For professional investors Asset Allocation Monthly September 2015 Joost van Leenders, CFA Chief Economist, Multi Asset Solutions joost.vanleenders@bnpparibas.com +31 20 527 5126 Growth weakness in emerging economies US and eurozone holding up Moving cautiously towards risky assets August was a rough month for risky assets. Global equities were down 7.0% over the month in US dollar terms and 8.9% in euro terms. Emerging equities, which have underperformed for a while now, took a bigger hit than developed equities. Risk spreads in corporate bonds and on emerging market sovereign bonds widened and emerging currencies suffered. At one point oil prices dropped to their lowest level since 2009. So we were happy that we closed our equity over early in the month. After the sell-offs in risky assets we have cautiously added risk. We closed our under in emerging market debt denominated in US dollars and we are now over highyield corporate bonds in the US. Growth weakness: not just China Multi-asset Duration Investment grade High yield Emerging market debt Real estate Commodities Active s Many investors have clearly become more concerned about growth in China. Indeed, some of China s economic activity indicators, which seemed to have stabilised early summer, weakened again in July and August. The unfortunate handling of the stock market bubble and its bursting, the sudden depreciation of the Chinese yuan and the major explosions at a container storage in the port of Tianjin added to the uncertainty. A series of rate cuts and cuts in banks reserve ratio requirement have been unable to stop the market unrest. Have the authorities lost their grip? We don t think China s economy is on its way to a hard landing. Retail sales have held up, the housing market has improved and authorities have
Asset Allocation Monthly September 2015 2 ample ammunition to further support the economy if needed. That said, weakness is showing up in other parts of the world. PMIs, industrial production and trade data and have been weak throughout most of Asia. modest downwards trend in July. We do not foresee monetary policy changing in the near term, even though some speculation about a higher pace of asset purchases has emerged. 58 56 54 52 50 Manufacturing PMI (index, GDP-ed) 48 10 11 12 13 14 15 Global Developed economies Emerging markets Source: Markit, BNPP IP 125 115 105 95 85 75 65 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 GDP (% yoy, rhs) Eurozone ESI & GDP -2-4 -6 ESI (index, lhs) Source: Datastream, BNPP IP 6 4 2 0 Elsewhere, Brazil is in recession. Sticky inflation and a rapidly widening fiscal deficit leave little room for the authorities to come to the rescue. Fortunately the weak Brazilian real supported net exports in the second quarter. We do not believe there will be a repeat of the Asian crisis. Currencies are more flexible now, more current accounts are in surplus and forex reserves have been built up. But low growth seems here to stay for a while. Better growth in the U sand the eurozone The revision of second quarter GDP growth in the US revealed that the economy grew by a strong 3.7% QoQ annualised. All components contributed positively, pointing to underlying strength. Data has turned positive, with recent improvements in consumer confidence and spending and in durable goods orders. The labour market has stayed robust, as well as the housing market. The main uncertainty has remained the timing of the Fed s first rate hike. The economy is strong enough for a move in September, but the recent market volatility could stay the Fed s hand. At the annual Fed conference in Jackson Hole, Fed Vice Chairman Fisher sounded fairly confident that inflation will move higher, so a rate hike in September is still possible, in our view. The recovery in the eurozone is still fragile and could be derailed by market unrest. But the trade exposure to China is generally limited and leading indicators have held up. In fact, the Economic Sentiment Index improved in August to its highest level in four years. The unemployment rate resumed its Moving cautiously towards risky assets Market gyrations have been extreme lately. Equity volatility was much higher in 2008/09, but the volatility of volatility set a record on 24 August. With many markets going through a correction and some even entering bear market territory, equity valuations have improved of course. But we don t think valuation alone will be the driver of a change in sentiment. We would want to see stabilisation in growth or earnings in emerging markets first. That said, if the equity market s negative reaction is excessive, this would be a good time to add to our exposure to risky assets. As we think markets may stay volatile for a while, we are reluctant to go all-in. In fact, we closed our equity over in early August. But we have our shopping list ready. Taking profit on our under in emerging market debt in US dollars looks prudent though, as spreads have widened close to their highest point this year. 500 450 400 350 300 250 Emerging bonds risk spreads (basis points) 200 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Hard currency Local currency Source: Bloomberg, BNPP IP
Asset Allocation Monthly September 2015 3 We have also bought US high-yield corporate bonds, in which we are now over. US dollar-denominated high-yield debt has underperformed equities over the past 12 months. Indeed, on a risk-adjusted basis, it is the worst-performing developed asset class. In the contexts of a likely Fed hike, some corporate releveraging and increasing stress among energy companies, we expect the default rate to move higher. But not as extremely as market pricing suggests. So, with low inflation, stable growth and a slow path of hiking we think the yield on this asset class is attractive. 600 US high yield (spread with 10-year Treasuries, basis points) 500 400 300 200 Jan-14 May-14 Sep-14 Jan-15 May-15 Source: Bloomberg, BarCap, BNPP IP
Asset Allocation Monthly September 2015 4 Asset allocation 1 Multi-asset Duration Investment grade High yield Emerging market debt Real estate Commodities European large caps Active s Active s Fixed income Euro Govies Euro Short Dated US Govies Investment Grade (EUR) Investment Grade (US) Investment Grade (US) Euro Inflation Linked High Yield (EUR) High Yield (USD) Emerging Bonds USD Emerging Bonds Local Ccy Active s European small caps US large caps US small caps Japan Emerging markets Real estate European Real Estate US Real Estate Asian Real Estate Active s KEY Over: : Under: Increase: No change: Decrease: Foreign exchange AUD CAD CHF DKK EUR GBP HKD JPY NOK NZD SEK SGD USD EM FX Active s * In foreign exchnage we are over USD vs CHF, USD vs EUR, MXN vs GBP and KRW and JPY vs NZD and KRW. 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.
Asset Allocation Monthly September 2015 5 Changed. The corrections in equity markets have improved valuations. The economic growth outlook is positive in the US and the eurozone, but negative in emerging economies, in our view. Monetary policy is generally supportive, although some of the recent volatility may be related to the uncertainty about the timing of the Fed s first rate hike in a decade. We want to see more signs of economic improvement in emerging economies or in global earnings before buying equities. For now, we think the risk of continuing high volatility is too great. We closed our equity over in early August. Small-cap equities: Over Unchanged. We regard the outlook for European small caps as positive relative to large caps. Small caps are highly exposed to domestic demand and should benefit from the decent pace of growth we foresee. Large caps have significant exposure to emerging markets, which have not shown any rebound so far. Ample liquidity also supports small caps and the earnings outlook is favourable, in our view. High valuations and a flattening yield curve are downsides, but we expect the positive factors to prevail. Government bonds: duration Unchanged. After the sharp reversal in May and June of the downward trend in government bond yields, yields have settled in a trading range, albeit a broad one. Improving growth and inflation should drive yields higher, but extremely accommodative monetary policy should prevent a sharp increase. For now, the safe haven function of bonds could even lead to lower yields. We are therefore neutral duration. Investment-grade corporate bonds: Unchanged. We see the macroeconomic fundamentals as positive for this asset class. Defaults remain subdued, while credit conditions continue to improve in the eurozone and yields remain historically low. With investment-grade in the eurozone excessively valued relative to high-yield credit, we prefer high-yield. High-yield bonds Over Changed. ECB asset purchases are actively crowding out investors amid shrinking net government bond supply, which could create a scarcity premium for euro fixed-income instruments. High-yield corporate bonds have suffered in the recent risk-off environment, but this has led to more attractive valuations. In the US, where markets now discount an unreasonable high default rate, we have moved to an over position. Emerging market bonds Changed. Underlying fundamentals are not universally positive, but spreads have widened significantly lately. After the sell-off of risky assets, we wanted to increase our exposure to risky assets. Buying US dollar denominated emerging market debt allowed us to increase risk, as well as to lock in profits on our under. Real estate securities: Unchanged. We believe in real estate fundamentals such as attractive dividend yields, positive supply factors and low funding costs, but since valuations rose earlier this year and recent bond market volatility had a negative impact on the asset class, we prefer to be neutral.
Asset Allocation Monthly September 2015 6 Commodities Under Unchanged. Overall commodity prices have fallen back to their lowest levels for several years. Supply is ample and demand growth limited. The carry on the asset class is negative, but an under would expose an investor to the risk of a rebound. In our view this justifies a neutral stance.
Asset Allocation Monthly September 2015 7 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 75009 Paris, France, RCS Paris 319 378 832. www.bnpparibas-am.com. ** 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. www.bnpparibas-ip.com