Outlook for 2014 Title 1 David Greene, Pioneer Investments
2014 A year of Transition Transitioning from fiscal tightening to less austerity. Transitioning from Euro-area recession to growth. Transitioning from Euro-area crisis to healing. Transitioning from historically low yields and volatility to normalised yields and volatility. Transitioning from multiple expansion to margin expansion in equities. We must move from a market model based on liquidity/credit creation to one driven by long-term economic growth fundamentals. But the biggest Transition in 2014 will be about managing the Transition to higher yields
DESPITE THE Q2 SELL-OFF IN FIXED INCOME, NOTHING APPEARS CHEAP. NOTHING.
Bond Yields at Historical Lows Core Government Bond Yields Still at 20-year lows 10 8 Max. 6 % 4 Av. 2 Min. 0 US Germany Japan UK Current level Source: Bloomberg. Data as of December 16, 2013.
We have been spoilt Annualised returns on equities and bonds.. 10 % 10 % 8 8 6 4 6 4 Equities Bonds 2 2 0 UK Europe 0 UK Europe Since 1950 = Baby Boomers Since 1980 = their children Source : NAPF, Pioneer. Data as of 30 th November 2013.
Even after the Q2 2013 sell-off nothing is cheap in Fixed Income 3.40 3.20 3.00 2.80 2.60 2.40 2.20 5y5y Euro swap, getting cheap over the 2013 but not over the longer period. % 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 08/1999 08/2000 08/2001 08/2002 08/2003 08/2004 08/2005 08/2006 08/2007 08/2008 08/2009 08/2010 08/2011 08/2012 08/2013 Source: Bloomberg, as at 27 November 13
MANY OF US ARE NOT POSITIONED FOR A BEAR MARKET.
500 400 300 200 100 0-100 -200-300 Majority of flows. are still into bond funds Fixed Income & Equity Cumulative Monthly Net Sales ( bn.) 2008-2013 Equity Bond Jan'08 Mar'08 May'08 Jul'08 Sep'08 Nov'08 Jan'09 Mar'09 May'09 Jul'09 Sep'09 Nov'09 Jan'10 Mar'10 May'10 Jul'10 Sep'10 Nov'10 Jan'11 Mar'11 May'11 Jul'11 Sep'11 Nov'11 Jan'12 Mar'12 May'12 Jul'12 Sep'12 Nov'12 Jan'13 Mar'13 May'13 Jul'13 Sep'13 Source: Pioneer, 2013. Universe is International/Cross-Border and local European funds.
Many pension schemes exposed to riskier fixed income Cumulative flow into bond funds (ETF s) as a % of Assets Under Management Emerging Markets Global HighYield Global High Grade ex Emerging Markets
Mind the (liquidity) Gap! Credit Fund AUM vs. Primary Dealer Credit Inventory $ 1, 000,000,000 $ 900,000,000 $ 800,000,000 $ 700,000,000 $ 600,000,000 $ 500,000,000 $ 400,000,000 $ 300,000,000 $ 200,000,000 $ 100,000,000 $ 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Funds AUM Dealer Inventory Source: Federal Reserve Bank of NY. AMG, EPFR. Data as at 5 June 2013
IS EUROPE TURNING JAPANESE?
Q2 sell-off far from enough unless we are turning Japanese 7 6 5 It played out differently in the Euro-zone core countries yields rose but peripheral countries yields fell. Spanish Sovereign Yield Curve 31/12/2102 4 % 3 Spanish Sovereign Yield Curve 28/11/2013 German Sovereign Yield Curve 28/11/2013 2 1 0 German Sovereign Yield Curve 31/12/2012 1m 3m 6m 1yr 2yr 3yr 4yr 5yr 6yr 7yr 8yr 9yr 10yr 15yr 20yr 25yr 30yr -1 Sources: Bloomberg 11 Nov 13
Why we believe the Euro-zone will not become Japan Japan Rich Aging Social Protection Poor Leadership Lack of Reforms Huge Banking sector Zombie Banks Deflation Euro-zone Some Rich Aging Social Protection Poor Leadership Some Reforms Deleveraging Banking sector Addressing Non-Performing Loans Low inflation (?) Source :Pioneer Investments
QE WAS POSITIVE FOR RISKY ASSETS. WILL QE REMOVAL BE NEGATIVE FOR RISKY ASSETS?
EM Bonds and US HG Bonds the biggest beneficiaries of QE3 Reaching for yield Top selling fund categories in Europe, 2010-12 cumulative, bn Bonds EM Bonds Global Currencies Asset Allocation Eq Em Bonds $ HY Eq Global MMkt Bonds USD Bonds Global HY Bonds Global Corp 0 20 40 60 80 Source: HSBC, 26 August 2013
I-Shares Emerging Markets Bond ETF 56 54 3 52 2.5 50 48-13.2% 2 1.5 46 1 44 0.5 42 0 Volume (Right) Last Price Source: Bloomberg, data as at 5 Nov 2013
Emerging Market Bonds & US High Grade Bonds adversely affected by tapering talk Global Exchange Traded Fund Flows since Q3 EM Bonds US HY Bonds US HG Bonds EM Equity US Equity Commodities Inflow Outflow from peak Commodities 6% -23% US Equity 16% 0% EM Equity 17% -9% US HG Bonds 21% -11% US HY Bonds 21% 0% EM Bonds 25% -12% -20% -10% 0% 10% 20% 30% Outflow from peak Inflow Source: JP Morgan, 24 October 2013
Global bond demand bn As of 31 st Oct 2013. 2014 numbers are JP Morgan projections.
EQUITIES AT RISK OF A CORRECTION?
Equity indices the last 20 years 2000 1800 1600 1400 1200 1000 800 600 400 200 0 450 400 350 300 250 200 150 100 50 0 S&P 500 at all-time highs Euro Stoxx 600 nearly there
Equity indices the last year 1900 340 320 1700 300 280 1500 260 1300 240 Very limited corrections over the last 12/24 months
Equities expecting stronger earnings growth in 2014 Although the Eurozone recession ended in the summer of 2013, Eurozone earnings remain close to recession lows. MSCI Eurozone equities are trading at 13.1x 12mth forward P/E, which is a 9% premium to it s 10-year average. Source : IBES, JP Morgan. Data as of Dec 31 st 2013.
But analysts regularly get their earnings forecasts wrong Change in consensus EPS growth projections during the last 3 years
FIXED INCOME 101: FAIR VALUE & DURATION
Finding Fair Value For Bonds US Europe Trend GDP 2.5% 1.5% Inflation 2.0% 2.0% Fair Value Bond Yield 4.5% 3.5% Current Yield 2.6% 1.7% Source: Pioneer Investments. Data as at 31 October 2013
The Danger of Duration In a period of rising bond yields, any duration exposure can cause losses Effect of 1% rise in bond yields on bond returns over one year % 0-2 -4-6 -8-10 -12-14 -16-18 2-year duration 5-year duration 10-year duration 30-year duration -0.6-0.8-0.2-2.4-3.1-2.5-5.3-4.9-6.3-13.4-13.5-16.2 US Germany UK Duration now Dangerous?? Source: Bloomberg / Pioneer Investments. Data as at 23 August 2013
We Expect Volatility to increase over the next 12-18 Months possibly the highest of the last few years 11 10 9 8 275 250 225 200 Percent 7 6 5 4 3 2 1 175 150 125 100 75 50 25 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Basis Point Government Benchmarks, Bid, 10 Year, Yield, End of Period, USD (Left Axis) Merrill Lynch, MOVE Index, 1 Month, Close (Right Axis) Source: Reuters EcoWin Source: Bloomberg, data as at 27 August 2013
Plenty of Risks and Opportunities Ahead We expect the next few quarters to be among the most volatile of the last few years Change in Fed policy and new leadership UK economy hitting BoE trigger points earlier than expected ECB flexibility Japanese QE Change in banks/brokers business models Ending of QE and it s effect on BRIC s
What to expect in 2014 Major driver of bond markets in 2014 = US yield curves. Will investors demand more term premia to compensate for potentially higher inflation in years to come? Can yield curves steepen further from current levels? If growth accelerates, will rate expectations be pulled forward? Investors are positioned for very low inflation what happens if inflation starts increasing? Peripherals now appear fair value, but what happens if Italy gets downgraded to sub-investment grade in 2014? Source : Pioneer Investments
Fixed Income becoming a Return-Free Risk? The combination of cheap QE money and low volatility has fuelled risk-taking and resulted in financial repression Forced investors to either accept return on investment below the rate of inflation or realise negative real returns on assets Yields are too low to compensate for the increased riskiness of sovereign debt Due to the concept of negative real returns, going forward investors are facing a return-free risk In Summary - Fixed Income should now be regarded as a risky investment
The Solution Implement an Absolute Return Fixed Income strategy that is uncorrelated to duration and has the ability to generate returns in all market conditions
How to construct an Absolute Return Bond strategy? Must have a number of key characteristics : - A cash benchmark as opposed to being benchmark-constrained - The ability to run negative interest rate and credit spread duration positions - A return which is derived from a number of well-diversified sources of alpha and lowly-correlated strategies rather than having one or two primary drivers of performance - Strong & disciplined risk/drawdown management techniques Caveat Emptor' be ABSOLUTELY sure it does what it says
What s gone wrong for some Absolute Return Funds? Why many Absolute Return Bond funds suffered negative performance in 2013? - Significant systematic risk (or market beta/risk) - High correlations between positions/trades - Poor (or no) risk management techniques - Exposure to High Yield and Emerging Markets..and in some extreme cases equities! Many such funds NOT actually Absolute Return Funds but Total Return Funds When the tide goes out you know who s been swimming naked
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