ING Investment Office Publication date: 15 August 2018 12:50 p.m. July August Asset allocation - + GDP growth and profits provide important support for the markets Equities Real estate Commodities Alternatives Fixed income Geographic allocation equities North America Europe Japan Emerging markets Pacific (excluding Japan) Sector allocation equities Energy Materials Industrials Consumer discretionary Consumer staples Healthcare Financials Information technology Telecommunications services Utilities Fixed income Sovereign bonds Investment grade corporate bonds High-yield bonds Emerging markets This month we see no reason for a change in our tactical asset allocation. This means that we are maintaining the overweight of marketable securities at the expense of fixedincome securities and maintaining our preference for equities. Our regional and sector preferences also remain unchanged. Many companies presented excellent quarterly figures, with particularly strong growth in profits in the US. This prompted analysts to increase their growth expectations for almost every sector. Just when the reports of additional import levies and unfair trade had been somewhat pushed into the background, investors were confronted with a new disappointment. Confidence in Turkey s economic and monetary policy has been reduced to the minimum, leading, among other things, to the free fall of the Turkish lira. Although the turmoil surrounding Turkey is likely to continue for the time being, we believe the likelihood of the problems spreading to other emerging markets to be limited. Nevertheless, the distinction between vulnerable and healthy countries will become clearer. Highlights The economy continues to do well, with the United States as the driving force However, the growth momentum has diminished slightly this quarter Strong quarterly figures from companies, especially in the US...... have led to an increase in profit expectations by analysts Geopolitical turmoil continues to affect stock market sentiment Turkey in trouble due to a sharp fall in the value of the lira...... but the risk of the problems spreading to healthy emerging countries appears limited We are maintaining our overweight positions in emerging market equities and bonds...... and keep our tactical asset allocation unchanged.
Investors risk appetite is again diminishing Geopolitics continues to cause concern Trade turnovers on the financial markets are relatively low during the holiday period, but as far as news is concerned, this is not a silly season. On the geopolitical front in particular, a steady stream of reports is creating uncertainty among investors. The Trump government continues to contribute to this, with the announcement of additional import duties on a further $200 billion in Chinese products and new sanctions on Russia due to the poisoning of the Russian former spy Skripal and his daughter in the United Kingdom. And just when President Trump s focus on Twitter shifted from unfair business practices to another topic of interest, investors were confronted with an acceleration in the fall in value of the Turkish lira. This once again dented investors willingness to take risks. Eurozone growth cools slightly, the Netherlands excels US economy growing rapidly Although investor sentiment has been largely determined by political unrest for some time now, the global economy is growing considerably. With growth of 4.1%, the United States recorded its strongest growth rate since the third quarter of 2014. Strong growth in consumer spending and exports were the main contributors. In addition, the US economy is being boosted by higher public spending and tax cuts. In the eurozone, economic growth is cooling down slightly from its peak of 2.8% year-on-year in the fourth quarter of 2017. Nevertheless, growth of 2.2% was reported for the second quarter of 2018 (+0.4% compared to the first quarter), which is still above the region s calculated potential growth level. Last year s appreciation of the euro has probably slowed down growth, and business confidence is held back by concerns about the EU s trade relations with the US. For the rest, the Netherlands and Germany were the leaders in the euro area, with growth of 0.7% and 0.5% respectively compared to the first quarter. Chinese exports not yet weighed down by trade war China taking measures to stimulate the economy In China, economic growth decelerated slightly in the second quarter to 6.7% year-on-year. The Chinese government has for some time now been reducing imbalances in the financial system, partly by curbing so-called shadow banking (lending outside the banking system) and slowing down credit growth. This is putting pressure on economic growth, although the authorities have so far been successful in ensuring that the slowdown is very gradual. An additional concern, however, is the threat of additional import duties by the US on another $200 billion of Chinese goods. Although Chinese exports, with 12.2% growth in July, did not appear to have suffered very much from the trade dispute, the Chinese government is anticipating a slowdown. It has therefore taken measures to stimulate the domestic economy, in part by promoting bank lending and increasing investment in infrastructure. Emerging markets under pressure The continuing strong growth of the Chinese economy and the government s measures to stimulate growth represent important support for the emerging markets. However, concerns about increased protectionism, higher policy and market interest rates in the US and the strengthening dollar have led investors to take a more critical look at emerging markets. Especially countries with large current account deficits, and which are thus more dependent on external financing, came under increasing Monthly Investment Outlook August 2018 2
pressure and saw their currency weaken, for example. Will Turkey be the first victim? The first victim, Turkey, now appears to be falling. The country has a large current account deficit and a relatively high level of foreign currency-denominated debt. However, the strengthening of the dollar is increasing the financing costs. These risks are known in the market, but until recently there was still sufficient confidence in Turkish policymakers, including the central bank. This confidence, however, has been seriously damaged. Since his re-election in June, President Erdogan has further increased his power, in part by appointing his son-in-law as Finance Minister and dismissing some cabinet members who enjoyed the confidence of the market and advocated prudent government policy. Furthermore, the independence of the Turkish Central Bank was affected by Erdogan's call for lower interest rates at a time when the economy needs a sharp rise in interest rates in order to curb high inflation and protect the lira. Distrust was reinforced when the central bank did not raise interest rates in July. Meanwhile, the Turkish lira has already fallen by dozens of percent against the dollar this year. Risk of contamination limited for the time being The Turkish crisis is now also affecting the currencies of other emerging markets. Especially where as in the case of Turkey there are current account deficits and high debts in foreign currencies such as the dollar. Indonesia, Argentina and South Africa, among others, are vulnerable in this respect. We expect the contamination of other emerging markets to remain limited. Indeed, many countries have significantly reduced their external financing needs following the so-called taper tantrum in 2013 (the shock reaction on the financial markets after the announcement of the Fed s phasing out of its buy-back programme). Turkey is an example of a country that has not intervened and is now forced by the market to do so. European banks in focus, euro declining Underweight of government Investors growing risk aversion is not confined to emerging markets. The equity prices of European banks with a relatively large number of outstanding loans in Turkey also came under pressure, especially following a report that the European Central Bank (ECB) had expressed its concerns about the exposure of some banks to Turkey. A number of banks, particularly in Spain, do indeed have a relatively large exposure, but not to such an extent that this could lead to major problems. Nevertheless, the euro-dollar exchange rate fell sharply, from $1.169 on 31 July to $1.132 on 15 August. In addition to the lira crisis, the weakening of the euro was probably due to the uncertainty surrounding the Italian government s budgetary plans. Investors are again fleeing to safe havens The decrease in risk appetite was also reflected in a flight in August to safe havens, such as German and US government bonds. Following a brief upturn in July, this caused both countries 10-year interest rates to fall again. The German 10-year interest rate, again at 0.30%, has reached the lower end of the range in which it has been moving for some time. We believe that fewer concerns about a trade war and a positive economic momentum will lead to a (slight) rise in interest rates. Moreover, the phasing out of the ECB s bond buy-back programme in the fourth quarter of this year may also put upward pressure on interest rates in the eurozone. With the prospect of higher yields on Monthly Investment Outlook August 2018 3
bonds maintained government bonds, we are maintaining the tactical underweight of this category and are also employing a relatively short duration (low interest rate sensitivity due to the short residual maturities of bonds). In the case of bonds, we are maintaining an overweight of corporate bonds at the expense of government bonds, which we are keeping underweight. Equity prices supported by strong quarterly figures Emerging market investments are the main victim of concerns about protectionism and the financial crisis in Turkey. The contamination to other regions remained limited. A relatively defensive region (less vulnerable to economic headwinds) like the US outperformed the more cyclically sensitive regions such as the eurozone and Japan. The second quarter will not be bettered in the US An important reason why equity markets remain buoyant, particularly in the US, is the better-thanexpected quarterly figures. US companies in particular reported very strong results. More than 80% of the companies in the S&P 500 Index outperformed analysts profit expectations. The five hundred largest US listed companies that together determine this index achieved an average 25% higher profit and 10% higher turnover in the second quarter compared to the second quarter of 2017. Profits were naturally boosted by the tax cuts, but strong domestic growth and the rise in the price of oil and other commodities also drove up profits. Profit growth in Europe was more limited. The companies in the Euro Stoxx 600 Index that have presented their figures so far reported an increase in profit and turnover in excess of 5% on average. Weaker economic growth and a negative impact of the strong euro are likely to have contributed to the limited growth. The fading effect of the stronger euro may therefore have a positive impact on earnings growth in the coming quarters. Analysts increase their profit expectations The trend in profit growth expectations is conspicuously strong, both for this year and next year. Following the good second-quarter figures and the positive outlook, analysts have increased their profit growth expectations for almost all sectors. Earnings growth of 15.9% is expected this year for the MSCI All Country World Index (developed plus emerging markets). For 2019, this is currently 9.8%. Equities have become less expensive It is striking that, while profit growth expectations have increased, equities have become less expensive this year. Because the rise in equity prices this year is lagging behind the profit growth (expectations), the price-earnings ratios have fallen in almost all regions. An exception to this is the AEX index: its profit growth forecast is approximately the same as this year s return. Monthly Investment Outlook August 2018 4
We are maintaining our overweighting of equities Uncertainties will not disappear any time soon Investor sentiment will probably be put to the test from time to time by reports of a predominantly (geopolitical) nature. Trade tensions, Brexit problems, the mid-term elections in the US in November, unrest in Turkey and possibly other emerging markets, the Italian Government s fiscal plans: just a few of the issues that can determine the mood on the financial markets in a negative sense, but also in a positive sense. However, these are likely to lead to greater price movements, but this does not mean that we do not see any opportunities in the marketplace. While economic growth is likely to have peaked, it remains stable at a high level, while expectations for global corporate earnings growth have continued to improve. In addition, the valuation of equities has fallen in recent months. We are therefore maintaining our overweight of marketable securities in relation to bonds and our preference for equities within marketable securities. Monthly Investment Outlook August 2018 5
Want to know more? See ing.nl/beursnieuws Disclaimer This investment recommendation was prepared and issued (in Dutch) by ING Investment Office, part of ING Bank N.V., for the first time on 15 August 2018, 12.30 p.m. For the preparation of this investment recommendation, use was made of the following substantive sources of information: S&P Capital IQ, Bloomberg, CreditSights, Oddo Securities, Standard & Poor s, Thomson Reuters Datastream, Moody s, Fitch, UBS Neo, Reuters Metastock and/or Sustainalytics. This investment recommendation was based on the following accounting principles, methods and assumptions: price/earnings ratio, price/book value ratio and/or net asset value (NAV). No protected models were used for this investment recommendation. A description of the ING policy regarding information barriers and conflicts of interest can be found here. Unless otherwise stated, ING Bank N.V. will not update the investment recommendation. Developments that have occurred after the preparation of this investment recommendation may affect the accuracy of the assumptions on which this investment recommendation is based. Investment recommendations are generally revised two to four times a year. This investment recommendation does not constitute individual investment advice, but only a general recommendation on which investors can also base their investment decisions and does not constitute an invitation to enter into any contract or commitment whatsoever. This investment recommendation is based on assumptions and does not represent any guarantee for a particular development or result. No rights can be derived from this investment recommendation. Decisions based on this investment recommendation are for your own account and risk. Neither ING Bank N.V., nor ING Groep N.V. nor any other legal entity belonging to the ING Group, accepts liability for any damage to any extent whatsoever, arising from the use of the above investment recommendation or the information contained therein. Investing entails risks. You could lose all or part of your initial investment. The value of your investment may fluctuate. Past performance is no guarantee of future results. ING Bank N.V. is not registered as a broker dealer and investment advisor as referred to in the US Securities Exchange Act of 1934, respectively, the US Investment Advisers Act of 1940, as amended from time to time, nor within the meaning of other applicable legislation and regulations of the individual states of the United States of America (hereinafter jointly referred to as: US investment law ). This investment recommendation is not addressed to and not intended for US Persons within the meaning of US investment law. Copies of this may not be sent or brought to the United States of America or provided to US Persons. ING Bank N.V. has its registered office in Amsterdam, Commercial Register no. 33031431, and is supervised by the Netherlands Authority for the Financial Markets (Stichting Autoriteit Financiële Markten) ( AFM ). ING Bank N.V. is part of ING Groep N.V. All rights reserved. This investment recommendation may not be reproduced, copied, published, stored, modified or used in any form, online or offline, without the prior written consent of ING Bank N.V. 2017 ING Bank N.V., Amsterdam.