SEB House View 6 September 2017
Summary Decision variables Macro and Markets In Focus Asset Class Views Risk Environment
Summary - We increase risk utilization to 75% because macroeconomic momentum in our view will accelerate faster than what the market is expecting/pricing - Soft data in the US indicates a reacceleration of employment growth over the coming months - Strong employment and wage numbers out of the US will lead to USD strength against DM currencies - Consensus forecasts for 2018 US GDP growth is at 2.3% which in our view does not fully reflect the strength which we are seeing in both soft and hard data - We expect to see upward revisions of both earnings estimates and GDP estimates over the coming months - We do not fear central banks as a risk factor on a tactical horizon - We expect the ECB to communicate a softer tapering process than what the market is currently expecting - The significant EUR strength of recent months increases the fragility of the European recovery and will lead to import of deflation - The downward pricing of the FED rate hike cycle over the past months has gone too far and will be partly reversed with stronger US labour data - We expect the FED to begin the balance sheet reduction in September and hike in December - Survey data indicates positioning has become less of a headwind for equities over the last couple of months - Institutional investors have increased cash balances and reduced equity overweight Old (70%) The speedometer controls to what extent the portfolios should utilize their risk budgets. It is connected to the model portfolio (page 3) which at all times utilizes its risk budget in-line with the speedometer. In a very general sense it can be interpreted as equities on/off (with 50% being neutral). New (75%) Slide 3
Multi Asset Model Portfolio - The model portfolio is 13% overweight equities - Financed by a 16% underweight to government bonds - We are neutral towards credits despite our positive 2017 and 2018 growth outlook - We see High Yield as being more aggressively priced than equities - We expect spreads to remain constant but absolute returns being dampened by rising US rates - We are overweight Emerging Market Debt (local currency) - Low EM inflation reduces the sensitivity of EM FX to US rates - FED rate hikes and/or a balance sheet reduction will not have a negative impact on EM FX; no 2013 tapering scenario - Over the past 6 months we have become increasingly confident about EM growth - Especially given the improvements in global trade - We expect the majority of return for EMD to come through FX appreciation but also foresee spread tightening - We reduce the underweight to commodities - We believe improving global growth will increase demand for industrial metals and oil fundamentals have turned - The model portfolio has a tracking error of 2.8% - The primary driver hereof is the equity overweight - The VaR(95%) of the portfolio is 17.5% - Driven by equities, EM FX, and High Yield spreads - Despite our neutral stance towards credits, High Yield still drives approximately 20% of the total portfolio risk Slide 4 Model Portfolio Government Bonds Equities Investment Grade High Yield Bonds Emerging Market Debt Commodities Cash -16% -3% 0% 0% 5% 1% 13% Allocation Strategic allocation Diff -30% 20% 70% Long only portfolio. Yearly VaR(95%) ex. mean between 7% and 21%.No restrictions on the individual asset classes. The weights are set manually by the House View committee; i.e. they are not based upon an optimization model.
Oil Size Risk contribution of new weights VIX Value (US) Growth (EU) EM FX USDSEK EURUSD USDJPY USDGBP US 2Y Yield US 10Y Yield SW 5Y Yield DE 5Y Yield Momentum Bloomberg Com US HY Spread EU IG Spread EMD Spread EM Asia vs EM Other EM vs GL US vs EU JP vs GL SW vs GL Bloomberg Com Oil US HY Spread EU IG Spread EMD Spread EM Asia vs EM Other EM vs GL US vs EU JP vs GL SW vs GL Size Idiosyncractic Tracking error Equities Momentum (US) Quality (US) Value (US) Growth (EU) VIX EM FX USDSEK EURUSD USDJPY USDGBP US 2Y Yield US 10Y Yield SW 5Y Yield DE 5Y Yield Momentum Idiosyncractic Multi Asset Model Portfolio Risk characteristics Value at Risk (95%) Tracking Error 0 3-5 2.5 2-10 -15-20 Equities Momentum (US) Quality (US) 1.5 1 0.5 0-25 Source: SEB -0.5 Source: SEB Slide 5
Return Multi Asset Class Risk and Return Estimates, 12M 10% 8% 6% 4% Hedge Funds EMD LC Global Equities Swedish equities EM Equities 2% High Yield 0% -2% Investment Grade Government Bonds -4% 0% 5% 10% 15% 20% Risk Source: SEB Slide 6
Regional equity model portfolio - The model portfolio is underweight US equities - The underweight is financing overweight's to Japan, EM Asia, and Europe - Europe being the biggest driver in terms of Tracking Error - The overweight to Japanese and European equities stems in essences from our view that global growth will remain at or above current levels - Looking beyond the pure growth argument we also expect: - Margin expansion in Europe, flat margins in Japan, and contracting margins in the US - A tight labour market and a tightening FED will push up wages and interest costs in the US at a pace which will exceed the same pressures for Japan and Europe - Significant spare capacity for Europe will ensure that margins automatically will rise with an improving topline - Boosting the growth in earnings and making the current bottom-up estimates achievable for Europe - The USD is looking excessively weak given the tightness of the US labour market, and the recent FED communication - We expect USD strength against both the EUR and JPY - This will lead to upside revisions of primarily 2018 EPS estimates for Japan and Europe - This will be a reversal of the trend of latter months Regional equity positioning EM Ex. Asia EM Asia East Asia ex. Japan Sweden Japan Europe North America -15% 0% 2% 0% 2% 4% 8% Allocation MSCI AC Diff -30% 20% 70% Slide 7
Return Equity Risk and Return Estimates Slide 8 9% 8% Sweden China Europe 7% 6% EM LatAm DM Japan 5% 4% 3% US 2% 1% 0% 10% 15% 20% 25% 30% Risk Source: SEB
Summary Decision variables Macro and Markets In Focus Asset Class Views Risk Environment
Change in positive/negative Positive/Negative House View Committee - Macro is the primary positive factor for risk in the eyes of the committee - It is as positive and important as it was in June - Earnings have become more positive but less importance - As the earnings season has come to an end we do not foresee upward revisions over the coming months - The strong EUR has forced 2017 and 2018 EPS estimates of European equities down - We see this process as overdone, both revisions and EURUSD strength, and expect negative revisions to halt - Politics have become significantly more important - The uncertainty about the US administration have been the driving factor over the past couple of weeks - Although we expect the political noise to reside we have a high focus on it at the moment and fear especially that Mnuchin (Treasury secretary) or Cohn (Chief Economic Advisor) resigns - We believe the markets can handle political uncertainty as long as growth remains strong and that the US economic policy team remains stable - Sentiment has become less negative and less important - The recent correction in equities and the increased political noise has tilted sentiment in a more negative direction (market participants are less bullish) - We believe this could foster a relief rally once the political noise resides Slide 10 Macro is the primary factor behind our overweight to risk. High valuations and tightening central banks are viewed as negative factors. 10 8 6 4 2 0-2 -4-6 -8-10 Earnings Sentiment Positioning Macro Politics Politics have become a more important factor since June. This is primarily due to the turmoil in the Trump administration. 5 4 4 3 3 2 2 1 Central Banks Valuations 0 2 4 6 8 10 Importance Source: SEB Sentiment Earnings 1 Central Banks Valuations Positioning Politics 0 Macro -4-2 0 2 4 6 8 Change in importance Source: SEB
Summary Decision variables Macro and Markets In Focus Asset Class Views Risk Environment
Developments in the Markets - Financial markets continues to be dominated by geopolitical risks - North Korea once more gained focus and increased financial volatility by conducting another missile test - The test led to negative markets in late August but the setback was quickly reversed with US equities once more posting new all time highs - Falling inflation rates and increased political uncertainty led to falling longer dated yields over July and August - Generating a flattening of the US yield curve - The pricing of the FED changed so that the divergence between the FEDs funds curve and the FEDs own rate hike projection grew to the highest levels of 2017 - The more dovish pricing of the US rate hike cycle led to significant USD weakness - With the broad USD index falling back to early 2015 levels - The USD weakness, and corresponding EUR strength, led to a significant underperformance of European vs. US equities - The underperformance was most pronounced for European exporters such as for example German large cap - Uncertainty regarding the implementation of fiscal stimulus and tax reform in the US, combined with EUR headwind for EU large cap, led to divergence in the small vs large cap factor for the US and Europe European small cap outperformed while US small cap underperformed. Caused by uncertainty regarding US fiscal reforms and EUR headwind for EU large cap. The strong move in the FX markets have led to a significant rise in the correlation between EU EPS revisions and EURUSD. Slide 12
Index Economy Developed Markets - Hard data has accelerated into Q3 for the US - Atlanta FED GDPNow is close to 4% following a relative strong Q2 reading - Economic surprises for both the US and Europe has started to increase over the last month; SEB House View indicator - More positive/less negative surprises have been confirmed by both Bloomberg s and Citi Groups surprise indicators - The improvement in both surprises and momentum comes primarily from hard data - While soft data for the consumer has moderated we have seen weakness in headline PMIs - Consumer confidence in the US is at decade highs which bodes well for future consumption - The US labour market remains very strong and looks set to gather pace over the fall - Employment components of PMIs have strengthen over the summer - This sub-component showing the most persistent strength across PMIs sub-components in general - Initial Jobless Claims have continued to hover around cycle lows - European industrial production and consumption have continued to gather pace - However recent EUR strength has lowered export orders on the margin Hard data has continued to strengthen for the US. Atlanta FED points towards US 3Q GDP growth in the vicinity of 4%. 50 40 30 20 10 0 Both momentum and surprises are improving for US data. This follows a period of falling momentum since April 2017. Surprise Momentum 16.7 16.4-10 -20 Slide 13-30 Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Source: SEB IM/AA
Economy Asia and Emerging Markets - EM growth momentum has continued to trail that of DM over the summer - The aggregated index has been constrained by weakness in Primarily India, South Korea, and Indonesia - Despite lackluster soft data we are continuing to see strength in especially hard data - Making us less concerned about moderating PMIs - Most of the strength within China macro is concentrated in the old growth engine - The Li Keqiang index is indicating running GDP growth of 11.2% - We expect some moderation herein given the tightening of monetary conditions in China - The significant monetary expansion we saw in China since the beginning of 2015 is receding on the margin - Global trade continues to expand and thereby supports EM exporters - EM inflation rates remains subdued - With low inflation being supported by stronger EM FX and low commodity prices - EM importing deflation and EM commodity importers (primarily Asia) seeing falling input prices - Falling input prices combined with rising output prices (especially for China) will support EM earnings growth EM growth momentum has continued to trail that of DM over the summer. Weakness in EM is concentrated in Asia. Trade for South Korea has continued to expand over the summer. Same picture can be seen on a broad EM level. Slide 14
Summary Decision variables Macro and Markets In Focus Asset Class Views Risk Environment
In Focus #1: US labour market - Soft data indicators are pointing towards a reacceleration in the US employment growth - Confirmed by both the consumer and the firms - Timely hard data such as Initial Jobless Claims and Job openings are confirming the positive picture of the labour market - Wage growth has failed to gain momentum despite the significant fall in the unemployment rate - We expect that wages will start to grow by a higher pace over the coming year - Phillip-curve dynamics are becoming ever more pressing the lower the unemployment rate becomes - Soft data indicators specific for wage growth have started to gain momentum - They have been indicating growth for a couple of years but the level has risen as of late - We expect that the USD will strengthen on a tactical horizon once the soft data strength starts to translate into hard data - As the market will be forced to reprice the FED funds curve - A stronger US labour market is one of our primary arguments as to why we are overweight risk - As we expect it will create USD strength and that FX stability (or USD strength) will be viewed as a positive by the financial markets The consumer is indicating that the US labour market is the most positive it has been in 16 years. We have also seen a clear improvement in the sentiment towards the labour market in the two ISM surveys. Slide 16
In Focus #1: US labour market Hiring plans in the US is standing at levels higher than pre-financial crisis. It is becoming increasingly hard to hire in the US. This is Phillips-curve dynamics and will lead to wage growth. Small firms in the US are the most optimistic about employment growth since 2006. While job openings have soared we have seen layoffs falling to decade lows. Slide 17
In Focus #2: US Debt limit - The debt limit is projected to be reached by end of September - We expect the debt limit will be raised and combined with a spending bill around the deadline - Continuing the trend of later years - We do not expect to see a prolonged shutdown given the majority of the republicans in congress and the need for stability by the Trump administration - Hurricane Harvey increases the likelihood for an increase in the debt limit given that federal funds are needed and it would be political suicide to obstruct reconstruction funds - We expect that the political debate in the US will be dominated by the debt limit and as such the tax reform will get a smaller focus - Once the debt limit has been raised we expect the Trump administration to push for tax reform - Chatter around tax reforms has increased over the last couple of weeks - Although the debt ceiling is a risk factor we put a very small probability on it of leading to a broad equity market correction - The large correction that we saw in 2011 happened at a time when the EUR crisis was still present and growth was weaker - With strong growth and a large republican majority in both champers of congress we do not expect equities to selloff once we get closer to the deadline The debt limit will be reached on 29 September according to Treasury projection. Slide 18
Index In Focus #3: North Korea - With the latest missile and nuclear bomb tests North Korea has gained headlines and has had a negative impact on financial markets - The tests of late are nothing new as North Korea has tested several bombs and missiles over the last couple of years - We do not want to be the judge as to whether it is a game changer that they now perhaps are able to hit the US mainland - In that case one could also have argued that it was a game changer when Seoul was within the range of a nuclear bomb - We choose to look past the geopolitical noise and take comfort in the fact that the market as of now has been able to shake of each test seen so far - To us earnings, macro, and central banks matters more than the small likelihood of a nuclear war; a war which North Korea in any case will loose extremely fast - Not having risk on because of North Korea geopolitical noise would have been extremely expensive over the last couple of years - And waiting for peace on the Korean peninsular seems futile - Although the process seems irrational one could argue that the build up of a potent armament in North Korea reduces the regimes fear for an invasion/preemptive attack - By raising the cost of such an attack on South Korea and its allies - We closely monitor the situation but does not let it impact our allocation There is no lack of North Korea noise over the last couple of years. 2500 2400 2300 2200 2100 2000 1900 1800 Threath (01 Sep 15) Nuclear test (06 Jan 16) Missile (07 Feb 16) Nuclear test (02 Sep 17) SP500 Missile (28 Aug 17) Missile (06 Mar 17) Missile (16 Apr 17) Missile (12 Feb 17) Missile (05 Sep 16) Missile (24 Aug 16) Nuclear test (09 Sep 16) Missile (06 Oct 16) Q4-15 Q1-16 Q2-16 Q3-16 Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Source: SEB Slide 19
Summary Decision variables Macro and Markets In Focus Asset Class Views Risk Environment
Developed Market Equities 12M Outlook - Developed Market equities will be the best performing major asset class over the coming 12 months - Driven higher by improving earnings - We do not expect multiple expansion or contraction - The return of equities will largely mirror the gains in earnings - Bottom-up 12M Forward EPS growth for Europe and the US stands at 9% and 10% respectively - We expect that European equities will deliver actual EPS growth above current estimates - Driven by margin expansion and a reversal of the latest EUR strength against the USD - Topline growth will dominate the overall margin pressure which we are foreseeing - Rising financing costs and wages will in our view drive margins for US companies down from the present all time high levels - However at the same time we expect to see margin expansion in Europe - Boosting the topline growth into earnings - And the pressure in the US will be small - The strong Q2 earnings season was shadowed by the political noise coming out of the US - This creates a latent potential for equities to rise on a tactical horizon once the political noise falls away We do not foresee further multiple expansion. Future equity returns will be driven by earnings growth. Source: Bloomberg and SEB We expect to see European margins converge upwards towards those of the US. Slide 21 Source: Bloomberg and SEB
Emerging Market Equities 12M Outlook - We expect that Emerging Market equities will deliver a return in excess of Developed Market equities - In contrast to Developed Market equities we are expecting both strong earnings growth and multiple expansion - Several factors are supportive for Emerging Market equities - Emerging Market is trading at a historically large discount to Developed Market equities - The premium by which EM is trading is in our view driven by the political uncertainty of later years and because investors shunned the asset class during 2014-2015 - We expect to see upward convergence of the sector adjusted PE for EM equities over the next couple of years - In itself generating a return potential of some 20% - Global trade is rising strongly at the moment - We believe this will boost EM earnings as it has done in the past - The strong Chinese growth momentum will lift growth for the rest of the rest of the EM space - As China has historically been leading aggregated EM growth We expect that the sector adjusted forward valuations of Emerging Markets will converge upward to that of DM. Source: Bloomberg and SEB The rise in global trade (here visualized by South Korea) increases our confidence in the outlook for EM growth; both in EPS and GDP. Slide 22 Source: Bloomberg and SEB
High Yield Bonds 12M Outlook - We expect that global High Yield bonds will outperform Investment Grade and Government bonds over the coming 12 months - Structural factors which historically have been supportive for the asset class are still in place - The growth outlook remains stable and the likelihood for a recession in 2017 or 2018 is very low - The latter is our primary argument as to why we expect High Yield bonds to outperform - Expectations to gradually rising core government bond yields will continue to drive investors into less rate sensitive asset classes; such as High Yield - Credit conditions are being loosened in both Europe and the US - Note that this is a reversal of the trend which we saw for 2016 as a whole - Free cash flows is improving rapidly at the moment - The primary risk for the High Yield space is rising financing costs - This as leverage within the High Yield space has risen over the last couple of years - However we do not expect this to be a major risk factor for the coming 6-12 months - On a tactical horizon we note that the recent rally in High Yield has made the asset class look expensive - Trading at ~70 bps sub our fair value estimate Factors that have historically been supportive for HY are still in place: Growth is strong and credit conditions are loose. Much of this is however in the price already. Source: Bloomberg and SEB Our fair value model indicates that US High Yield (ex. energy) is trading 60 bps too tight. We do not expect tightening spreads from here. Slide 23 Source: Bloomberg and SEB
Emerging Market Debt 12M Outlook - We expect Emerging Market debt to deliver a return in excess of DM government bonds, Investment Grade and High Yield for the coming 12 months - A return supported by both stronger EM FX against the USD and higher carry - We expect EM FX and EM rates to remain resilient to FED rate hikes following the current projection - Led by China we have seen a broad based revival in EM growth - We believe this revival is more stable than those of later years given the regional breadth and the uptick in global trade - As EM growth has gained momentum of its own we do not expect to see a negative impact on EM FX from rising US policy rates - Assuming a rate hike path such as predicted by the FED - Low EM inflation reduces the likelihood that EM countries will be forced to hike in tandem with the FED - Spreads in EM has fallen significantly and the return potential from further spread compression is low - We believe the bulk of EMD LC performance will come from FX appreciation - The main risk to Emerging Market debt is political risks - There remain a lack of structural reforms but we do not expect it to generate a correction while growth is strong Low EM inflation generates a scenario in which US rates can edge higher (due to strong growth) without denting EM FX. We see most value in EMD Local currency. We expect the majority of future return will come from FX appriciation rather than spread compression. Slide 24
Core Government Bonds 12M Outlook - We expect core government bonds to deliver a negative return over the coming 12 months - Driven on an aggregated level by rising US rates - In contrast to the US market we expect short rates in Europe to remain firmly anchored - Leaving a steeping of EUR curves as the only possible outcome so forth rates and inflation expectations continues higher - The divergence between Europe and the US is largely a reflection of the different stages in the business cycles - While slack in the US economy has all but evaporated European unemployment rates are still sitting firmly above most NAIRU estimates - We are as such a long way from experiencing any meaningful core upward inflationary pressures in Europe - This view is starting to be priced into the market as well as we have seen 5Y5Y break-even inflation falling back over March - We expect European peripheral bonds to continue to outperform as growth strengthen - Supply/demand dynamics favors Europe over the US - Fiscal stimulus in the US will increase supply while demand in Europe will remain high given the ECBs QE program Yields have now reverted to the lower range of 2017. In so far this is a reflection of recent low inflation prints we think the move is overdone. Slide 25
Summary Decision variables Macro and Markets In Focus Asset Class Views Risk Environment
Risk Environment - The biggest tactical risk factor for equities is a negative reaction to the upcoming FED balance sheet reduction - A reaction similar to that of FED tapering in 2013 - The scenario is a risk since it is the first, true, reversal of the quantitative easing that we have seen since the financial crisis - Although the implementation hereof is our biggest risk scenario we ascribe it a low probability of actually generating a negative outcome - The reduction will be gradual (as indicated by the June FED meeting) and it is not happening while inflationary pressures are high for the US - Allowing the FED to postpone the next rate hike till December 2017 - Over the coming months we see political risks as elevated for both Europe and the US - For Europe we are primarily concerned about Italy and the upcoming elections - At the latest to be held in March 2018 - We see the risk as elevated especially since the market pricing as of yet has been so benign - US political risks have over the past couple of weeks dominated the financial markets - Although we do not allocate on the basis of political risk we acknowledge that they are presently heightened - A departure of Mnuchin (Treasury secretary) or Cohn (Chief Economic Advisor) would lead us to reevaluate our current stance towards risk The FED balance sheet reduction will be the first real reversal of QE since the financial crisis. Slide 27
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