largest exposure to developed markets outside the US where valuations look most favorable Selective in Fixed Income Underweight intermediate US bonds and nonus government bonds, where higher yields bring weaker performance

2 In 2018, the fundamental backdrop for growth assets remains favorable, as we expect economic expansion to strengthen around the world. So we are keeping our general riskon positioning in multiasset portfolios, maintaining a balanced overweight to equities going into the new year. It might be difficult, however, to replicate 2017 s serendipitous combination of growth surprising to the upside and inflation surprising to the downside, which proved to be a tonic for healthy earnings gains and only moderate monetary policy tightening. With the MSCI ACWI Index up 15.4% through the third quarter of 2017, and all major developed and emerging market regions posting doubledigit gains, such broadbased equity returns may be hard to repeat. 2

3 Figure 1 Asset Class Performance through Q Percent Trailing 12 Month YTD Prior Month 3.5 US Corporate High Yield US Treasury Index Commodities Index Source: Bloomberg Finance, L.P. As of September 29, Past Performance is not a guarantee of future results. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect capital gains and losses, income, and the reinvestment of dividends. Performance returns for periods of less than one year are not annualized. Performance is calculated in USD. You cannot invest directly in an index. Also notable was the collapse in both realized and implied volatility in US equity markets to 24year lows in July 2017 (see Figure 2). Despite ongoing geopolitical uncertainty, this complacency could be chalked up to a number of factors, including robust growth in corporate earnings aided by a weakening US dollar and the absence of any material policy mistakes that might upset markets. Figure 2 Volatility Seasonality Percent Debt ceiling debate and Fed balance sheet talk may put the current low volatility market to a test. VIX Index in Year Average If the VIX to reverts to its 10year average that would imply an increase of more than 100% from its current level. Source: 10Year Average is the daily average from 2007 to Bloomberg Finance, L.P. As of September 29, Past performance is not a guarantee of future results. 3

4 Current Positioning in MultiAsset Portfolios Overweight growth assets with a preference for diversified exposure to global equities that is set to continue to benefit from the synchronized worldwide recovery of earnings growth. Favorable growth environment also gives cover to central banks to gradually tighten policy, which would result in higher bond yields and weak performance in global government bonds, particularly those with intermediate maturities. With implied equity volatility at multidecade lows and credit spreads close to cycle lows at the close of 2017, chances are good we will see realized volatility rise on average during However, this does not materially alter our favorable view on growth asset exposures to start the year. Signs of economic recession the largest risk to global equity markets are almost nowhere in sight. In the US, fiscal policy should be no worse than neutral on growth and may have some upside as disaster recovery funds are deployed and corporatefriendly tax reform gets a serious hearing. Equity Overweight a diversified basket of global equities, with the largest overweight positions in developed markets outside the US where valuations look most favorable. Smaller overweight positions in US large caps and emerging market equities. Our 2018 global equity forecasts call for modest positive returns of 4.1% for US largecap equities, 4.7% for developed markets outside the US and 5.8% for emerging markets. Our positioning relative to fixed income is consistent with these outcomes, and we could see further upside if earnings growth strength continues as we are anticipating. US equities would also benefit if the lack of legislative milestones on a probusiness and investment agenda in 2017 gives way to some forward progress in And we hold a slightly smaller overweight to emerging markets given their outsized gains in 2017 and greater vulnerability to any tightening in global financial conditions. 4

5 Fixed Income Underweight intermediate US bonds and global government bonds outside the US. Slight overweight to long duration fixed income. Slight underweight to highyield credit. Though the longawaited selloff in sovereign bonds never came to pass in 2017, and yields on 10year US Treasuries dropped 60 basis points from March to August on a swoon in realized and expected inflation, we still expect a firming in inflation expectations consistent with renewed strength in the global economic cycle. And with monetary policymakers such as the European Central Bank (ECB) gingerly winding down stimulus programs and others like the US Federal Reserve (Fed) actively raising shortterm interest rates in 2018, we anticipate a move higher in yields with scope for further curve flattening in 2018 as demand for duration remains strong and yield movements will be greater at the front end where central banks have more direct influence (see Figure 3). Our credit positioning reflects that with spreads near cycle lows, we see limited upside from continued spread tightening and asymmetric downside to spread widening as the business cycle matures and financial conditions gradually tighten. Figure 3 Global Bond Market Perspective Yield to Worst (%) or Duration (Years) Credit Spread (%) Yield to Worst, lhs Duration, lhs Credit Spread Over Treasuries, rhs US Aggregate Bond Index (Agg) 20yr Average Yield = 4.2% Global Aggregate Government Index Global Aggregate Index US Treasury Index Global Aggregate Credit Index US Aggregate Index US MBS Index US Credit Index EM USD Aggregate Index US Corporate High Yield Index Source: Bloomberg Finance, L.P., as of September 29, year average yield from 4th quarter 1997 to 3rd quarter Past performance is not a guarantee of future results. 5

6 Model Portfolio Figure 4 US Model Portfolio Tactical Position vs Benchmark Illustrative purposes only as of November 8, 2017 Tactical position Benchmark World Government ex US 6

7 Glossary Commodities Index A rolling commodities index composed of futures contracts on 19 physical commodities traded on US exchanges. The index serves as a liquid and diversified benchmark for the commodities' asset class. Emerging Markets (EM) USD Aggregate Index The index is a hard currency emerging markets debt benchmark that includes US dollardenominated debt from sovereign, quasisovereign, and corporate issuers in the developing markets. Global Aggregate Index A benchmark that provides a broadbased measure of the global investmentgrade fixed income markets. The three major components of this index are the US Aggregate, the PanEuropean Aggregate, and the AsianPacific Aggregate Indices. The index also includes Eurodollar and EuroYen corporate bonds, Canadian government, agency and corporate securities, and USD investmentgrade 144A securities. Global Aggregate Credit Index A benchmark that covers the global investment grade and highyield fixed income markets. Global Aggregate Government Index Represents primarily government bonds within the Global Aggregate Index. US Aggregate Index A benchmark that provides a measure of the performance of the US dollar denominated investment grade bond market, which includes investment grade government bonds, investment grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities that are publicly for sale in the US. US Credit Index An index designed to measure the investment grade, US dollar denominated, fixedrate, taxable corporate and governmentrelated bond markets. It is composed of the US Corporate Index and a noncorporate component that includes nonus agencies, sovereigns, supranationals and local author. US Corporate High Yield Index The index consists of fixed rate, high yield, USDdenominated, taxable securities issued by US corporate issuers. US Mortgage Backed Securities (MBS) Index Measures the performance of investment grade fixedrate mortgage backed passthrough securities of GNMA, FNMA and FHLMC. US Treasury Index A rulesbased, marketvalue weighted index engineered to measure the performance and characteristics of fixed rate coupon US Treasuries which have a maturity greater than 12 months. To be included in the index a security must have a minimum par amount of 1,000MM. Chicago Board Options Exchange (CBOE) Volatility Index (VIX) An index constructed using the implied volatilities of a range of S&P 500 options to forecast 30day volatility. Gold Spot The price quoted for gold for immediate delivery on the spot market. Implied Volatility A measure of the market s estimate of the future volatility of the price of an asset. MSCI EAFE Index Designed to represent the performance of large and midcap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the US and Canada. The Index is available for a number of regions, market segments/sizes and covers approximately 85% of the free floatadjusted market capitalization in each of the 21 countries. MSCI Emerging Markets (EM) Index A free floatadjusted market capitalization index designed to measure equity market performance in 23 global emerging market economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and the United Arab Emirates. MSCI All Country World Index (ACWI) A free floatadjusted market capitalization index that is designed to measure equity market performance in the global developed and emerging markets. Realized Volatility A measure of the historical volatility of the price of an asset. Russell 2000 Index An index comprised of the smallest 2000 companies in the Russell 3000 Index, representing approximately 8% of the Russell 3000 total market capitalization. S&P 500 Index A market value weighted index of 500 stocks that reflects the performance of a large cap universe made up of companies selected by economists; the S&P 500 is one of the common benchmarks for the US stock market, and investment products based on the S&P 500 include index funds and exchangetraded funds. YieldtoWorst A measure of the lowest possible yield that a bond would earn based on the terms of its indenture. 7

8 State Street Global Advisors Worldwide Entities ssga.com Australia, Australia, Limited (ABN ) is the holder of an Australian Financial Services Licence (AFSL Number ). Registered office: Level 17, 420 George Street, Sydney, NSW 2000, Australia. T: Belgium Belgium, Chaussée de La Hulpe 120, 1000 Brussels, Belgium. T: , SSGA Belgium is a branch office of Limited. Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Canada, Ltd., 770 Sherbrooke Street West, Suite 1200 Montreal, Quebec, H3A 1G1, T: and 30 Adelaide Street East Suite 500, Toronto, Ontario M5C 3G6. T: Dubai State Street Bank and Trust Company (Representative Office), Boulevard Plaza 1, 17th Floor, Office 1703 Near Dubai Mall & Burj Khalifa, P.O Box 26838, Dubai, United Arab Emirates. T: +971 (0) , France Ireland Limited, Paris branch is a branch of Ireland Limited, registered in Ireland with company number , authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson s Quay, Dublin 2. Ireland Limited, Paris Branch, is registered in France with company number RCS Nanterre and whose office is at Immeuble Défense Plaza, 2325 rue DelarivièreLefoullon, Paris La Défense Cedex, France. T: (+33) Germany GmbH, Brienner Strasse 59, D80333 Munich. Authorised and regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht ("BaFin"). Registered with the Register of Commerce Munich HRB T: +49 (0) Hong Kong Asia Limited, 68/F, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. T: Japan (Japan) Co., Ltd., Toranomon Hills Mori Tower 25F 1231 Toranomon, Minatoku, Tokyo Japan, T: Financial Instruments Business Operator, Kanto Local Financial Bureau (Kinsho #345), Membership: Japan Investment Advisers Association, The Investment Trust Association, Japan, Japan Securities Dealers' Association Ireland Ireland Limited is regulated by the Central Bank of Ireland. Registered office address 78 Sir John Rogerson's Quay, Dublin 2. Registered number T: +353 (0) Italy Limited, Milan Branch (Sede Secondaria di Milano) is a branch of State Street Global Advisors Limited, a company registered in the UK, authorised and regulated by the Financial Conduct Authority (FCA ), with a capital of GBP 62,350,000, and whose registered office is at 20 Churchill Place, London E14 5HJ. State Street Global Advisors Limited, Milan Branch (Sede Secondaria di Milano), is registered in Italy with company number R.E.A and VAT number and whose office is at Via dei Bossi, Milano, Italy T: Netherlands Netherlands, Apollo Building, 7th floor Herikerbergweg CN Amsterdam, Netherlands. T:: SSGA Netherlands is a branch office of State Street Global Advisors Limited. State Street Global Advisors Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom Singapore Singapore Limited, 168, Robinson Road, #3301 Capital Tower, Singapore (Company Reg. No: D, regulated by the Monetary Authority of Singapore) T: Switzerland AG, Beethovenstr. 19, CH8027 Zurich. Authorised and regulated by the Eidgenössische Finanzmarktaufsicht ("FINMA"). Registered with the Register of Commerce Zurich CHE T: +41 (0) United Kingdom Limited. Authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No VAT No Registered office: 20 Churchill Place, Canary Wharf, London, E14 5HJ. T: United States, One Lincoln Street, Boston, MA

9 Disclosure For use in Australia Issued by, Australia, Limited (AFSL Number , ABN ) ( SSGA Australia ). Registered office: Level 17, 420 George Street, Sydney, NSW 2000, Australia T: Web: ssga.com. The information provided herein does not constitute investment advice and is not a solicitation. It does not take into account any investor's particular investment objectives, risk tolerance, or financial and tax status. You should consult your tax and financial advisor. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information. This communication is directed at institutional and wholesale clients only. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) are not entitled to rely on this communication. For use in EMEA The information contained in this communication is not a research recommendation or investment research and is classified as a Marketing Communication in accordance with the European Communities (Markets in Financial Instruments) Regulations This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research. The information provided does not constitute investment advice as such term is defined under the Markets in Financial Instruments Directive (2004/39/EC) and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into account any investor's or potential investor s particular investment objectives, strategies, tax status, risk appetite or investment horizon. This communication is directed at professional clients (this includes eligible counterparties) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication. For use in Switzerland The information provided does not constitute investment advice as such term is defined under applicable Swiss regulation and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into account any investor's or potential investor s particular investment objectives, strategies, tax status, risk appetite or investment horizon. If you require investment advice you should consult your tax and financial or other professional advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information. This communication is directed at qualified investors (as defined by FINMA) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication. Investing involves risk including the risk of loss of principal. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA's express written consent. The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information. The views expressed in this material are the views of Lorne Johnson noted as of 15 November 2017 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forwardlooking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Equity securities are volatile and can decline significantly in response to broad market and economic conditions. Bonds generally present less shortterm risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longerterm securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Diversification does not ensure a profit or guarantee against loss. The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data. CFA is a trademark of the CFA Institute. Companies with large market capitalizations go in and out of favor based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations. Investments in smallmid sized companies may involve greater risks than in those of larger, better known companies. Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries. All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment State Street Corporation. All Rights Reserved. INST8171 Exp. Date: 11/30/2018 9