Mid-year Outlook. June 2017

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1 Mid-year Outlook June 2017 This document contains the views of HSBC Global Asset Management and is distributed by HSBC Investment Funds (Canada) Inc., HSBC Private Wealth Services (Canada) Inc., and the HSBC InvestDirect division within HSBC Securities (Canada) Inc., each of which are subsidiaries of HSBC Bank Canada. This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination.

2 What s happened so far in markets and the economy So far in 2017, investors have experienced strong returns across a variety of asset classes. A combination of good economic growth, low inflation and low market volatility have created a supportive environment for risk assets, like equities, to perform. Recent Recent market performance in focus: The total return on global government bonds has been positive Emerging market asset classes (both local currency government bonds and equities) have continued to perform strongly after an already impressive year in 2016 Rest of the world equity markets have outperformed US equity markets, reversing a trend in place since 2010 The return for investing in higher yield corporate bonds has been lower than the bumper returns of 2016 At the start of the year, most global economists were worried that political change in the US and UK, elections in Europe, and uncertainty in Asia and other emerging markets would affect financial markets. But this hasn t happened. Markets in all asset classes have not been as volatile as expected and have stayed calm. The economic environment has also been helpful for risk assets. There is a pick-up in global growth synchronised across advanced and emerging economies. Inflation remains low, but price pressures are slowly picking up. Altogether, we believe this is favourable for equities and other risk assets rather than for government bonds. Returns have been strong so far in 2017 across a variety asset classes, thanks to good economic growth, low inflation and low financial market volatility. Political worries and uncertainty have not materialised, or have not affected markets so far, contrary to the expectations of many economists. Instead, the economic environment has been one of synchronised growth across advanced and emerging economies. Meanwhile, inflation pressures have remained low. 2

3 What is happening now and what it means for markets In advanced economies, growth rates are the strongest at any time since the financial crisis. Gross Domestic Product (GDP) data is now above the pre-crisis high in the eurozone, and significantly so in the USA. Emerging countries are lagging, but almost all have joined in a synchronised global upturn. Given this pick-up in economic activity, the stage seems set for a burst of inflation. We do think we will see some inflation pressures soon, but so far inflation pressures continue to look very subdued. This is despite low unemployment and supportive monetary policy, both of which tend to create higher inflation. What does this mean for the policy environment? The low pressure of inflation limits the risk of central banks raising interest rates quickly, but some of them are slowly starting to reduce their support for economies, especially the US Federal Reserve. Even so, interest rate rises will be extremely gradual. On the other hand, this year government spending will add to economic growth. With this support, growth could be stronger than markets expect. Investment Strategy outlook In our view, the current backdrop implies a market environment that favours risk assets, like equities, over government bonds. But the challenge is that risk asset markets have posted strong performance since the summer of 2016, so we think the potential reward for investing is lower than before. However, as with all investments the value of your capital is at risk. Key risks for the second half of 2017 An obvious first risk for the performance of our portfolios is a slowdown in growth, though this seems unlikely at the moment. But better economic growth than expected is also a risk, because it could force the US Federal Reserve to raise interest rates more quickly. That could destabilise markets. Political worries also linger, even if they have not impacted markets in the first half of Yet more than anything, the key risk to the value of investments is valuation risk. This time last year many asset classes were extremely cheap. Today this is much less the case, so if anything does go wrong, there could be periods of volatility in markets. Central banks still provide substantial support for growth, but they have started to cut back. Government spending is now also supporting the economy, creating a possibility that global growth could be stronger than markets expect. The current market environment supports risk assets more than government bonds, in our view. But after a period of strong performance in financial markets, we think the potential reward for investing in risk assets is now a little lower. There are still selective opportunities, especially in equities and emerging markets. Investing is not without risk. In particular, in 2017 there are threats to the economic outlook and from the political environment. But the key risk for investors remains valuation risk, because more expensive financial markets create scope for greater volatility. 3

4 Multi-asset outlook In our multi-asset portfolios, we focus our asset allocation on areas of the market which we consider will benefit from the economic environment but which also show attractive prices. We believe we can find this in eurozone and Japanese equities, and also in emerging markets (both equities and some types of bonds), with a careful selection. How this impacts government bonds Global bonds suffered significant losses during the second half of So much so that, today, US government bonds can again play the role of a diversifier in our portfolios. But, if growth and inflation strengthen, which we believe is likely, bonds values could fall further. We remain cautious on global government bonds. Monitoring the economy and policy trends and actively managing investments will be key for us here. Our view on risk assets Both corporate bonds and equities are more expensive today after a phase of market strength, but the economic environment remains supportive for risk assets. What really matters is how the outlook will evolve compared with what the market expects. The challenge in corporate bonds is that prices already reflect a lot of the good news. We continue to like equities in the context of our multi-asset portfolios. Based on comparisons of valuations and profits, we have a preference for rest of the developed world equities over the US, especially Europe and Japan. We focus our asset allocation on areas of the market which we consider will benefit from the economic environment but which are also attractively priced Eurozone equities, Japanese equities, emerging market equities and bonds The outlook for emerging markets Emerging markets (EM) performed strongly in 2016 and early 2017, like other asset classes, and EM equities are no longer as cheap as they were. But for now, and compared with the other opportunities available, we think EM equities still look attractive. Similarly, local-currency EM bonds continue to look attractive to us too. Joseph Little Global Chief Strategist HSBC Global Asset Management 4

5 Equities outlook What s happened so far Global equity markets have been relatively strong so far, delivering a better-than-expected performance despite significant geopolitical concerns. Major market events including the unveiling of the new administration s agenda in the US, the rollout of Brexit, concerns around North Korea s missile tests and the French elections all failed to derail the rally in the equity markets. But the year so far has reinforced at least one key theme for investors Do not try to time the market. Investors who tried to choose their entry and exit points based on the predicted results of these geopolitical events would likely have met with little success, and this also makes a strong case for holding a well-diversified portfolio. Equities have raced ahead of our expectations for long-term returns since the beginning of 2017, and they are now more expensive. This means that we will need to be especially careful when selecting investments in equities in the coming quarters. How we see the rest of the year for equities Although equities have, broadly speaking, reached fair value and are no longer materially cheap, we don t expect to see a significant downturn in equity markets in the rest of the year. With the world economy seemingly on the mend and de- globalisation failing to happen in the way that was previously feared, investors now have more confidence in the markets. Many investors around the world are still holding back on investing in more equities, particularly emerging market equities, so there may be renewed interest from them to catch up on their equity investments and this could drive the next rise in stock markets. We are generally positive about the outlook for the equity markets in the second half of 2017, but we will remain cautious as we now see that equities in most markets are at or close to fair value. We will be looking at equities in a particularly careful manner to spot opportunities. We think Europe, Japan and Asia ex Japan offer relatively better value than US equities for the portfolios we manage, because of their lower valuations and ongoing recovery in company earnings. Bill Maldonado Global CIO Equities HSBC Global Asset Management 5

6 Bonds outlook What s happened so far Given the good economic outlook and low market volatility, bonds have underperformed stock markets in most regions. But they have clearly beaten returns from cash. The US Fed started raising interest rates, but slowly, and at the same time making sure markets don t overreact. Overall the interest rate environment is not causing bond investors to worry. So far this year, bond markets have delivered returns between around 1% and 6% across a variety of asset classes. This is only about half of the returns they delivered last year, but it s already what we were expecting for the whole of Emerging market bonds delivered the highest returns, followed by high-yield bonds riskier corporate bonds that have a credit rating below BBB/Baa. Emerging market bonds remain our preferred investment for bonds, notably because their rates are historically high compared to developed market government bonds. How we see the rest of the year for bonds Valuations are not as good as last year and we expect US interest rates to continue slowly rising. Bond prices fall when interest rates rise, so we think that slowly rising US rates could potentially reduce the price of government bonds and investmentgrade corporate bonds. We remain comfortable holding high-yield bonds in our portfolios: now that companies have quite a high level of debt, they are more careful to preserve their credit rating. Emerging market bonds remain our preferred investment for bonds, notably because their rates are historically high compared to developed market government bonds. The main risks for bonds, that could cause their values to fall, are the threats to the economy that could come from the Fed raising interest rates faster than expected, or from Chinese growth slowing down more than anticipated. Political risk in Europe is also still a risk, but the probability of German and Italian elections causing global worries has reduced. Xavier Baraton Global CIO Fixed Income HSBC Global Asset Management 6

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8 Important information This document has been prepared by HSBC Global Asset Management Limited (AMG) and is distributed by HSBC Investment Funds (Canada) Inc. (HIFC), HSBC Private Wealth Services (Canada) Inc. (HPWS), and the HSBC InvestDirect division within HSBC Securities (Canada) Inc. (HIDC) ( we refers to AMG, HIFC, HPWS, and HIDC collectively). The contents of this document may not be reproduced or further distributed to any person or entity, whether in whole or in part, for any purpose or otherwise, without the prior written permission of AMG. All non-authorised reproduction or use of this document will be the responsibility of the user and may lead to legal proceedings. The material contained in this document is for general information purposes only and does not constitute advice or a recommendation to buy or sell investments. 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