Global Investment Strategy SEPTEMBER 218 ANDREW JENNER HEAD OF INVESTMENT Mitsubishi UFJ Asset Management (UK) Ltd. (Registered in England No 1842259) A member of MUFG, a global financial group
Investment Summary 218 has seen firm global growth. Business confidence has rolled over on trade war fears but still points to growth. Other potential road bumps: Syria, North Korea, Iran, Turkey have yet to have a major impact. We remain optimistic on growth but do not get too carried away. Inflationary pressures continue to firm. Globally labour markets remain tight, but wage growth has yet to accelerate. Service sector prices are firm, commodity prices have been rising. Inflation expectations have moved upwards to discount the prospect of 2% inflation. Bond markets continue to price in a low inflation future with limited rate hikes. The Fed is now expected to raise rates a further 2 times over 218 and continue hiking into 219. We remain in the camp that rates globally need to rise to return to normal conditions. Equity markets are seeing good profit growth. Earnings revisions remain in positive territory and results show firm growth, but it is slowing. Valuations are not cheap, so equities should only return in line with earnings at best. Volatility is on the rise. 2
Growth and Inflation Source: JP Morgan, Sentix, OECD, Bloomberg, JP Morgan Global PMIs JPMorgan Global Manufacturing JPMorgan Global Services PMI S 56. 55. 54. 53. 52. 51. 5. 49. 48. 47. 9/215 3/216 9/216 3/217 9/217 3/218 OECD G7 Inflation 3.5% OECD Major 7 CPI Total Index Non-Food & Energy 3.% 2.5% 2.% 1.5% 1.%.5%.% -.5% -1.% -1.5% 9/28 9/21 9/212 9/214 9/216 SENTIX Business Expectations Survey 4 3 2 1-1 -2 Sentix Confidence -3 USA Europe Japan -4 Lat Am East Europe Asia ex Jp 6/215 12/215 6/216 12/216 6/217 12/217 6/218 Implied Inflation from Index Linked Bonds 4 % 3.5 3 2.5 2 1.5 1.5 US Constant Maturity 1 Yr Bre Germany Breakeven 1 Year UK Breakeven 1 Year Japan Breakeven 1 Year 4/213 4/214 4/215 4/216 4/217 4/218 3
Main Risks Trade risks are rising, which dampens growth. China is at the forefront, and risks of a credit crunch have risen. US cycle rolls over as Trump s growth policies lead to higher interest rates. Europe is growing, but has to resolve BREXIT and populism. Japan s PM Abe unable to extend time in power, economic experiment drifts, inflation never arrives. Growth is stronger and central banks get behind the markets. Too much emphasis on Europe s structural issues cyclical rebound. Japan gets growth and inflation. Global rebalancing reduces risk, capital spending / infrastructure boom. Inflation targets become more ambiguous. Wages start to rise, as tight labour markets finally reach breaking point. Central Banks allow inflation to rise, citing target is over the long cycle. Problems have not gone away. Debt reduction still has a long way to go, while structural reform remains difficult. Political risk is high and everywhere. Lack of policy options if growth deteriorates. 4
Fixed Income
Fixed Income Strategy (1) DURATION We remain short duration. The consensus continues to expect that inflation will struggle to reach the central bank s target. US long dated yields are predicted to peak at 3.%, or ~1% real rates, they will go higher. German long term rate expectations are still below target inflation. Japan s yield curve is flat with no yield, yet inflation pressures are building. SPREAD PRODUCT Spread product position is having its risk contribution reduced. We are still overweight spread product as economic activity is firm and default rates are low. But we expect corporate managements with cash to increase M&A and capex. We still want to pick up carry where we can, but only if spreads warrant. Higher quality and smaller overweight positions meets our strategy. Financials are still attractive. Regulatory pressure on financials to deleverage remains in place. Subordinated securities to outperform Senior debt. 6
Forward Yield Curves Source: Bloomberg, USA GERMANY JAPAN 6. 6. 6. USD yield curve in 1y in 5y in 1y DEM yield curve in 1y in 5y in 1y 5. 5. 5. JPY yield curve in 1y in 5y in 1y 4. 4. 4. 3. 3. 3. 2. 2. 2. 1. 1. 1.... -1. 1m 3m 6m 1y 2y 3y 5y 7y 1y 3y -1. 1m 3m 6m 1y 2y 3y 5y 7y 1y 3y -1. 3m 6m 1y 2y 3y 5y 7y 1y 3y AUSTRALIA UK MEXICO 6. 6. 9. AUD yield curve in 1y in 5y in 1y GBP yield curve in 1y in 5y in 1y 5. 5. 8. MXN yield curve in 1y in 5y in 1y 4. 4. 7. 6. 3. 3. 5. 2. 2. 4. 1. 1. 3. 2... 1. -1. 1m 3m 6m 1y 2y 3y 5y 7y 1y 3y -1. 1m 3m 6m 1y 2y 3y 5y 7y 1y 3y. 1m 3m 6m 1y 2y 3y 5y 1y 2y 7
Fixed Income Strategy (2) COUNTRY ALLOCATION We prefer markets where future yields already discount growth. We continue to favour higher yielding countries: USA, Australia, Mexico, Korea. US fundamentals remain strong, rates are starting to discount this. Australian yield curve is still flat and we see better than expected growth and higher rates. It is not the same for Europe or Japan. The short end still offers negative yields, yet economies have been doing well. It is only inflation that is keeping super loose money in play, but this is also changing. Italy may allow rates to stay lower for longer, but fundamentals will reassert. Japan only has attractions as rates are rising elsewhere and the BOJ will stay loose for the longest. German 1 year yields are poor value with inflation over 2%. CURRENCY We have limited currency positions. The firm USD story makes sense based on rates and fiscal policy, but not the twin deficits. For choice we are long AUD as growth and rates will firm. We are short JPY where real rates will fall as inflation picks up. 8
Equity
Equity Strategy (1) GLOBAL The global profit cycle is now at new highs. Most markets acknowledge this with Europe the only real laggard on the earnings front. Good economic growth and low bond yields remain supportive of share prices. But markets now have to price in slower profit growth as we move towards 219. Valuations are mixed and currently are not in focus. US equities continue to look stretched on most valuation measures. European equities also have high P/Es thereby discounting strong earnings growth. Japan looks best value at present, but the Yen here still has influence. Global Emerging Markets have stabilised and are not expensive. Improving global growth is floating all boats including commodities. The risks are mainly domestic or the USA (protectionism, USD etc.). We remain buyers and not sellers. Profit momentum favours Japan and Europe. European profits are still 3% behind previous highs. Japan s profits are at all time highs with scope for structural improvement. 1
MSCI Equity Indices and Earnings (right hand axis) Source: MSCI, Bloomberg, WORLD USA EUROPE 25 MSCI WORLD 12m Trail EPS Shiller (1yE)PS 123 MSCI USA 12m Trail EPS Shiller (1yE)PS 1416 MSCI EUROPE 12m Trail EPS Shiller (1yE)PS 18 2 15 1 5 125 8 2 6 15 4 1 2 5 12 14 12 1 1 8 8 6 6 4 4 2 2 16 14 12 1 8 6 4 2 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217 JAPAN ASIA ex JAPAN GLOBAL EMERGING 12 1 8 6 4 2 MSCI JAPAN 12m Trail EPS Shiller (1yE)PS 3 7 25 6 2 5 15 4 1 3 5 2 1-5 MSCI AC ASIA PACIFIC ex JP 12m Trail EPS Shiller (1yE)PS 45 16 4 14 35 12 3 1 25 8 2 6 15 4 1 5 2 MSCI EM 12m Trail EPS Shiller (1yE)PS 1 9 8 7 6 5 4 3 2 1 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217-1 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217 11
Equity Strategy (2) SECTORS Technology leading the way. Technology stocks, almost alone, are pulling markets higher due to strong profit growth. Other cyclicals are limping side ways with only Consumer Discretionary showing life. Stable growers (Consumer Staples, HealthCare) are still in retreat, and are yet to get cheap. Financials are still near relative lows, profitability is improving but ROE s will be lower than the past. FACTORS Value has yet to establish itself as interest rate trend is weak.. Value stocks have had a poor second quarter, unusually so have Momentum plays. Small Caps continue to do well and remain the growth asset of choice. Low Vol also has had its moments as volatility on the whole is moving higher. Quality plays have seen improved relative valuations but lack impetus at present. EMERGING MARKETS Markets have been weak so far in 218 and are now subject to domestic risks. The firmer USD, trade barriers and domestic politics are current causes of concern. Valuations are slightly dear and earnings are just below recent highs. 12
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