For professional investors Asset Allocation Monthly October 2015 Joost van Leenders, CFA Chief Economist, Multi Asset Solutions joost.vanleenders@bnpparibas.com +31 20 527 5126 Uncertainty about US monetary policy continuous The negative environment for risk assets continued in September, even though equity markets showed signs of bottoming out. Among the developed regions Japan lost more than the US or Europe. Among sectors, the most severe losses were in energy and materials. The two main drivers of negative sentiment remain the prospect of a rate hike in the US and the GDP growth slowdown in China. We have left our asset allocation broadly unchanged, favouring a modestly positive exposure to risky assets. The Fed blinks Cautious about emerging markets Modestly positive view on risky assets Multi-asset Sep-15 Oct-15 Duration Investment grade High yield Emerging market debt Real estate Commodities At the much-discussed September monetary policy meeting the Fed decided not to raise rates. We saw this as a hawkish hold, as Fed Chair Yellen still seemed willing to raise rates later this year. Yellen just wanted some more time to assess the downward impact on inflation from slower growth in China and the strong US dollar. Later on, most comments from Fed officials confirmed that the Fed s views have not fundamentally changed and that they are willing to hike this year. Some of the latest data brings this view into question. Indicators about the manufacturing sector have been weak. The ISM manufacturing index barely held above 50 in September. The labour market proved more broadly disappointing in September than in August. Although this bears close monitoring, overall the US economy is not weak. Consumer spending is growing solidly; car sales have risen above levels last seen in 2000 to 2007.
Asset Allocation Monthly October 2015 2 Orders for capital goods are on track for their first quarterly rise since the third quarter of last year. The weak September labour data was out of sync with other indicators. Consumers are now more positive about the labour market than for many years. The number of job openings is high and small business owners say they are having difficulties filling vacancies. 1.0 0.8 0.6 0.4 0.2 US labour 0.0-4 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 Job openings per unemployed (lhs) Real hourly earnings (% YoY, rhs) Source: Datastream, BNPP IP 6 4 2 0-2 Services PMIs in developed economies fell on average to their lowest level since April 2014, but they still point to robust growth. We expect growth in the eurozone to hold up, with the cyclical recovery continuing. This view is confirmed not just by PMIs, but also by the strong gain in the Economic Sentiment Index in September and the high level of Germany s Ifo. We are still cautious about emerging markets. In China, debt levels are dangerously high and several other countries also face high or rapid increases in debt, weak commodity prices and the slowdown in China itself. Nervous financial markets Sentiment is still negative in equity and credit markets. Some equity markets have fallen through the lows set on 24 August, when the volatility of volatility hit a record level. Fortunately they have rebounded somewhat, but markets are still nervous. Growth in the third quarter may have slowed from the second quarter s strong pace due to an inventory correction and a drag from foreign trade, but domestic growth looks more robust. Markets currently see only a 34% chance of a rate hike in December, but the uncertainty about US monetary policy will continue to hang over the markets. 3600 3400 3200 3000 European equities & high-yield 500 450 400 350 PMIs: diverging Trends in PMI indices have been diverging for several months and this continued in September. Declines in PMIs were broad-based, but the weakness was concentrated in manufacturing in emerging economies. PMIs also declined in manufacturing in developed economies but remain in the range of the previous month. 65 60 55 50 45 40 Composite PMIs (index, GDP-ed) 35 07 08 09 10 11 12 13 14 15 Global Developed economies* BRIC * France, Germany, Ireland, Italy, Japan, Spain, UK, US Source: Markit, BNPP IP 2800 Jan-15 Mar-15 May-15 Jul-15 Sep-15 (index, lhs) High-yield (spread, rhs) This is seen in day-to-day changes as well as in intraday moves. The outsized negative reactions to the problems at VW and Glencore are also telling. Our sentiment and positioning indicators are negative, which from a contrarian perspective should be positive for equity markets. The sensitivity to US monetary policy is also large. The weak US September labour market was treated positively as it led to delayed rate hikes. In this environment of modest growth, low inflation, uncertainty but improved valuations and negative sentiment we prefer a modestly positive exposure to risky assets. We specifically like high-yield corporate bonds in the US and Europe. Yields are attractive, while corporate fundamentals in Europe should improve and discounted defaults in the US look extreme. For investors unable to buy high-yield credits we see European equities as a viable alternative. 300 Source: Bloomberg, Datastream, BNPP IP
Asset Allocation Monthly October 2015 3 Asset allocation 1 Multi-asset Duration Investment grade High yield Emerging market debt Real estate Commodities European large caps Sep-15 Oct-15 Sep-15 Oct-15 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 Sep-15 Oct-15 European small caps US large caps US small caps Japan Emerging markets Real estate European Real Estate US Real Estate Asian Real Estate Sep-15 Oct-15 KEY Over: : Under: Increase: No change: Decrease: Foreign exchange AUD CAD CHF DKK EUR GBP HKD JPY NOK NZD SEK SGD USD EM FX Sep-15 Oct-15 * In foreign exchnage we are over USD vs CHF, USD vs EUR and MXN vs GBP 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 October 2015 4 Unchanged. corrected further in September, although markets are showing signs of bottoming. Robust US domestic demand, improved valuations and the contrarian signs of negative sentiment and positioning are positive factors. But uncertainty about US monetary policy and about growth in China, other emerging markets (and thus globally) is negative. Triggers for a sustainable rebound could be lower volatility itself, but also improvements in global growth indicators, more monetary support by the ECB or the Bank of Japan and a better earnings outlook. Japan is currently the only region where upgrades still outnumber downgrades but even there the ratio has fallen. 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. Speculation about more monetary policy support from the ECB, through higher monthly asset purchases or an extension of the programme, should be positive for eurozone government bonds. Indeed, yields have drifted lower recently. But we expect a smaller impact than that seen early this year. Expansion of quantitative easing is not a given and investors should still bear in mind the sharp correction in German bunds in April and May. We expect yields to stay low, but we don t see a catalyst for a long-duration position. 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 bonds in the eurozone excessively valued relative to high-yield credit, we prefer high-yield. High-yield bonds Over Unchanged. 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, markets are discounting an unreasonably high default rate, in our view. Emerging market bonds Unchanged. Spreads have widened significantly lately. This makes the carry on these bonds more attractive, but we took profit on an under position just last month. We think the growth fundamentals are not positive and rising debt levels are a downside risk in a number of countries.
Asset Allocation Monthly October 2015 5 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. Commodities Under Unchanged. Overall commodity prices have fallen back to their lowest levels for several years. Even gold has not been able to benefit from negative sentiment towards risky assets. 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 October 2015 6 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