INVESTMENT STRATEGY & MARKET OUTLOOK GREG FLEMING HEAD OF INVESTMENT STRATEGY (NZ) MAY 2018
2018 ASSET RETURNS LED BY COMMODITIES, NZ SHARES NZ Cash NZ Bonds Global Treasuries Global Agg NZ Equities Aus Equities (AUD) MSCI World (local) EM Equities (local) NZ Property Global Property Global Infra Commodities NZD (MSCI) NZD/AUD Source: AMP Capital -2.2% -2.1% MTD CYTD Returns to 31 May 2018-1.2% -0.7% -0.4% -0.3% 0.2% 0.2% 0.5% 0.4% 0.0% 0.1% 0.1% 0.8% 0.7% 1.0% 0.5% 1.1% 1.0% 1.3% 1.0% 1.4% 2.0% Income 2.5% 3.1% Growth FX 3.1% 3.0% -3% -2% -1% 0% 1% 2% 3% 4% 3.7% > May saw additional gains in equities rebound from weak First Quarter performance as US 10Y yields slid from 2.95% to 2.75%. > Global bonds weak performance continued, with a flat Year-to-Date performance despite small May gains in Government sector. > YTD NZ cash continued to outperform Global bonds (+0.8% vs. 0.0%.) NZ Bonds have fared better, with a 1.0% YTD return. > Global equities improved and are now just into positive territory for 2018. The USA has driven returns with S&P up 2.0% YTD offsetting declines in Europe and Japan. NASDAQ hit a record high. > Medium-term, economic and earnings data remain supportive, and US tax reform suggests more M&A / share buybacks developing in H2 2018. > However, political uncertainty remains given the US Administration s tariff hikes and aggressive trade rhetoric, and differences widening within Europe. > High risk of escalation given November 18 election and Trump s need to motivate the Republican voting base. Populism continues to be rewarded. > Emerging Markets underperformed as the stronger USD impacted on sentiment, and news flows were poor (Turkey, Mexico, Brazil.) Year-to-Date returns from EM are now effectively flat (-0.4%.) > The NZ share market built on April s recovery, gaining +2.5% in May and thus, +3.1% YTD. > Australian shares slightly lagged other markets in May (+1.1%). The YTD market return is now in line with the +1.0% Global index. > The softening in US and Domestic bond interest rates supported a rebound in the Property sector from marked weakness in the First Quarter. > NZ Listed Property gained 3.1% in May and is now up +0.5% YTD. Global REITs rebounded +3.0% but are flat Year-to-Date (-0.3%) due to expected higher US rates dampening confidence. > Returns from Infrastructure managed a 0.1% gain but remain down -2.1% Year-to-Date as yields on competing global assets firmed. > Commodities rally continued, +1.4% in May and 3.7% YTD. > NZD was flat against the MSCI basket but softened versus AUD. PORTFOLIO WATCH - JUNE 2018 2
THE GLOBAL INVESTMENT CYCLE STILL IN THE SWEET SPOT BUT WATCH US INFLATION FEARS Impending phase of: lower growth / higher inflation supports a cautious asset allocation Current position: moving toward high noon but still in the sweet spot for growth assets Source: PIMCO, AMP Capital PORTFOLIO WATCH - JUNE 2018 3
CYCLE IS YET TO DISPLAY DOWNTURN CHARACTERISTICS THE POST-GFC CYCLE REMAINS EXTENDED, WITH DEBT DYNAMICS CRUCIAL JOBS INFLATION DEBT DYNAMICS Source; Morgan Stanley, AMP Capital PORTFOLIO WATCH - JUNE 2018 4
RISK INDICATORS SUGGEST LIKELY MARKET TOPS IN H2 18 GLOBAL INVESTOR CONFIDENCE IS NEUTRAL NEITHER EUPHORIC NOR PANICKED Inflation, credit quality and interest rate fears not yet reflected in investor sentiment, which is neutral Source: Morgan Stanley, AMP Capital Last data point: 31 May 2018 PORTFOLIO WATCH - JUNE 2018 5
MAY EQUITY REBOUND A US (AND CANADIAN) STORY > Globally, stocks, bonds and property are all markedly expensive compared to long-term historical norms. US is particularly so. > Since the Q1 18 correction, PE valuations have improved, but not to a degree suggesting value. Hence, uncertain market direction. > Risk is still considered to be under priced leading to compressed risk premia for historically volatile assets. Volatility indices supressed (e.g. VIX ) and again, VIX is well below its 10-year average value of 17.7 as at 7 June, at 11.7. > This was the level of the VIX index at end-jan. prior to the market correction. > While US Corporate earnings have surprised very positively this year, some of the causes (tax, USD) are transitory. > Higher global interest rates are gradually eroding the bullish fundamentals, but the markets may still achieve new highs in the absence of either inflation or major political shocks. > Neutral strategies in most growth assets are prudent, even if some additional upside may be foregone, as risk of further shocks more elevated than normal. > Weakening equity returns from Emerging Markets have potential go further, after a stellar 2017 performance. MSCI EM Index gained +31% in 2017; but in 2018 YTD the Index has declined only -2.5% despite a range of negative developments. Source: Morgan Stanley, AMP Capital Source: Morgan Stanley, BCA Research, AMP Capital PORTFOLIO WATCH - JUNE 2018 6
NZ EQUITIES STILL OUTPERFORMING GLOBAL MARKETS 3 YEARS LOCAL CURRENCY CUMULATIVE RETURN: NZ +30% ABOVE MSCI WORLD HISTORICALLY, WHEN GLOBAL GDP BEGINS EXCEEDING NZ, THE RELATIONSHIP FLIPS MODERATION IN NZ EQUITY RETURNS AHEAD, BUT INTEREST RATE SUPPORT REMAINS 60.0 50.0 40.0 30.0 20.0 10.0 0.0-10.0-20.0-30.0 May 2015 Nov 2015 May 2016 Nov 2016 May 2017 Nov 2017 May 2018 NZX 50 Gross % change: 50.8 MSCI World (USD) % change: 20.1 Source: AMP Capital, Bloomberg Data to 6 June 2018 PORTFOLIO WATCH - JUNE 2018 7
EMERGING MARKET SHARES VULNERABLE TO RISKS COMING FROM THE USD AND INTEREST RATES > EMERGING MARKET PERFORMANCE WAS ROBUST ON GLOBAL GROWTH OPTIMISM. NOW, OUTPERFORMANCE OF DM HAS CEASED AND EM MAY LAG DM FOR 2018-19. > THE RISK-OFF PERIOD IN FEBRUARY-MARCH INDICATED DIFFICULTIES AHEAD AS CAPITAL FLOWS RETREAT. > POSITIVES MOSTLY DISCOUNTED, WHILE RISKS ARE THEREFORE RISING. WE REMAIN NEUTRAL ON EM. > MAJOR DIFFERENCES BETWEEN INDIVIDUAL EMS. > COMMODITY-PRODUCING EMS MAY BE BOOSTED ON HIGHER PRICE TREND, BUT DEBT GROWTH HAS BEEN STRONG IN COMMODITY IMPORTERS LIKE CHINA. > SUBSTANTIAL DOMESTIC ISSUES REMAIN TO BE RESOLVED IN MANY EMERGING ECONOMIES, WHICH WILL BE TESTED BY HIGHER GLOBAL RATES, CREDIT SPREADS, TRADE POLICY CHANGE AND A RISING USD LATER IN 2018. > IN CONTRAST TO THE US, FORWARD EARNINGS REVISIONS HAVE RECENTLY TURNED NEGATIVE. > KOREAN / SOUTH CHINA SEA RISKS STILL A WILD CARD, BUT THIS RISK HAS DIMINISHED IN THE LAST QUARTER. > TRADE CONFRONTATION RISKS ARE HOWEVER RISING FAST. PORTFOLIO WATCH - JUNE 2018 8
Thousands FIXED INCOME NORMALIZATION WELL UNDERWAY TRADERS STILL EXPECT UPSIDE YIELD RISK ON THE US-10Y NOTE 31 MAY 2018 OBSERVATION SAW AN INCREASE IN NET SHORTS TO A RECORD 500 400 300 200 100 0-100 -200-300 -400-500 Speculative short positioning and US 10Y yield 3.20 3.00 2.80 2.60 2.40 2.20-600 Apr 17 Jun 17 Aug 17 Oct 17 Dec 17 Feb 18 Apr 18 2.00 US 10-year bond speculative short positions (LHS) US Govt 10 Year Bond Yield (RHS) SOURCE: BLOOMBERG, AMP CAPITAL PORTFOLIO WATCH - JUNE 2018 9
FIXED INCOME STILL PROVING A WEAK DIVERSIFIER RISING BOND YIELDS AND WIDENING SPREADS LED TO LOSSES IN MOST US FIXED INCOME SECTORS YTD > THE MARKET IS NO LONGER FIGHTING THE FED. THE RISE IN US YIELDS IS INCREASINGLY BEING ACCEPTED AS A PERMANENT UPWARD ADJUSTMENT. > WHILE US GOVERNMENT LONG BONDS ARE CLOSER TO FAIR VALUE THE MOVE MAY NOW PAUSE AWAITING CPI INFLATION CONFIRMATION. > FEDERAL RESERVE REMOVAL OF QE COULD ADD 1.0% TO THE 10Y YIELD OVERALL, SO 3.5% IS A REASONABLE TARGET BY END-2018. > HOWEVER, THE MARKET POSITIONING IS NOW VERY NEGATIVELY EXTENDED FOR MATURITIES 2Y-10Y. > WE REMAIN UNDERWEIGHT, BUT REDUCED THE EXTREME EXTENT OF THE U/W IN NOVEMBER. > AFTER AN ADDITIONAL, MEANINGFUL SELL-OFF, WE MAY AGAIN REDUCE THE U/W BY A SMALL QUANTUM. > WHILE WE DON T EXPECT ANY BOND RALLY, SCOPE FOR ADDITIONAL CAPITAL LOSSES FROM US SOVEREIGN BONDS IS DIMINISHING. > THE POST-FEBRUARY EQUITY CORRECTION SAW VERY LITTLE ADDITIONAL DEMAND FOR BONDS, WITH CASH BEING PREFERRED. > LOWER DIVERSIFICATION BENEFITS GOING FORWARD. SOURCE: AMP CAPITAL, MORGAN STANLEY PORTFOLIO WATCH - JUNE 2018 10
EMERGING MARKETS ARE FINALLY PRICING IN SOME RISK THE MOST VULNERABLE FREE ECONOMY EMERGING MARKET YIELDS ARE RISING NOTE THE RESILIENCE SO FAR IN CHINA AND RUSSIA Source: Topdown Charts, AMP Capital PORTFOLIO WATCH - JUNE 2018 11
EMERGING MARKET CURRENCIES HAVE TURNED DOWN RISE IN US INTEREST RATES A CHALLENGE. INDIAN CENTRAL BANK LATEST TO HIKE RATES VALUATIONS FOR EM FX ARE NOT EXCESSIVE, BUT DEBT (BOTH USD AND LOCAL) IS HIGH EMERGING MARKET WEAKENING A CANARY FOR DECLINING CARRY TRADE REGIMES MSCI Emerging Currencies Index 1800 1750 1700 1650 1600 1550 1500 1450 1400 1350 ----- post-2010 average 1300 1250 1200 May 10 May 11 May 12 May 13 May 14 May 15 May 16 May 17 May 18 Source: Bloomberg, AMP Capital Last data point: 31 May 2018 PORTFOLIO WATCH - JUNE 2018 12
CURRENCIES: USD MODERATE REBOUND UNDERWAY LATIN AMERICAN EMERGING MARKET CURRENCIES HAVE WEAKENED SHARPLY Source: Morgan Stanley PORTFOLIO WATCH - JUNE 2018 13
CURRENCIES: NZD NO LONGER SUPPORTED BY USD CARRY 3 MONTH FORWARD POINTS MEASURE THE PREMIUM USD SELLERS RECEIVE TO COMPENSATE FOR FORGOING THE USD S YIELD ADVANTAGE 20 NZD forward points vs. NZD/USD exchange rate 0.35 0-20 -40 0.45 0.55-60 0.65-80 -100-120 0.75 0.85-140 0.95 May 00 May 02 May 04 May 06 May 08 May 10 May 12 May 14 May 16 May 18 NZD forward points (lhs) NZD/USD (rhs, reverse scale) Source: Bloomberg, AMP Capital PORTFOLIO WATCH - JUNE 2018 14
COMMODITIES: FUNDAMENTALS-DRIVEN PRICE GAINS RISE IN GLOBAL INDUSTRIAL PRODUCTION (+5% YOY) SUPPORTS METALS GAINS OIL DYNAMICS STILL POSITIVE, BUT OPEC COULD INCREASE OUTPUT TO OFFSET THE SANCTIONS US IS RE-IMPOSING ON IRAN PRECIOUS METALS PROVING LESS ATTRACTIVE FOR RISK OR INFLATION HEDGING SOURCE: MORGAN STANLEY, AMP CAPITAL PORTFOLIO WATCH - JUNE 2018 15
GEOPOLITICAL RISK WATCH LIST A WIDE VARIETY OF POLITICAL OUTLIERS ARE IN PLAY AT PRESENT EVENT POTENTIAL IMPACT SIGNIFICANCE PROBABILITY OF POTENTIAL IMPACT BREXIT complications / Italy angst Hit to UK and European FX Medium Medium (raised since Dec. 17) US politics Trump risks Hit to US confidence High Medium (raised since Dec. 17) Terrorism threat / Syria problem Confidence disruption Medium Low but watch US punitive moves South China Sea / Korea escalation War High Low (diminished since Dec. 17) Trade war between US & China Economic disruption High Medium (increased from Dec. 17) Financial price shock (Bitcoin, EM ) Market disruption / contagion High Medium-High Source: AMP Capital PORTFOLIO WATCH - JUNE 2018 16
ASSET OUTLOOK AND POSITIONS Asset class Near term view Medium term view Bias Global equities Remain broadly positive on a 12 month horizon on fiscal easing and US economic optimism lifting corporate earnings. However, no strong immediate catalysts for further gains from record index levels. An incipient euphoria has been deflated with Q1 market volatility, which is healthy as interest rate risk is priced more realistically. Valuations are still positive for this asset class relative to bonds and cash but US is extended compared to its historical fair value and cyclically-adjusted P/E. NEUTRAL Emerging market equities EM countries with external funding needs remain vulnerable on debt levels. As US trade policy becomes more discriminatory, there would be grounds to move defensively on this volatile asset class. Medium-term fundamentals remain attractive on an absolute and relative basis. Short-term country and currency risks do not yet justify active EM positions. NEUTRAL Australasian equities NZ should underperform global shares as global sentiment improves. Australian shares offer better value but require more certainty on banks and domestic corporate earnings track. Fragility to continue given banking enquiry, housing market softness etc. Australasian shares are reasonably priced given current financial and economic conditions. However, regulatory and debt-quality issues affect the banks. NEUTRAL Listed property Should track global equities in the near term with risk of underperformance if longer-term US interest rates continue to rise and if the yield curve steepens. However, demand levels are high. From an absolute return perspective, the low real yield global environment should provide support over the medium term. Accelerated tightening risk rising, particularly in US but not yet a threat in Australasia. NEUTRAL Alternative Growth Infrastructure can benefit from US administration part-funding projects, but interest rate rises challenge the yield of utilities. Commodity prices are in a period of consolidation. Some upside if inflationary sentiment mounts, but oil is around its 3-year highs. Cyclical price lows and improving demand are positive factors but the energy oversupply issue is expected to constrain upside in prices for some time. OVERWEIGHT Global bonds Yields have moved higher in Q1. Core inflation pressures remain contained around the world so upside from current levels is limited. Fed balance sheet trimming proceeding, ECB may accelerate too. Global bonds are still poor value, with yields remaining artificially supressed by central bank activity. US Federal Reserve will likely continue normalizing its balance sheet throughout 2018. UNDERWEIGHT New Zealand bonds Expect long-end and returns to take lead from US but relatively robust fiscal outlook could maintain decent demand for NZ bonds. As with global bonds, upward pressure on yields foreshadows low returns over the medium term. UNDERWEIGHT Cash Foreign currency The Official Cash Rate is 1.75%. We believe this is the low for this cycle. Interest rates likely on hold until early 2019. USD out of favour but diverging monetary policy between the US Fed and RBNZ suggests NZD risks are skewed to downside on a 12 month horizon. NZ econ policy shifts are impacting confidence. We forecast similar returns from cash and bonds over the medium term but cash has lower risk of capital loss than bonds. The NZD is a little overvalued on a MSCI weighted basis. Domestic growth lacks catalysts beyond migration at present. Dairy prices forecast lower. OVERWEIGHT OVERWEIGHT PORTFOLIO WATCH - JUNE 2018 17
IMPORTANT NOTE Neither AMP Capital Investors (New Zealand) Limited, nor any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this presentation. Past performance is not a reliable indicator of future performance. While every care has been taken in the preparation of this document, AMP Capital Investors makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. This document has been prepared for the purpose of providing general information, without taking account of any particular investor s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided. PORTFOLIO WATCH - JUNE 2018 18