House View September 2016
Summary - Risk utilization is lowered from 40% to 35% - The last change in risk utilization was implemented on 4 August 2016 where it was brought down to 40% from 50% - The reduction in risk utilization reflects an ever larger divergence between macroeconomic momentum and the equity markets as well as a perceived shift in the FEDs reaction function - Macroeconomic momentum has deteriorated over the last 1-2 months - The deterioration has not been priced into the equity markets for two reasons: - Macro surprises have been positive since BREXIT - Which has overshadowed the falling momentum - There is a widespread belief that falling macroeconomic momentum will lead to a more supportive monetary environment - An argument which we believe have been partly eroded by recent FED speakers - The combination of macro, the pricing of equities, and the latest FED comments skews the return profile of equities to the downside - And given the high level of cross- and intra asset class correlation a correction can in our view be initiated by a broader set of factors than previously in the cycle - Weaker macro, negative EPS revisions, falling oil prices, geopolitical events, and most importantly a repricing of the FED rate hike cycle New(35%) Old (40%) Slide 2
Multi Asset Model Portfolio - The underweight to equities is increased by 4%-points - The allocation towards EMD LC and government bonds are increased by 2%-points each - EMD LC is now an outright overweight compared to the strategic allocation - The overweight to EMD LC and European equities (slide 5) both serve as a hedge to our main portfolio positioning - So forth equities rise from current levels this will be due to speculation about a more accommodative global monetary environment (improving macro will at best only validate current valuations; it cannot in itself push them higher) - In such a scenario the model portfolio is expected to underperform relative to the strategic allocation but it should see positive contributions from EMD LC and the European equity overweight - As such these are positions which to some extent hedge our aggregated allocation - Viewed in isolation the overweight to EMD LC reflects a more positive view on Emerging Market macroeconomic momentum - EMD LC looks set to outperform in all scenarios except in a significant global recession or a very strong isolated US growth period - In case of a mild DM growth pause we expect to see falling EM yields and a flat to positive development of EM FX relative to the USD - In case of a modest positive growth scenario we expect Slide 3 Model Portfolio Government Bonds Equities Investment Grade High Yield Bonds Emerging Market Debt Commodities Cash Allocation Strategic allocation Diff -10% 10% 30% 50% to see falling EM yields combined with stronger EM FX 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. Source: SEB
Return Multi Asset Class Risk and Return Estimates, 12M 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% Hedge Funds High Yield Investment Grade Government Bonds Global Equities EMD LC EM Equities -2% 0% 5% 10% 15% 20% Risk Source: SEB Slide 4
Equity Model Portfolio (Pure) - The model portfolio is underweight Emerging Markets and overweight Developed Markets - Asia remains the preferred region within Emerging Markets - The earnings outlook for Asia is stronger than that of LatAm - The geopolitical risk of LatAm remains highly elevated - Macroeconomic momentum is stronger and more stable for Asia than that of LatAm - EPS revisions are currently a more positive factor for EM Asia than for LatAm - The model portfolio is slightly overweight Europe compared to the US - The outlook for earnings in Europe is looking stronger than for the US - Lower current and future margin pressure - Increased leverage to a stabilization in global and Emerging Market growth - Less stretched valuations - The model portfolio remains neutral towards Japan - Faltering growth and inflation combined with a strengthening Yen lifts the likelihood for increased stimulus over the coming months - However it is in our view not prudent to lift the allocation towards Japan before we see more and larger stimulus than what have been implemented over the summer Relative positioning EM Other Russia LatAm Allocation MSCI AC Diff EM Asia East Asia ex. Japan Sweden Japan Europe North America -20% 0% 20% 40% 60% Source: SEB Slide 5
Return Equity Risk and Return Estimates, 12M (Forward P/E) 10% 9% 8% 7% Sweden (16.0) Europe (14.2) EM (13.4) China (13.3) 6% 5% DM (17.4) Japan (16.5) LatAm (16.1) 4% US (18.4) 3% 2% 1% 0% 10% 12% 14% 16% 18% 20% 22% 24% 26% Risk Source: SEB and Bloomberg Slide 6
Fixed Income Model Portfolio (Pure) - Duration: - We remain short duration - Brexit effects have so far been smaller than expected and financial markets have rebounded strongly since the vote - FED will continue the process of normalizing US interest rates - A hike this year is likely. Initial reaction will probably be subdued as markets will continue to expect a very slow tightening cycle - ECB and the Riksbank will keep conditions as easy as needed to promote inflation moving towards their target - More QE seems to be the preferred tool - We do not expect to see further rate cuts by ECB or the Riksbank - Credits in general: - We stay neutral to credits - The market is still supported by expansionary monetary policy but the business cycle is becoming mature - Strategically we are still concerned about the outlook for credits which we regard being stuck between two relatively negative scenarios - In case growth remains stable we expect to see further and faster rate hikes by the FED which in our view will be credit negative - If we are wrong about FED tightening this will most likely be due to a significant deterioration in the growth outlook, which again will be credit negative Recommended duration allocation Source: SEB Slide 7
Macro and the markets September 2016
Systemic risk Developments in the Markets - Low volatility and high cross-asset interdependence has characterized the markets over the past month - The unifying driver behind the developments in the fixed income and equity markets has been expectations to the central banks - Macroeconomic prints which in the past would have had a significant effect on the markets have largely been ignored - As a prime example hereof we saw no material selloff following the large declines and disappointments in the two ISMs - Comments made by Eric Rosengren (Boston FED) combined with a disappointing ECB meeting (no extension of QE) led to a sharp selloff on 9 September - The selloff broke the period of extremely shallow moves in equities that have persisted ever since BREXIT - The period up until the 9 th of September was the second longest since 2000 in which the SP500 had neither gained nor lost more than 1% on a day - Despite generally weaker macroeconomic data the pricing of the rate hike cycle did not change - The market is still expecting one hike for 2016 and one hike for 2017 - The pricing of the rate hike cycle continues to dominate the moves in the USD which also continues to be a prime driver of the moves in the ever important commodities market Cross-asset systemic risk is at the highest levels since 2013 75 70 65 60 55 50 45 40 35 30 100 days 150 days 25 2010 2011 2012 2013 2014 2015 2016 2017 Source: Bloomberg and SEB The period up until 09 September was the second longest since 2000 where the absolute SP500 daily returns<1% 2011-04-15 2016-06-22 2013-01-31 2010-12-31 2005-12-30 2005-10-04 2007-02-26 2005-02-03 2012-09-05 2006-11-03 2005-11-30 2013-04-02 2005-06-22 2014-12-09 2010-04-13 2005-08-15 2014-09-24 2007-01-24 2016-09-08 0 10 20 30 40 50 60 70 Days where SP500 has been in +/- 1% range 2014-07-16 Source: Bloomberg and SEB Slide 9
Macro momentum Economy Developed Markets - Recent macroeconomic prints have in general surprised on the downside for both Europe and the US - Thereby reversing the post BREXIT trend - While surprises were positive post BREXIT the momentum deteriorated for Europe - Led by a decline in production data and PMIs - The trend of negative momentum has extended over the past month - Putting the macroeconomic momentum of Europe at the lowest levels since early 2016 - While macroeconomic data in general has been stronger for the US than for Europe important prints turned south in late August and early September - Both ISM Manufacturing and non-manufacturing fell back - The latter to levels last seen in 2010 - The details of the two reports were both disappointing - New orders within the Manufacturing index fell to 49.1 - The employment component of the ISM non- Manufacturing index fell to 50.7 - This indicator has historically been one of the best predictors of employment growth - Non-farm disappointed as it fell to 151k - However this print follows a series of very strong months - In general we are for the US seeing weakness in leading data and strength in lagging data 3M macroeconomic momentum for Europe is at the lowest levels since early 2016 25 20 15 10 5 0-5 -10-15 -20-25 Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct The fall in the ISMs put them back to a combined cycle low Source: Macrobond 0.6-17.1 Source: Bloomberg and SEB Europe USA Slide 10
Economy Asia and Emerging Markets - The Emerging Market space continues to stabilize in terms of tactical macroeconomic momentum - Thereby improving relative to Developed Markets - Chinese PMIs have continued to rise albeit by a modest pace which combined with stronger industrial production and consumption have mitigated some of the fears about an imminent hard landing - The strength in the old growth drivers of China has pushed the Li Keqiang Index to the highest levels since early 2014 - A development which in isolation should be positive for the countries which in the past has been reliant on exports to China (primarily commodity exporters) - EM Asia ex. China has continued to print positive macroeconomic surprises - These gains seem to have been supported by the recent strength in Chinese macro as exports have risen more than expected - The improvements/stabilization in macroeconomic developments of the EM space has not yet been tested over a US rate hike - Although 2016 has presented improvements in for example current account deficits the EM space remains vulnerable to capital outflows as a consequence of higher US rates - So while tactical macroeconomic momentum has improved the stability all else equal remains fragile The old growth drivers of China have risen significantly as of late The gap between EM and DM PMIs has narrowed Source: Macrobond Source: Macrobond Slide 11
In Focus September 2016
Strategic views Short term view Extremely low volatility lead to heavy exposure among hedge and risk parity funds, VAR sensitive. Weaker macro readings and central bank uncertainty. This will continue for some time. We reduce risk but keep risk in asset classes. Emerging markets Emerging markets have turned the corner, positively. Stronger fiscal balances, policy changes a recession scenario that they will have real problems. In a positive growth scenario the potential is rather big. Will growth accelerate? Growth engines. The economy today is supported by consumption and a balanced monetary policy. That will continue. If fiscal stimulus will come into play 2017 as the UK now indicates, both US candidates says and Europe will need to handle political issues this will be positive. Strong indicator for EPS revisions and style/sector rotation. Strategic outlook Our strategic outlook is constructive on growth, but a continued subdued pace. FED will hike. We have late cycle climate with no obvious problem in the economy leading to a need to raise interest rates aggressively. Higher bond yields Risk of higher bond yields. Our base scenario does not include a massive upturn in bond yields but we are calling the bottom recent CB actions point in that direction. Higher bond yields are not necessarily bad for markets as a whole as it points to growth but some segments of the equity market will fare badly. We maintain our focus on yielding assets EMD and HY. Techs in markets Markets technicals. On a general level investors are probably not long risk, but segments of the markets, Hedge funds and risk parity funds from time to time maximizes mandates that're VAR steered. This creates volatility and point to a strict valuation based approach for us. Long term there is a potential for further rebalancing into equities in a positive scenario The positive case The positive growth case. This is a likelihood that the economy can accelerate in the fourth quarter with support from fiscal expansion and a stable commodity and EM environment. This is not the main scenario but markets sometime focuses on the possibility. Potentials The positive scenario would lead to a reprising of markets with focus on value sectors, higher bond yields and cyclically sensitive assets. The potential from a changed outlook for cyclicals and investment related assets is probably big as they are cheap today. Commodities ok Commodity markets have rebalanced and seems to be in a stable phase. Given that the large EM s still grow healthily and China from time to time return to a fiscal stimulus agenda risk from commodities shall be subdued and we will probably see a small return to investments in capacity. Slide 13
The major challenges Inflation and earnings For some time the entire trend in equities has been a multiple expansion. Markets really need earnings to lift further, wage costs are starting to increase, this will be a challenge. If volume does not pick giving some room for pricing power. The inequality challenge. The persistent trend with low real wages in the industrials driven by innovation, less demand for old industries, demographics etc and the feeling of inequality being accelerated by monetary policies is one of the mayor political challenges. The risk here are multiple, but a knee jerk reaction with higher taxes is a real danger. This will in that case direct assets to regions with a constructive policy mix. The geopolitics The situation in Syria and the middle east is not getting any easier. There is s risk of full scale war and the weak outlook for the oil producers does not make it easier. At some level this risk affecting oil prices and foster a generally higher riskpremia. This is tricky to hedge but inflation and commodity linked asses will be in demand. Nationalism in politics We are in a trend now when globalization is being challenged from many sources not only tin hats but also people like Martin Wolf and Larry Summers discusses policy consequences. From a growth point of view this is a policy mix challenge. To balance the discussion is crucial. And not revert into outright protectionism. Low investments and productivity. Growth is challenged if investments and productivity does not pick up. Secondly we risk creating bottlenecks if demand picks up, there are already tendencies of that anecdotally in some sectors. We are not close to a stagflation scenario, but it is in the danger zone. The situation is at a level that it is strong case for public investments and the commodity related industries are probably in line. Central banks are changing direction affecting bonds. Under the coming 12 moths central banks will try to change direction, this will post a challenge for markets. If credit demand does not pick up the low level of credit creation will make this complicated. And t posts a challenge for bond yields. This will be challenge for bond proxy investments. Depending on how one values equity markets all assets that are prices with a stable income stream will face headwinds. Slide 14
Asset Class Views September 2016
Developed Market Equities 12M Outlook - We expect that Developed Market equities will be the second best performing asset class over the coming 12 months - We expect that the aggregated return will be lower than the historical average - Despite the positive aggregated view a range of important strategic challenges exist - Multiples are at highly elevated levels - The potential for further expansion is limited - The empirical evidence of the FED model (which would support the case for further multiple expansion) is very limited - Margins in the US have risen to very high levels - We expect too see margin compression going forward; primarily due to rising wage costs - Leverage for the equity market ex. tech have risen to cycle highs - Global growth continues to decelerate - 2017 GDP growth forecast are in stark contrast to 2017 EPS growth forecasts - The reason why we still foresee a positive return is that growth, albeit low, remains positive - With the current high leverage that should translate into a positive earnings growth around 4-5% - Even taken account of a gradual margin compression - And while multiples are high we do not foresee a large decline herein as central banks remains supportive The scope for further multiple expansion in Developed Markets are limited Source: Bloomberg Slide 16
Estimated EPS Growth Emerging Market Equities 12M Outlook - The return expectation to Emerging Market equities is increased so that it now exceeds that of Developed Markets - Several factors have over the past couple of months started to turn positive for the EM space in general and EM Asia in particular - The negative sentiment towards the asset class have eased - Leading to large inflows - Macro has not only stabilized but also improved - Especially the old growth engines of China - Stronger EM FX have reduced the inflationary pressures which were in place during 2015 - This has allowed several EM countries to lower rates - Similar to the Developed Market equities we expect to see relatively strong EPS growth for the EM space - As sentiment towards EM equities remains muted we do not believe that this EPS growth is fully priced in - We have previously stated that EPS estimates for the EM universe would have to be revised lower - However as growth seems to be consolidating we have lowered our conviction in this view - Despite our positive strategic stance we stress that the tactical risks for the asset class are elevated - We believe that EM equities and EM FX will come under pressure once the markets start to price in more rate hikes by the FED - Which will lead to USD strength - We are furthermore concerned about the geopolitical risks of the universe The negative trend in EM Asia EPS estimates has been broken 30 25 20 15 10 2015 5 0-5 2012 2013-10 2014-15 Jan13 Jan14 Jan15 Jan16 Source: Bloomberg 2016 2017 2018 Slide 17
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 - Albeit not exuberant - The global hunt for yield is still alive - As such we still expect investors to move from higher rated bonds and into High Yield - On a sector like for like basis - Credit conditions are improving in Europe - For Europe the funding costs are declining rapidly - We expect that ECBs expanded QE program will have a positive spillover effect on the European High Yield market - We recommend having an neutral position to global High Yield in a multi asset portfolio - Our primary cause for concern of the asset class is the tightening of credit conditions in the US - We are also concerned about the asset class underperforming in both a more positive and a more negative growth scenario - In the former due to higher rates in the US - And the upward pressure on the USD, negative pressure on commodities in such a scenario - In the latter due to a further deterioration in free cash flows and earnings Credit conditions are getting tightened in the US Source: Macrobond Our fair value model predicts further spread tightening Source: Macrobond Slide 18
Emerging Market Debt 12M Outlook - We expect that Emerging Market bonds will deliver a positive return over the coming 12 months which will exceed that of High Yield and Investment Grade bonds - Over 2016 we have seen an improvement in EM fundamentals which has eradicated the fears of a broad based hard landing - We have also seen an improvement in external balances of some major economies which has reduced the exposure of these to a tightening of monetary policy in the US - Noticeably the current account deficits of both Brazil and Turkey have started to narrow - Albeit they remain negative - The improved macroeconomic backdrop and the benign pricing of the FED rate hike cycle has since February 2016 led to a significant rally in EM FX - A rally which has reduced the inflation rates of the universe and as such reduced the pressure for further counter cyclical rate hikes - Given the significant outflows of later years the spreads remain at relative high levels for EMD ; especially Local Currency - The major risk for EMD remains a more aggressive pricing of the FED rate hike cycle - But given the improving fundamentals of the space we believe this dependence will fall over the coming quarters - In a portfolio context we note that it hedges our other recommended positions - So while EMD might suffer in the initial phase of a repricing of the rate hike cycle the portfolio as a whole should gain relative to our strategic allocation EMD LC is looking more attractive than both EMD HC and US HY Source: Macrobond EM FX is slowly starting to become more resilient towards US rising rates. We do not foresee a reversal to tapering 2013 Slide 19 Source: Macrobond
Investment Grade Bonds 12M Outlook - We expect to see further spread tightening for global Investment Grade bonds - The recession risk for the US economy has resided - The global hunt for yield remains and is supported by the QE program of ECB Albeit the absolute return potential remains moderate we expect spreads to tighten on the back of ECB - In isolation several factors are supporting Investment Grade spreads - QE by the ECB should help to reduce spreads even further - Making the asset class interesting in a pure fixed income perspective - We are presently seeing inflows to the asset class - The economic environment remains stable - With improving credit conditions for Europe - Given that absolute spread levels remains low it is still not an asset class on which we expect to earn significant positive returns - And we are seeing better value in High Yield Source: Macrobond Slide 20
Core Government Bonds 12M Outlook - We expect to see global yields move higher over the coming 12 months - Primarily for the US Wage inflation is on the rise for people in jobs - We expect that US inflation both core and headline will rise over the coming months - The deflationary pressure from commodity prices will start to leave the headline index - Wages will continue to rise - The unemployment rate is firmly below most NAIRU estimates - Soft data indicators continue to point towards higher wages - Albeit they have moderated as of late - The participation rate has started to rise, but we do not expect that this in itself will be enough to mitigate the shortages in the US labour market - We note that wages for people already in occupation is rising faster than the aggregated number Source: Macrobond Soft data indicators point towards more wage inflation - We stress that rising inflation will be an issue for the US and not for Europe - The latter still has a significant output gap - The recent strength in the EUR will on the tactical horizon lead to lower headline inflation Slide 21
Commodities 12M Outlook - We recommend a low allocation towards commodities - We do so on the basis of four primary arguments: - Stronger macro will lead to a repricing of the FED rate hike cycle and a stronger USD - This will push down commodity prices - Oil production has risen significantly since the start of the year - Driven primarily by OPEC - We do not believe an agreement to cut production will be implemented given the tension between Saudi Arabia and Iran - Rig count in the US started to rise once WTI closed in on 50 USD per barrel - We expect that this trigger level for increasing production will persist going forward and as such put a lid on oil prices - We do not foresee a significant rise in demand for industrial metals driven by Chinese demand - Net-speculative positions in oil started to decline as WTI hit 50 USD per barrel - We find comfort herein as it to us signals that momentum in isolation will not drive prices higher - We do not expect a deal to be struck on the upcoming OPEC meeting Net-speculative positions started to decline prior to oil hitting 50 USD per barrel Source: Macrobond The marginal cost of US oil production also appears to be around 50 USD per barrel Source: Macrobond Slide 22
Risk environment September 2016
Risk Environment - The high level of cross-asset correlations lifts the number of potential drivers behind an equity correction - A rise in longer US rates will diminish the attractiveness of earnings yields and credit spreads and as such it will lead to a repricing of all risk - A further deterioration in macro will only increase the divergence between expected EPS growth and the economic fundamentals - The major short term financial risk factor is in our view a tapering scenario - A scenario in which a sharp rise in yields leads to a selloff in equities and credits - We find evidence in that this scenario is still very much alive in the developments of the markets Friday 09 September - Where hawkish comments from Rosengren led to a significant selloff in both equities and bonds - The likelihood for such a scenario is in our view elevated - Although employment growth slowed in August there are still signs of shortages in the labor market - We especially take note of the rise in wages that we have seen in 2016 - The fall in leading indicators for both the US and Europe increases the risk for a growth slowdown - While we do not expect an imminent recession the pricing of equities is at the moment so aggressive that even a small setback in growth will have large repercussions The rise in US wage inflation stands at odds with the pricing of FED rate hike cycle Source: Bloomberg Traditional models continue to point towards a heightened likelihood of a recession Slide 24 Source: Macrobond
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