Macro & markets. Sheffield Life & Pensions Investment Conference. 23 September Keith Wade Chief Economist

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1 Macro & markets Sheffield Life & Pensions Investment Conference 23 September 2016 Keith Wade Chief Economist September 2016 For professional advisers only. This material is not suitable for retail clients

2 May you live in interesting times Gilt yields, % South Sea Company founded American War of Independence 1815 victory at Waterloo 1720 post South Sea Bubble flight to quality 1931 Sterling leaves the Gold Standard Outbreak WWII WWI Wartime controls 0 08/31/ /31/ /30/ /31/ /31/ /30/ /25/ /31/ /30/ /31/ % Perpetual UK government bond yield UK 10-year government bond yield UK inflation in excess of 20% 1997 BoE independence 2009 BoE QE Source: Bank of England ( ), Thomson Datastream, 6 September

3 It could be worse $7 trillion DM sovereign bonds now have a negative yield 35% 30% 25% 20% 15% 10% 5% 0% Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 $9 $8 $7 $6 $5 $4 $3 $2 $1 $0 Source: Bloomberg, Schroders Economics Group. 26 August % of Bloomberg Developed Sovereign Bond index with negative yields, weighted Value of Bloomberg Developed Sovereign Bond index with negative yields, rhs (trillions)

4 2016 another year of global downgrades Once again forecasters prove to be too optimistic Source: Thomson Reuters Datastream, Schroders, 5 September Forecast risk warning: Please see the information slide at the end of this presentation 3

5 Global trade growth has stalled Trade multiplier has collapsed Source: Thomson Reuters Datastream, Schroders, 5 September

6 Central banks continue to buy bonds in size How much money has been printed? Value of assets in central banks' balance sheets (Trillions of USD) $11.7 trillion Eurozone Japan Switzerland China US UK Source: Thomson Datastream, Schroders Economics Group. Updated 25 August

7 Brexit Much ado about nothing?

Brexit What they said England has collapsed politically, monetarily and economically Mark Rutte, Dutch PM You cannot discern that anybody in the British isles had a plan Frank-Walter Steinmeier,

8 Brexit What they said England has collapsed politically, monetarily and economically Mark Rutte, Dutch PM You cannot discern that anybody in the British isles had a plan Frank-Walter Steinmeier, German foreign minister The Brexit vote yet again reflected the drawbacks of Western democracy. Yang Chengxu, former Chinese ambassador to Vienna Source: Financial Times 2/3 July, The Economist magazine 30 June

9 Near-term impact of Brexit on UK economy New post-brexit forecast: Stagflation looms y/y 4.0% y/y 3.5% 3.5% 3.0% 2.5% Real GDP forecast 3.0% 2.5% 2.0% 2.0% 1.5% 1.0% 1.5% 1.0% 0.5% CPI inflation forecast 0.5% 0.0% 0.0% i ii iii iv i ii iii iv i ii iii iv i ii iii iv % i ii iii iv i ii iii iv i ii iii iv i ii iii iv Current forecast Pre-Brexit Current forecast Pre-Brexit Source: Thomson Datastream, Schroders Economics Group. 15 August Previous forecast refers to May Please note the forecast warning at the back of this document. 8

10 Crisis? What crisis? PMI bounces back and retail sales were up in July 10% 80 8% 60 6% 40 4% 20 2% 0 0% -20-2% -40 Source: Thomson Datastream, Markit, CBI, ONS, Schroders Economics Group. 30 August % ONS retail sales volumes excl. auto fuel, 3m, y/y (lhs) CBI Distributive trade survey, volume of sales, 3m-MA (rhs)

11 Has the Bank of England over reacted? Mark Carney: 'I'm absolutely serene Buddha Governor of the Bank of England Source: Bank of England, likesuccess.com 10

12 Corporate reaction will be key Investment likely to fall UK GDP breakdown ( average) 1 Survey points to sharp cut in capex 2 Government spending, 19.7% Government Investment, 2.5% Investment in dwellings, 4.5% Other, 2.3% Domestic business investment, 7.6% Consumption, 61.7% Total business investment 9.2% Foreign direct investment, 1.6% 1 Source: Thomson Datastream, ONS, Focus Economics consensus survey, Schroders Economics Group. 28 June Source: Thomson Reuters Datastream, Schroders, 12 September

13 GBP is now cheap Brexit means that the UK is winning in the currency wars Source: Thomson Datastream, Schroders Economics Group. 12 September

14 but it needs to be UK resembles troubled EM countries more than Western Europe % of GDP Swi Ger Swe Rus Ita Chi Jap Spa Fra Can US Tur Gre Arg SA UK Bra Current account Budget balance Total Source: Bloomberg 2016 forecast. 5 July

15 Europe Brexit and beyond

16 Eurozone continues to grow, but problems persist Surveys are firm, credit growth elusive Source: Thomson Datastream, Markit, CBI, ONS, Schroders Economics Group. 8 September

17 Inflation remains low too low Eurozone needs to pull clear of deflation Y/Y 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% Core Energy Food incl. alcohol & tobacco Headline Source: Thomson Datastream, Eurostat, Schroders Economics Group. Updated 24 August

18 ECB QE continues, but for how long? QE set to end March 2017, but expect an extension Source: Thomson Datastream, Markit, CBI, ONS, Schroders Economics Group. 8 September

19 Concerns have shifted from the economy to immigration What are the two most important issues facing the EU? Immigration, Terrorism, Economic situation, Public finances, Unemployment, Crime, Note, numbers do not sum to 100. Source: Standard Eurobarometer report No.85 Spring Schroders Economics Group. 18

20 Political risk set to return in Europe A roadmap and guide to upcoming events Country Event risk Date Probability Market impact Hungary Migrant quota rejected in referendum 2 October 2016 High Low Austria Italy Netherlands France Germany Re-run of presidential election with far-right Freedom party winning Constitutional referendum, leading to Renzi losing his job General election with the Party for Freedom calling an EU referendum Presidential elections with the National Front winning Federal election with Alternative for Deutschland winning 4 December 2016 Medium Low Late 2016 Medium High 15 March 2017 High Medium 23 April and 7 May 2017 Low Extreme Aug-Oct 2017 Very low Extreme UK Article 50 triggered Q2 Q High Low Source: Schroders Economics Group. 13 September

21 US Better macro ahead of heightened political risk

22 Has the market become complacent on US rates? Wages subdued (for now), but dollar has eased deflationary pressure y/y % 8 y/y % ECI (wages and salaries), y/y% Unemployment rate (%, inverted), rhs Asia crisis Import Prices exc Oil US $ Broad fed index (3m lag), rhs Source: Thomson Datastream, Schroders Economics Group. 24 August

23 Credit channel: Households unwilling, or unable to re-leverage Balance sheet repair persists despite de-leveraging US debt/ GDP by sector % of GDP US home equity loans Households Govt (Fed., State & Local) Business (Non-fin) Home equity loans as % of GDP, lhs Home equity loans ($bn) rhs -100 Source: Thomson Datastream, Schroders Economics Group. 24 August

24 US Political risk The 2016 US Presidential Election Source: Flickr.com. 23

25 Polls suggest a Clinton victory (307 electoral votes vs. 231) But keep an eye on the swing states, Ohio and Florida in particular The probability of Clinton winning is 61.1% State Top 10 swing states number of electoral votes Spread Florida 29 R Pennsylvania 20 D Ohio 18 R Michigan 16 D North Carolina 15 R Virginia 13 D Wisconsin 10 D Colorado 9 D Nevada 6 D Minnesota 10 D Total 146 Ohio predicted 10/10 of last presidential elections and Florida 9/10 Florida has more electoral votes (29 vs 18 for Ohio) so is a bigger prize Source: FiveThirtyEight.com. Updated 19 September 2016 *The model weights each poll by its sample size, how recently it was conducted, and the historical accuracy and methodology of the polling firm Poll outcome for rest of states Trump win 198 Clinton win 194 Implied outcome Trump 260 Clinton

26 Incumbent party to win? The S&P performs well during the 3-months before the election when the incumbent party wins S&P 500 Avg: Presidential Election Years & Incumbent Party Outcome Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Strategas Research Partners, August 2016 Incumbent Party Lost Incumbent Party Won 2016 Election The S&P has correctly predicted 19 out of the past 22 elections Year S&P return Incumbent party Correct Won Lost Won Won Won Won Lost Won Lost Won Lost Won Lost Lost Won Won Lost Won Lost Won Lost Won 25

27 Macro impact of fiscal and trade policy Projections, difference from baseline % 4.0 Trump % 1.5 Clinton At face value % 4.0 Real GDP, y/y CPI, y/y Fed funds Deficit/GDP -0.5 % 1.5 Real GDP, y/y CPI, y/y Fed funds Deficit/GDP In Washington Real GDP, y/y CPI, y/y Fed funds Deficit/GDP -0.5 Real GDP, y/y CPI, y/y Fed funds Deficit/GDP Source: Moody s Analytics. June and July

28 Emerging markets Return to favour?

29 EM signs of life Developed Markets vs. Emerging Markets PMIs Balance Developed markets Emerging markets Source: Thomson Datastream, Markit, Schroders Economics Group. Updated 13 September

30 EM FX: significantly cheaper RUB, BRL and INR are cheap, CNY less expensive 4 Expensive 3 Expensive Cheap EUR JPY GBP USD Upper quartile Lower quartile Current nominal TW exchange rate (10yr z-score) Last year -3 Cheap RUB BRL INR CNY Lower quartile Upper quartile Current nominal TW exchange rate (10yr z-score) Last year Source: Thomson Datastream, Schroders Economics Group, Updated 16/09/

31 Can China control its capital flows? Chinese official currency reserves Billions USD 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 0,500 0, Source: Thomson Datastream, Schroders Economics Group. 24 August

32 Less dependence on foreign capital Most (not all) have reduced their vulnerability since 2013 Gross external financing requirement (% GDP) ZAR TRY PEN MYR CLP COP BRL MXN PLN IDR INR HUF CZK PHP KRW CNY TWD RUB THB Q Taper Tantrum Source: Thomson Datastream, Schroders Economics Group. 26 August

33 EM inflation moderating Room for rate cuts building Headline inflation minus inflation target, y/y 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% Brazil Russia India Indonesia Current inflation target (max when range) Source: Thomson Datastream, Schroders Economics Group. 25 August

34 Outlook and risks

35 Forecast update: the race for growth No break from the square root recovery Contributions to World GDP growth (y/y), % Forecast US Europe Japan Rest of advanced BRICS Rest of emerging World Our forecast for global growth in 2016 has been revised down from 2.5% to 2.3%, with our global growth forecast for 2017 remaining at 2.6% Reductions in our forecasts for the US and the Eurozone are partially offset by increases to Japan and the UK. Meanwhile, the forecast for the emerging markets (EM) remains unchanged Source: Thomson Datastream, Schroders Economics Group. 15 August Please note the forecast warning at the back of the document. 34

36 2017 Inflation vs. baseline forecast 23/09/ :50:52 Scenarios and the balance of risks Some upside, but risks are skewed toward deflation Stagflationary Trade wars Currency wars return US wages accelerate Reflationary Global reflation Secular stagnation seen as biggest single risk Trade wars based on Trump victory US recession Brexit shakes Europe Secular stagnation Baseline Global reflation: co-ordinated expansion of fiscal policy FX wars: Sharp drop in JPY triggers round of devaluations Deflationary Growth vs. baseline forecast Productivity boost Source: Schroders Economics Group. 15 August Please note the forecast warning at the back of the document 35

37 Markets outlook

38 Are equities still good value? MSCI US reported P/E ratio MSCI-US reported price-earnings ratio SD=21.8 Avg Equities overvalued SD=10.8 Equities undervalued Source: Thomson Datastream, Schroders Economics Group. Updated 13 September

39 Equities still supported by low returns from bonds Measuring the equity risk premium % '73 '75 '77 '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15 US S&P500 dividend yield US 10yr treasury benchmark yield to maturity Source: Thomson Datastream, Schroders. Updated 13 September

40 Liquidity surge increases risk for portfolios More QE has reduced the diversification benefits of bonds Quarterly change in the value of assets in central banks' balance sheets (Trillions of USD) Source: Thomson Datastream, Schroders Economics Group. Updated 15 September US UK Eurozone Japan Switzerland China Sweden Total Rolling 1Y correlation between US 10-yr treasuries and S&P500 weekly returns

41 Where else can we find diversifiers? Japanese yen offers the best protection Gold vs. S&P 500 EUR/JPY vs. S&P 500 DXY vs. S&P 500 Correlation (y/y, 12m weekly returns) Correlation (y/y, 12m weekly returns) Correlation (y/y, 12m weekly returns) Gold vs. S&P EUR/JPY vs. S&P DXY vs. S&P500 Source: Thomson Datastream, Schroders Economics Group. Updated 15 September

42 Asset allocation views September 2016 Equity 0 Bonds - Alternatives + Cash + Currency By region By sector By sector USD 0 US + (0) Government 0 Commodities + JPY + Europe ex UK 0 (-) US - Gold + EUR 0 UK 0 (+) UK 0 GBP - Pacific ex Japan (AUS, NZ, HK & Sing.) 0 Inflation-linked + AUD 0 Japan 0 (-) Investment grade - (0) CHF 0 Emerging Markets 0 High Yield 0 EM + Emerging market ($ debt) 0 Key: +/- market expected to outperform/ underperform (maximum ++ minimum ---) 0 indicates a neutral position. The above asset allocation is for illustrative purposes only. Actual client portfolios will vary according to mandate, benchmark, risk profile and the availability and riskiness of individual asset classes in different regions. Source: Schroders. Updated 19 September

43 Important information For professional investors or advisers only. This material is not suitable for retail clients. Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get back the amount originally invested. The views and opinions contained herein are those of the Schroders Economics Group, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This presentation is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the presentation when taking individual investment and/or strategic decisions Third party data is owned or licensed by the data provider and may not be reproduced or extracted and used for any other purpose without the data provider's consent. Third party data is provided without any warranties of any kind. The data provider and issuer of the presentation shall have no liability in connection with the third party data. The Prospectus and/or contains additional disclaimers which apply to the third party data. The forecasts included in this presentation should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors Issued in September 2016 by Schroder Unit Trusts Limited, 31 Gresham Street, London EC2V 7QA. Registered No: England. Authorised and regulated by the Financial Conduct Authority. UK

An economic update Craig Botham, Economist May 2017

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