IV Investment Views 30 January 2015 This commentary has been produced by HSBC Global Asset Management to provide a high level overview of the recent economic environment, and is for information purposes only. The views expressed were held at the time of preparation; are subject to change without notice and may not reflect the views expressed in other HSBC Group communications or strategies. This marketing communication does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. The content has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. You should be aware that the value of any investment can go down as well as up and investors may not get back the amount originally invested. Furthermore, any investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in established markets. Any performance information shown refers to the past and should not be seen as an indication of future returns. You should always consider seeking professional advice when thinking about undertaking any form of investment. ECB launches sovereign QE, providing support for asset prices Key takeaways European equities outperformed in January as the European Central Bank (ECB) announced sovereign Quantitative Easing (QE). Falling oil prices will exert downward pressure on inflation but are expected to provide a net boost to global growth, which is also supported by easy monetary policy. In our view, the major government bond markets do not offer an attractive balance of prospective risk and return. However, peripheral Europe and some Emerging Market (EM) government bond markets seem to offer better opportunities. We believe that corporate assets offer better value, including equities, even though equity market volatility looks set to become a more regular occurrence. High yield credit spreads are now above our assessment of equilibrium. After a strong rally, the USD now looks fair value against the EUR and JPY but versus the other G10 currencies, it still looks under-valued, particularly the AUD and NZD. Central banks remain determined to give as much support as they can to the global economy. The ECB has finally ramped up its asset-purchase programme and falling oil prices may enable the Fed to delay increasing rates from the historic low of 0.25% they have been stuck at for over six years. In addition, fiscal policy looks set to be less of a drag on growth. However, country growth outlooks are cyclically diverging and spare capacity continues to weigh on pricing power. We believe that safety assets, including major developed market government bonds, offer poor longterm prospective returns. Peripheral Europe and some of the EM government bond markets look more attractive on a risk/return basis. The absolute return from equities is likely to be low by historic standards due to meagre cash rates. This makes for a fragile equilibrium in which the short-term return from equities is vulnerable to being pushed into negative territory by a shock.
DM equities EM equities UST (7-10 yrs) Global Agg Global EM Global HY WTI Crude Oil Gold Asset class performance: January 2015 Chart of the month: The ECB has finally joined other central banks by engaging in QE % 10 Equities Bonds Commodities EUR, bn 3,500 Assuming EUR60bn purchases a month until September 2016 0-10 3,000-20 -30 MTD 2014 2,500-40 -50 2,000 Forecast Note: MTD- Month-to-Date; DM- Developed Markets; EM- Emerging Markets; UST- US Treasury; HY- High Yield; WTI- West Texas Intermediate; Agg= Aggregate. All performance data is calculated in total return terms. Equities are in local currency, other assets are in USD. Source: Bloomberg, as at 27 January 2015. For illustrative purposes only and does not constitute any investment recommendation in the above-mentioned asset classes. Past performance is not indicative of future returns. 1,500 10 11 12 13 14 15 16 ECB Balance Sheet Assets Source: Bloomberg, HSBC Global Asset Management as at 27 January 2015. For illustrative purposes only. Any forecast, projection or target contained in this presentation is for information purposes only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets. ECB launches sovereign QE, supporting both global equities and bonds, while oil prices fell further European equities outperformed and major government bond yields fell as the ECB provided further monetary stimulus In January, global equity markets edged higher on improving risk appetite, supported by the announcement of quantitative easing by the European Central Bank (ECB). The gains came despite oil prices falling a further 13% during the month and significant episodes of volatility as the Swiss National Bank (SNB) decided to abandon its minimum exchange rate policy of 1.2 CHF/EUR and investors assessed the outcome of the Greek elections. The MSCI AC World index rose 0.9% in local currency total return terms, with the MSCI Eurozone index outperforming, advancing over 7%. Perceived safe-haven developed market government bond yields fell considerably in January as declining oil prices weakened the inflation outlook and the ECB announced further monetary easing. US Treasury 10-year yields fell around 35bp to 1.82% while 10-year German bund yields fell over 15bp to 0.38%. The EUR depreciated almost 6% against the USD as relative rate expectations continued to diverge. (All data as at 27 January 2015). Falling oil prices will exacerbate global disinflationary pressure but should be a net positive for global growth Although consensus inflation forecasts (Figure 1) have fallen in response to the near 60% fall in the oil price since the end of June, there has been a reluctance to accept that the fall in the oil should act as a boost to global growth. The consensus forecast for global growth in 2015 is 3.0%, down from 3.2% three months ago. In part the fall in consensus growth expectations reflects further turmoil in the Eurozone and the on-going slowdown in the pace of growth in China. Nonetheless, there seems to be an unwillingness to accept that lower oil prices, provided that they are sustained, should be positive for global growth. Easy monetary policy and less fiscal drag will act as supports to growth There are two other reasons to believe that global growth will be robust this year. First, central banks remain determined to give as much support as they can to the global economy. Indeed, at its January meeting the European Central Bank (ECB) finally bowed to the inevitable and ramped up its asset-purchase programme. The ECB now intends to buy EUR60bn of assets a month, including for the first time a big slug of government bonds, until it is confident that inflation is on its way back up from December s reading of -0.2% to the 2% target. Meanwhile, the fall in the oil price may enable the US Federal Reserve (Fed) to once again delay starting the process of increasing policy rates from the historic low of 0.25% they have been stuck at for over six years. Secondly, there is expected to be less fiscal drag on average over the next two years in the advanced economies than there has been over the last five. This is even the case in the fiscally challenged Eurozone and there is a possibility that the strong performance of the anti-austerity Syriza party in the recent Greek election could start turning the tide against austerity. Country growth outlooks are cyclically diverging Although in aggregate, global growth is holding up pretty well, there continues to be cyclical divergences across countries. Now-casts suggest that US growth is tracking at around 3% and the balance of risks to consensus 2015 US growth forecasts is probably to the upside. Cyclical indicators for the Eurozone and Japan have been losing momentum and growth consensus expectations are moribund. In the case of the Eurozone the combination of more aggressive action by the ECB, a fall in the exchange rate, and signs in the ECB s loan officers survey that both credit supply and demand are starting to improve, point to an improvement in growth momentum through the course of 2015 and with it, potential for an upward surprise to beaten-down consensus growth expectations. Expectations for Chinese growth in 2015 have moderated slowly to 7% and will probably continue to adjust lower. Spare capacity continues to weigh on pricing power In the major developed economies, inflation trends remain benign with little wage inflation and falling inflation expectations. Disinflation pressures are now a feature in emerging markets too. Organization for Economic Cooperation and Development (OECD) wide inflation has halved from 3.2% in late 2011 to 1.5% and looks set to fall further in the months ahead as low energy prices feed 12/02/2015 Investment Views 2
through and excess capacity continues to take its toll. Low inflation means that central bank policy rates are likely to remain low over the medium term. Consequently, we expect that real interest rates will be low relative to historic experience, helping to support economic growth and risk-asset prices. Figure 1: Consensus inflation forecasts have been downgraded considerably since June as oil prices have fallen Figure 2: Although the USD has strengthened, it is still below its early 2000s level Note: CPI= Consumer Price Index; yoy= year-on-year; LHS= Left Hand Side; RHS= Right Hand Side. Source: Bloomberg, as at 27 January 2015. For illustrative purposes only. Source: Bloomberg as at 27 January 2015. For illustrative purposes only and does not constitute any investment recommendation. Periphery Europe and some of the EM government bond markets seem to offer opportunities After their strong performance in 2014, which saw the Barclays Global Aggregate Index, hedged into USD, return 7.6% and the yield on 10-year US government bonds drop to just 2.2% by the end of the year, we believe that safety assets, including the main developed market government bonds, offer poor long-term prospective returns. Peripheral Europe and some of the Emerging Market (EM) government bond markets look more attractive on a risk/return basis. In our view, Eurozone peripheral 10-year government bonds offer higher potential excess returns than German government bonds. We expect the implementation of sovereign bond Quantitative Easing (QE) by the ECB to compress risk premia in the periphery, causing these bonds to outperform. However, over the next few weeks Eurozone peripheral bond markets are likely to be volatile as the new Greek government attempts to negotiate an improved bailout package. The negotiation process could potentially cause markets to worry about Greece exiting the Eurozone or other peripheral economies also attempting to cut a better deal with their creditors. The USD now looks fair value against the EUR and JPY but versus the other G10 currencies it still looks under-valued The US dollar, as measured by the DXY Index (Figure 2), rose 12.8% in 2014 and has risen a further 5% so far this year. We estimate that after this strong run the dollar is now at fair value relative to the EUR and JPY. Hence, further USD strength from here against the EUR and JPY is most likely to be driven by relative macro fundamentals rather than additional valuation adjustment. However, versus the other G10 currencies, the US dollar continues to look under-valued, especially when compared to AUD and NZD. As well as not having valuation on its side, the Australian dollar is also likely to suffer from the economy s links to China, commodity dependency and cooling housing market. Among the EM currencies we continue to observe a regional divergence in outlooks between Asia and Latin America. Over the medium term, some of the Asian currencies continue to look attractive on an expected risk/reward basis and have historically been relative safe-havens when the Fed is raising interest rates. High yield credit spreads are now above our assessment of equilibrium Since the end of Q3 2014, US credit spreads have widened due to a combination of anticipation of US interest rate rises and in the case of high yield, the impact of falling oil prices on the credit worthiness of shale gas companies. Energy accounts for 14% of the US high yield index. European credit spreads have exhibited significantly less volatility. Although, the risk-adjusted returns for investment grade credit are roughly where they were at the end of September 2014, those for high-yield have risen, as spreads have widened further (Figure 3), and are now above our assessment of equilibrium. Although the extra yield for taking credit risk remains relatively attractive, there are risks. For example, a more rapid rise in US interest rates remains as a major risk for high yield credits. However, for now, the default environment remains pretty benign with a speculative default rate of only 2.2% and Moody s is forecasting that it will only rise to 2.6% in 2015. Equity market volatility looks set to become a more regular occurrence in 2015 Although we expect global equities to return a normal 4% premium over global cash on average over the next few years, the absolute return from equities is likely to be low by historic standards due to meagre cash rates. This makes for a fragile equilibrium in which the short-term return from equities is vulnerable to being pushed into negative territory by a shock. Prime candidates to generate a shock include a more rapid increase in US interest rates, if an acceleration in pay inflation finally materialises, a sharper than expected slowdown in the Chinese economy and another bout of the Eurozone crisis if the new Greek government succeeds in negotiating a significantly better deal with its creditors and that encourages other peripheral countries to also push for improved terms. Regardless, we expected the fragile equilibrium to mean that the spikes in equity market volatility (Figure 4) become a more regular occurrence than they have been over the last few years. The spikes in volatility over the last three months are probably a taste of what is to come in 2015. 12/02/2015 Investment Views 3
Figure 3: US high yield credit looks increasingly attractive Figure 4: Spikes in equity market volatility may become more frequent Source: Bloomberg as at 27 January 2015. For illustrative purposes only and does not constitute any investment recommendation. Past performance is not indicative of future returns. Source: Bloomberg as at 27 January 2015. For illustrative purposes only and does not constitute any investment recommendation. Summary of long-term views (>12 months) Views are based on a meeting of the HSBC Global Asset Management Global Strategic Investment Committee (GSIC) held on 21 January 2015, portfolio positions and the HSBC Global Asset Management s long-term expected returns forecasts. Data within this document and commentary is at 27 January 2015 unless stated otherwise. Asset class View Summary Equities Global US UK Eurozone Japan Central and Eastern Europe (CEE) & Latin America (LatAm) Government bonds Neutral We expect to be better rewarded over the long-term for holding equities rather than government bonds, corporate bonds, commodities or cash. Even if growth slows somewhat, we believe the global economic recovery is still on track and equity valuations don t look stretched. Continued support from QE will likely outweigh headwinds created by concerns about risks from geopolitics, slower growth in China, tighter than expected US monetary policy and Eurozone deflation. Although, these uncertain risks will likely lead to sudden spikes in volatility. A US economic recovery that looks increasingly durable and a central bank that remains focused on sustaining that recovery are supportive for US equities, in our view. With bond yields so low, equity valuations remain relatively attractive. We expect US earnings growth to continue to be a driving factor in global equity growth. UK valuations are attractive too, relative to low fixed income yields, especially as the Bank of England seems to be in no obvious hurry to tighten monetary policy. The global easy money environment should offer support but elections will inject some political uncertainty to 2015. Eurozone equities should see considerable support in 2015 from the substantial quantitative easing programme. Stimulus, ultra-low rates, a weak euro and attractive valuations should outweigh negatives like systemic Eurozone risks, lowflation and lack-lustre earnings growth. Aggressive monetary and fiscal policy changes will likely keep equities buoyant, the yen weak and should provide support to economic and corporate earnings growth, although declines in real wages are weighing on domestic demand in the short term. Attractive valuations and low bond yields will remain supportive for equities. In the long term, we anticipate positive growth differentials compared with Developed Markets to be maintained. As with Asia however, these markets are vulnerable to investor concerns about reduced global liquidity. The recent fall in commodity prices will continue to be a severe headwind for commodity dependent producers such as Chile. In addition, geopolitical tensions remain high and unpredictable. US We believe US treasuries are pricing in an overly pessimistic macroeconomic outlook for the US economy. Equally, with yields this low we think risks are asymmetric to the downside and prefer to be underweight relative to risk assets like equities. UK We believe UK gilt yields are also too low relative to their long-term averages and are pricing in an overly pessimistic macroeconomic outlook. Hence on a relative basis we generally prefer equities to perceived safe-haven government bonds. 12/02/2015 Investment Views 4
Eurozone Core European bonds are overvalued but with European QE starting we think this is unlikely to correct. With negative yields in the core we see more opportunity in some periphery assets. Overall, with upside limited from here, we prefer to be underweight bonds and long equities and credit. Emerging markets Spreads in the EM debt universe are at risk of further widening when tighter US policy arrives. Local currency bonds have lost ground with a stronger dollar over the last six months although we expect stronger local currencies longer term; bonds from commodity dependent currencies are particularly at risk. Dollar denominated debt spreads look tight relative to history but the yield pick-up continues to make them attractive relative to Developed Market (DM) government debt. Corporate bonds Investment grade High yield Gold Other commodities Neutral Although leverage is increasing, we believe corporate balance sheets remain in good shape and investors are likely to continue to reach for investment grade yield against a backdrop of low rates and a gradually improving global economy. Tighter US policy remains a major risk. Given the notable widening of developed market high yield credit spreads, valuation has improved and with it our estimate of the expected return for this asset class. Defaults remain low and the demand for yield high. However, there are risks. As with Investment Grade (IG), as the market starts to anticipate tighter US monetary policy, high yield credit could be volatile. Gold remains at risk in a low inflation and strong USD environment. Although the prospect of massive QE programmes in the Eurozone and Japan could help stabilize the precious metal in the near term, we believe gold offers limited value. Other commodities will be unable to benefit substantially from a pickup in the global economy due to excess supply. Crude prices now appear too low but the period of achieving a supply/demand balance may take some time and so we remain neutral commodities overall. Real estate Property continues to offer a positive yield margin and attractive long-run return relative to government bonds but we are selective by region. Asian assets EM Asian Fixed Income Asia ex Japan Equity - China - India - Hong Kong Neutral - Singapore Neutral - South Korea - Taiwan Neutral From a long term perspective, return signals remain positive, backed by sound fundamentals in terms of economic growth, stable inflation and credit quality. Local currency debt offers a better prospect given the appreciation trend we still perceive in the region. However, on a nearer term perspective, this asset class is sensitive to US monetary conditions and its impact on global interest rates, liquidity and USD. Higher market volatility is expected for 2015, which could limit potential gains in the medium term. Asia ex. Japan valuation and growth prospects remain attractive. The risk to these markets comes from foreign investment outflows. Higher US rates/ lower liquidity has historically led to portfolio rebalancing and a drawdown in Asian equities. However, aggressive hikes are not our core scenario and Asia has a more diverse investor base now than it has had historically. Comprehensive reforms for the next 5 to 10 years, combined with more supportive monetary and fiscal policy, a better prospect for profit margins and corporate governance [on continued State-Owned Enterprises (SOE) reform] and still low valuation metrics should support Chinese equities. However, the willingness of regulators to reduce market volatility could dampen the market temporarily. Improved macro stability (a fall in inflation and smaller current account deficit, energy subsidy reform), decline in global oil prices and reform announcements continue to support the Indian equities. Valuation metrics are above historical averages, but an economic recovery and looser monetary policy should drive earnings and structural reforms could trigger a further rerating of Indian equities. Hong Kong stocks should benefit from monetary easing in China and China s ongoing capital market opening. However, the Hong Kong economy remains weak and the market faces the risks of tightening monetary conditions from Fed rate hikes and China s economic slowdown. Valuations look neutral with low price-to-book and low profitability. Valuation metrics are neutral, both from a Price-to-Earnings (P/E) or price-to-book, but against a relatively low Return On Equity (ROE) perspective vs. most other Asian markets. The macroeconomic backdrop remains challenging, and Singapore is vulnerable to US interest rate increases, although Singapore market reflects more the state of global economy (less domestic economy). Korean economy and equities should benefit from supportive monetary, fiscal and housing policies, better global growth and lower energy costs. Policy to boost dividend payout could be a positive catalyst. Valuations are low against reasonably solid profit margins. Yen weakness remains a key concern for Korea s export competitiveness. Taiwan is well positioned to benefit from a recovery in advanced economies and relatively insulated from the threat of capital outflows. However, the strong earnings growth in 2014 provides a high base for this year, despite undemanding valuations. Political uncertainty and policy risks could increase heading into the March 2016 presidential election. Data shown is for illustrative purposes only and does not constitute any investment recommendation in the above-mentioned asset classes or countries. Any forecast, projection or target contained in this presentation is for information purposes only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets. 12/02/2015 Investment Views 5
Definitions:, overweight and neutral classifications are the high-level asset allocations tilts applied in diversified, typically multi-asset portfolios, which reflect a combination of our long-term valuation signals, our shorter-term cyclical views and actual positioning in portfolios. The views are expressed with reference to global portfolios. However, individual portfolio positions may vary according to mandate, benchmark, risk profile and the availability and riskiness of individual asset classes in different regions. "" implies that, within the context of a well-diversified typically multi-asset portfolio, and relative to relevant internal or external benchmarks, AMG has (or would have) a positive tilt towards the asset class. "" implies that, within the context of a well-diversified typically multi-asset portfolio, and relative to relevant internal or external benchmarks, AMG has (or would have) have a negative tilt towards the asset class. "Neutral" implies that, within the context of a well-diversified typically multi-asset portfolio, and relative to relevant internal or external benchmarks AMG has (or would have) neither a particularly negative or positive tilt towards the asset class. 12/02/2015 Investment Views 6
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