ABN AMRO Private Banking Outlook 2019, English version

Investment Outlook 2019

Adjusting to changing conditions

ABN AMRO Private Banking

Contents

INTRODUCTION 3 ADJUSTING TO CHANGING CONDITIONS

4

ASSET ALLOCATION AND ITS ROLE IN RETURNS

6

INVESTING IN A SUSTAINABLE FUTURE

8

LOWER GROWTH, BUT NO RECESSION

10

EQUITIES: CHANGING CONDITIONS AHEAD

12

AI: THE NEXT WAVE OF DIGITALISATION

14

BONDS: ADAPTING TO CHANGE

16

POSITIVE OUTLOOK FOR COMMODITIES

18

PRIVATE EQUITY: PLAYING IT SAFE

20

EUR/USD TO STRENGTHEN

21

CONTRIBUTORS 22

This is an international ABNÂ AMRO publication. Risk profiles and the availability of investmentproducts may differ by country. Your local advisor will be able to provide more information.

2

Investment Outlook 2019

Introduction

Richard de Groot Global Head Investment Centre ABN AMRO Private Banking

December 2018

In 2019, as the effects of the fiscal stimulus in the US slowly fade, we expect the US economy to head down a path similar to the European economy.

Slower, but still decent growth does not mean that we expect a recession any time soon. Instead, reduced growth, especially in combination with low interest rates and muted inflation, can still be positive for financial markets. It does mean, however, that some changes might be required as this scenario unfolds.

Market nervousness clearly increased at the end of 2018. Stock markets around the world suffered declines. We expect markets to continue to be volatile in 2019. Nonetheless, companies can continue to grow their earnings. And, even at a lower pace of earnings growth, we expect positive returns from stock investing in 2019. Sector and regional choices will be important, as growth will not be the same everywhere. On the bond side, the low interest rates in Europe might persist for longer than anticipated, which supports bond investing. But, the more riskier bond segments have become more expensive. Slowly moving back to a more balanced bond portfolio, such as by rebuilding government bond holdings, is a likely strategy for the year ahead.

The trade war and political choices in Europe will certainly feed headlines in 2019. In the US, the Trump administration will have to find a new equilibrium, after the midterm elections ended the dominance of Trump’s party. And there is Brexit, where the final outcome remains murky. There are clearly a number of important issues to carefully monitor in the year ahead.

In this Investment Outlook, we also introduce longer-term ideas.

Developments in artificial intelligence, for example, are going fast and are becoming more widely available to companies of all sizes. This development provides a number of interesting investment opportunities. And last but not least, the shift towards a more sustainable world is taking on increasing significance. With sustainability as a motivation and innovation as a tool, companies are providing solutions that will help create a more sustainable world. This will go hand in hand with good returns for investors.

This Investment Outlook is prepared by the investment specialists of ABN AMRO Private Banking. Your investment advisor will gladly support you in adjusting your portfolio to the new conditions we expect in 2019.

3

ABN AMRO Private Banking

Adjusting to changing conditions After years of solid growth and strong stock returns, it is time to adjust to changing conditions. We expect that the global economy will continue to grow in 2019, but at a slower pace.

As global growth slows in 2019, different players in the

Lower growth can still support risky assets

economy will review their choices and adjust where needed. Central bankers, for example, will be scrutinising

●●

In 2019, solid economic growth is expected to continue

their monetary policies, and their actions will be anticipated

in the US, but will likely decline in the second half of the

by financial markets. Even US President Donald Trump will

year. This reduction is expected given the fading effect

be adjusting his way forward, now that his political party no

of the stimulus package introduced by the Trump admin-

longer dominates US politics.

istration. Our projection for 2019 US economic growth is 2.7%; in Europe, we forecast growth of 1.4%, as the

Interest rates in the US have risen, but in Europe they are still

European economy has less exposure to the technology

low, or even, at negative levels. While it remains a support-

sector and other fast-growing segments.

ive environment for company earnings, stock returns in 2019 are expected to be more muted than what we have seen

●●

With lower growth, central banks will likely be more

over the past five years. Given an outlook for continued but

careful in raising interest rates in order to protect growth.

slower growth, we prefer stocks over bonds in investor port-

In Europe no increase in interest rates is expected in 2019.

folios. But it will be important to monitor economic develop-

In the US, the Federal Reserve has already been raising

ments and to adjust portfolios to the changing conditions

interest rates, but when growth slows, we expect the US

expected in the year ahead.

central bank will adjust its monetary policy to the changing conditions.

More modest returns than in the past

●●

Against this supportive economic background, companies should be able to grow their earnings – which will be posi-

●●

For the past few years, financial returns have been solid;

tive for stocks. There will, however, be significant differ-

2018, however, was disappointing. We expect modest

ences between sectors and companies. Stock selection

returns in 2019. Lower economic growth will lead to lower

and diversification will be important.

earnings growth, which is an important factor in stock market returns. ●●

Risks to watch

For European investors, bond returns, which are mainly determined by interest rates, will likely be in the low single digits.

●●

The trade war, started by Trump in 2018, is clearly negative for the global economy. We do not expect a quick resolution to the dispute between the US and China. The

●●

4

Risk in financial markets, as measured by market volatil-

trade conflict could impact growth, and it could also lead

ity, will most likely increase compared to previous years,

to higher prices if companies start passing on their higher

given the variety and growing number of risks. We expect

costs. We do not expect a major trade escalation, but we

markets to remain volatile in 2019.

will continue to closely monitor developments.

Investment Outlook 2019

neu t r a

An unexpected increase in inflation, which could lead

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EQUITIES

Where are the opportunities?

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have supported productivity increases without signifi-

BOND

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far this has not occurred, as technological developments t

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EQUITIES

to higher interest rates, is also a risk. Higher wages, as a result of lower unemployment, could be a trigger. So

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●●

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BONDS

Stocks. We continue to favour a moderate overweight in stocks, given our forecast for a still growing economy. In terms of sectors, we recommend investing in the energy sector, which will benefit from higher oil prices. In terms of regions, we prefer the US over European markets.

●●

Thematic investing. Thematic investing can add a new dimension to investment portfolios. In this Outlook we describe how Artificial Intelligence is a means for companies to build a competitive advantage across a wide swath of industries. We expect it to become increasingly commonplace, as it moves out of labs and into business models.

●●

Commodities. Our forecast for rising oil prices and continued growth supports an allocation to commodities.

●●

Emerging-markets bonds. Emerging markets experienced difficulties in 2018, but conditions are improving. Investing in emerging-markets debt in local currency can further increase returns, but we suggest keeping the allocation small, as the local-currency exposure increases risks.

●●

Sustainable investing. Climate change has been widely recognised as a key long-term risk. We suggest looking for companies that are leading their peers in sustainable practices or innovating in areas related to sustainable targets.

Richard de Groot Global Head Investment Centre

5

ABN AMRO Private Banking

Asset allocation and its role in returns In the June 2018 Investment Outlook, we discussed the importance of global diversification and avoiding a strong bias for your home country. This time, we turn our attention to the importance of asset allocation.

Figure 1: Taking more risk is rewarded in ABN AMRO client profiles Return (%) 8 7

historical returns

6 5

6

Some of the most basic and fundamental principles of investing can often be learned through simple, real-life experiences. The age-old proverb, “Don’t put all your eggs in one basket,” for example, emphasizes the basic investment tenet

5

tions. Have you ever noticed, for example, that shops often

1

sell seemingly unrelated products, such as umbrellas and

0

sunglasses? It makes business sense for them not to limit themselves to one market. The same is true with investing.

2 1

1

0

2

6

expected returns

3

2

3 2

4

3

4

of risk diversification. There are widespread practical applica-

5

4

4

6

8

10

12

14

16

18 20 Volatility

Five-year historical returns and risk, by client profiles, based on the strategic asset allocation weighting and indices (brown).

Expected long-term risk and return in ABN AMRO’s six client profiles (blue).

Source: ABN AMRO Private Banking

Three sources of portfolio returns Strategic asset allocation

Tactical asset allocation

There are three sources of portfolio return. The first and the

The second most important source of portfolio return, espe-

most important source is the strategic asset allocation (SAA),

cially in the current low-return environment, is the tactical

which is the percentage of capital allocated to equities, fixed

asset allocation (TAA), which is often steered by ‘market

income and alternative asset classes. Academic research

timing,’ i.e. attempting to predict the best time to make port-

has shown that a huge portion of a portfolio’s performance

folio changes ahead of or in reaction to market movements.

1

can be attributed to the right asset allocation decision.

When is the right moment to overweight or underweight,

The art of investing is finding the optimal combination for a

for example, equites, relative to the percentage that is set

client, striking a balance between their return requirements

by the SAA?

and the level of risk they are willing to assume. With a longterm perspective, the choice is between increasing the risk

It is a difficult decision and requires systematic and emotion-

you are willing to accept or accepting lower returns with

free decision-making – especially when markets are driven

less risk. At ABN AMRO, clients have six risk/return profiles

by human emotions, such as fear or greed. At ABN AMRO,

from which to choose, ranging from a very conservative

our tactical asset allocation is anchored to an in-house devel-

(profile 1) to a more-risky (profile 6) investment approach.

oped quantitative model. Our Quantitative Asset Allocation

We have also developed forecasts for the risk and return

Model (QAAM) is based on three pillars: economic leading

of each of the profiles. See Figure 1 for how these profiles

indicators, price momentum and equity versus bond market

have performed over the past five years in terms of risk and

valuations. We use the QAAM to track stock and bond valu-

return and in comparison with our forecasts.

ations and to calculate their relative attractiveness. (See Figure 2.)

6

Investment Outlook 2019

Figure 2: Backtesting our model’s signals gives confidence in its ability to evaluate markets QAAM signal (left)

MSCI World (total return, right)

1

6000 5000 4000

0

3000 2000 1000

-1

0 2006

2008

2010

2012

2014

2016

2018

Note: A signal above zero indicates an environment to take more risk, while a signal below zero indicates risk reduction. The graph above is the result of applying the Quantitative Asset Allocation Model to historical data to evaluate its performance. This is also known as ‘backtesting.’

Source: ABN AMRO Private Banking, Bloomberg

The big question in today’s markets is if and when rising

to invest if we invest in equites? Which segments are we

yields will hurt equity performance. We believe it is still too

focusing on in fixed-income? Selection of specific stocks or

early to have more than a temporary effect. Based on histori-

bonds can help to generate extra performance and improve

cal data, we know that ten-year US Treasury yields will likely

a portfolio’s balance between return and risk. In contrast

have to rise to more than 4% and global bond yields, such

to buying an entire market, such as by using an exchange-

as Bunds, will need to move by 60 basis points higher from

traded index fund, security selection enables specific

their trough before equity markets are negatively affected.

market views to be implemented.

So far, global yields have moved up by only 30 basis points

Reinhard Pfingsten

and ten-year yields are not close to 4%. Moreover, in the last

Global Head Asset Allocation Services

cycle of Fed rate hikes, we saw 17 interest rate increases before equity markets peaked. So far, there have only been eight rate hikes, although a ninth is expected before the end of the year.

Endnote 1 Roger G. Ibbotson and Paul D. Kaplan, “Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?”, Financial Analysts Journal, January/February 2000.

Asset selection Last, but definitively not least, performance is driven by specific security selection. In which companies do we want

7

ABN AMRO Private Banking

Investing in a sustainable future Sustainable investing puts capital to work toward strategies and companies that can support society’s long-term goals. It enables investors of all sizes to contribute to a better world while also earning a market-like return.

The economic reality of a growing middle class One of the concerns regarding a wealthier global populace is the impact on carbon emissions and other climatechange goals. Growing global wealth is generally regarded

In the past, what occurred under the umbrella of sustainable

as having a negative effect on the environment, owing to

investing was often linked to red line issues. In the 1960s,

the increased use of fossil fuels and demand for food, such

for example, this type of investing was exemplified by

as meat, which is expensive in terms of the water and other

demands to ban investment in nuclear arms. Over the years,

resources used to produce it.

the list of exclusions from investment policies has come to include cluster bombs, chemical & biological weapons and

According to the Brookings Institution, a world-renowned

anti-personnel mines. More recently, tobacco joined the list

think tank, “A larger middle-class population has signifi-

of what to avoid.

cant environment and social implications. Naturally, assuming technology does not change, the carbon footprint per

For ABN AMRO and many other investors, exclusion is not

person will rise as the middle class expands.”1

the only answer. In order to make serious gains against an increasingly long list of environmental threats and the challenges presented by changing demographics, a more active

Innovation to mitigate climate change

stance is needed.

But “assuming technology doesn’t change” is problematic.

Putting capital to work

It denies the widespread efforts by governments, companies and other organisations to actively seek solutions to sustainability’s challenges. There are a number of global

At ABN AMRO, sustainable investing includes supporting

initiatives underway, including the Paris Climate Accord,

companies that can have a positive impact on issues such

the Principles for Responsible Investment and the UN

as climate change, pollution or the demographic challenge

Sustainable Development Goals designed to be achieved by

of a growing middle class.

2030. (See Figure.)

It is an economic reality that every year for the next five

There are also numerous industry groups, found across

years around 150 million people will join the middle class.

every sector and ranging from clothing to palm oil, working

By 2020, the middle class will, for first time, be the largest

to develop processes, regulations and innovations to

global income segment. (For research purposes, middle

improve sustainability within specific industry segments.

class is defined as a wealth group with a per capita income

Companies all over the globe are focussing on solutions to

of between USD 10-100 per day.) Most of the growth in

reduce carbon-dioxide emissions, improve the environment

the middle class is occurring in Asia and other emerging

and support other sustainability initiatives.

markets, while middle-class growth in developed markets is stagnating.

8

Investment Outlook 2019

Investing in the future

The Brookings Institution notes that middle-class growth is associated with migration from rural to urban areas. Urban

The urge to do good is not the only reason for these corpo-

households tend to have a smaller carbon footprint than

rate actions. It is increasingly driven by investors choos-

households in rural areas, especially for transportation. But

ing sustainable investment strategies that require portfolio

perhaps a larger global benefit is that middle-class house-

managers to consider environmental, social and governance

holds tend to invest more in the education of their daughters,

factors before investing. Increasing amounts of investment

which can reduce fertility rates. And, as incomes rise and

capital are also flowing to sustainable investment strate-

more girls complete their secondary education, the number

gies because of the social and financial returns that can be

of women in the labour force increases. The Brookings

earned by companies operating under the large and inclu-

Institution concludes that while a larger middle class will

sive umbrella of sustainability.

undoubtedly contribute to higher carbon emissions, at least some portion of that increase will be offset by urbanisation,

Many of the companies in which ABN AMRO invests,

if properly managed, and by a smaller global population.

for example, are directly aligned with the UN Sustainable Development Goals. These companies include a Danish

It is human nature to want to believe that the future will be

wind-turbine manufacturer that has introduced pioneering

better. To hope that technology and innovation will evolve

wind energy in 37 countries (Goal 7). Also represented is

to make our lives more peaceful, healthier, safer and more

a diversified German company with a large presence in

interesting. Sustainable investing can take a step toward

personal care products, which is dedicated to eliminating

achieving these goals for the world at large.

unnecessary plastic packaging and ensuring that any plastic it uses can be recycled (Goal 12).

Richard de Groot Global Head Investment Centre

The economic reality of the growing middle class also has positive implications – not only for the families who are moving out of poverty, but for the rest of the world as well.

Endnote 1 Homi Kharas, “The Unprecedented Expansion of the Global Middle Class: An Update,� Brookings Institution, February 2017.

UN Sustainable Development Goals

Source: United Nations

9

ABN AMRO Private Banking

Lower growth, but no recession The macroeconomic environment remains benign, with low inflation and positive, but slowing, global growth, as US fiscal stimulus comes to an end.

China plays a crucial role in world trade It is not obvious what is behind the slowdown of world trade growth. We suspect China has played a crucial role.

Growth of the global economy slowed in 2018 and busi-

Given the growth rate, size and the openness of the Chinese

ness confidence fell sharply, although it is still consistent

economy, it has a significant impact on the global business

with a decent pace of growth. (See Figure.) The slowdown

cycle. Unfortunately, the Chinese economy is less well

has been obvious in Europe and in the emerging world,

documented than other economies.

while the US economy has gone from strength to strength.

The situation in the US has been largely driven by stimulus

For some time, Chinese policymakers have tried to address

provided by fiscal policy.

the problem of high indebtedness. The result has been a significant drop in the growth rate of public investment. An

The slowdown in Europe has been mainly caused by

overall slowing of economic growth must have been a side-

slowing world trade growth. Exports to Asia have been the

effect, although this is not reflected in China’s GDP data.

main culprit. In recent months, a sharp drop in car production has added to the weakness in Europe. It would appear

Other possible causes for the global slowdown include the

that the introduction of new emission testing procedures

increase in oil prices, rising US interest rates (which have a

in September has caused the auto industry’s problems.

bearing on emerging markets) and the subsequent tighten-

German car production, for example, was down by more than

ing of financial conditions. There is also the inventory cycle,

25% year-on-year in August/September. This decline alone

deteriorating sentiment due to the trade conflict, Brexit and

equates to about 1% of German GDP during that period. We

the Italian budget discussions.

must assume that these problems are temporary.

10

Investment Outlook 2019

More recently, Chinese policymakers have started provid-

acceleration of US inflation could force the Fed’s hand. We

ing targeted stimulus by easing monetary policy and again

expect US inflation to rise gradually, but not at a pace that

encouraging higher investment spending. It would appear

would cause the US central bank to become more aggres-

that the policymakers are keen to not let growth slow too

sive. Interest-rate sensitive sectors in the US, such as home

much, and they seem now to be prioritizing growth over

sales and car sales are soft, suggesting the Fed’s past rate

deleveraging. Experience suggests that they will continue

hikes are already having an impact. Given that US inflation

adding modest stimulus until they are successful. Recent

remains low, there is reason for the Fed to be cautious. In

trade data in Asia was strong, suggesting the situation may

addition, Trump’s fiscal stimulus will fade in the course of

be improving.

2019. After a hike in December, we expect that the Fed will implement only one hike in 2019, likely during the first half of the year.

No recession fears

Overall, it is a benign period ahead for the macro environLooking ahead, the slowdown in global growth should

ment. Global growth is expected to settle near its current

bottom out in the months ahead, as the Chinese slowdown

rate, inflation will remain modest and central banks will

is halted and European car manufacturers get their act

reduce stimulus, but not at a pace that would upset financial

together. A global recession does not look likely any time

markets.

soon. Recessions are caused either by shocks or as a sideeffect of deliberate policies, very often monetary policy.

Han de Jong Chief Economist

Fed will be cautious Perhaps the biggest risk to global growth is therefore a further tightening of US monetary policy, beyond what is currently expected. That is not impossible. A sudden

Global manufacturing is slowing 58

index

Forecasts: Economic growth and inflation (%)

56

Global Purchasing Manager’s Index

29 November 2018

54

52 neutral

50

48 10

11

Source: Bloomberg

12

13

14

15

16

17

18

GDP growth

Inflation

2019

2019

US

2.7

2.5

Eurozone

1.4

1.7

Japan

1.0

1.2

UK

1.7

1.9

China

6.3

2.5

World

3.5

3.7

year

Updates to ABN AMRO forecasts can be found at https://insights.abnamro.nl/en/ Source: ABN AMRO Group Economics

11

ABN AMRO Private Banking

Equities: changing conditions ahead Market behaviour in 2018 was characterised by higher volatility and erratic movements, triggering investors to question if a more defensive positioning is required. For the time being, we are retaining our recommendation for a modest overweight in stocks, but we are on alert, as conditions may deteriorate.

as investors are unwilling to buy stocks with elevated prices.

The derating is already partly taking into account (or partly discounting) the upcoming slowdown.

Early in 2018, world equity markets were trading at a price/earnings multiple at 19; today, this multiple is 16.

Valuation metrics, such as the price-to-book ratio, have also decreased somewhat. (See Figure.) Overall, equity market

In 2018, markets were influenced by strong economic

valuations appear more attractive, but two factors must be

growth in the US and slowdowns in emerging economies

considered. Analysts are likely to revise earnings growth

and in Europe. The desynchronisation of economies was

downward. And, for international investors, holding cash in

exacerbated by European political risks and trade war fears.

US dollars, such as by investing in US Treasuries, is becom-

This situation laid the groundwork for monetary tightening

ing more attractive. This creates some competition to more

by the US Federal Reserve and a more cautious stance from

risky assets, such as stocks.

other central banks.

As a result, earnings growth in the US is strong (+20%),

US stocks continue to be preferred

partly boosted by the Trump administration’s tax reforms, and weaker in Europe (+8%). For next year, we expect some

In 2018, we took steps to increase the allocation to US stocks

kind of resynchronisation of economic growth around the

(overweight), took a neutral stance toward emerging markets

world, with a slowdown in the US economy.

and found European stocks unattractive (underweight).

These decisions were based on the following findings: US

While our forecast is for decent world economic growth

equity markets showed resilience and were supported by

of something above 3% in 2019, a potential slowdown

strong economic and earnings growth, with an outsized IT

in the second half of the year, in particular in the US, has

sector, compared with other regions. Emerging markets

raised some concerns regarding company earnings. So far,

were out of favour, due to a deteriorating earnings outlook

analysts are expecting earnings growth of around 10% for

and an increase in risks specific to the region. Our position-

most of the regions in 2019. But, based on our economic

ing regarding Europe was based on the region’s slowdown

views, we believe that this may be overly optimistic.

in economic and earnings growth, as well as higher political risks and materialising structural weaknesses, such as lower

Derating has already partly discounted the slowdown

economic and earnings growth potential.

For now, we are retaining our regional preferences. Despite the compelling valuation of emerging markets, earnings

The earnings growth in 2018 and the modest increase in

momentum remains very weak. Triggers to reconsider

US share prices, and the drop of emerging and European

this positioning would be signs of stabilisation in earnings

indices have generated a ‘derating’ of equity markets.

momentum and if the Federal Reserve would seem less

Derating means that equity market valuation is decreasing,

eager to hike rates. European markets could also come to

12

Investment Outlook 2019

be considered as attractive compared with the US, but not

Sector view (29 November 2018)

while economic and earnings fundamentals remain weaker

Sector

View

than in the US.

Energy

Overweight

Industrials

Overweight

Consumer discretionary

Neutral

Consumer staples

Neutral

Health care

Neutral

We retain our preference for a few cyclical sectors, which

Information technology

Neutral

typically do well in an environment of economic growth. In

Materials

Neutral

particular, we are positive regarding the energy and indus-

Communication services

Underweight

trials sectors. The latter can benefit from capital expendi-

Financials

Underweight

tures as the economy improves. The energy sector, which

Utilities

Underweight

suffered recently due to the collapse in oil prices, can also

Source: ABN AMRO Private Banking

Invest in sectors exposed to growth

be considered as a defensive addition to portfolios, in case of any increase in geopolitical risks.

We remain neutral regarding the technology sector. Tech

Valuations are becoming more supportive 32

stocks are suffering from high valuations, despite strong

28

sales and earnings growth. The sector’s volatility has also

26

been elevated. Key large technology companies suffered from significant profit-taking during the third-quarter earnings

24 22 20

season. Areas of the market that we find unattractive include

18

the communication services and utilities sectors as well as

16

most of the consumer staples sector – companies in these areas tend to underperform when interest rates are rising.

Olivier Raingeard Global Head Equity

Price-earnings ratio Forward price-earnings ratio

30

14 12 10 8 Jan-90

Jan-94

Jan-98

Jan-02

Jan-06

Jan-10

Jan-14

Jan-18

A comparison of current and forward price-earnings ratios for world markets.

Source: Bloomberg

13

ABN AMRO Private Banking

AI: the next wave of digitalisation Artificial intelligence (AI) has reached an inflection point of rapid adoption in many businesses.

Investors can profit by positioning their portfolios towards companies that are helping to enable this next wave of digitalisation.

autonomous car division) have already driven more than 16 million kilometres. Alphabet is also pioneering an AI-based taxi service and testing a trucking company for hauling cargo.

Three trends behind AI

Artificial intelligence represents a group of techniques, ranging from machine learning and natural language process-

This new wave of digitalisation is powered by three trends.

ing to speech, image and facial recognition (among others),

The first trend is the exponential growth of data. As oil was

which simulate human intelligence. It is different from tradi-

the fuel for the industrialisation of the 1900s, data is the

tional software programming in that it can extract knowl-

fuel for digitalisation in the coming decades. We believe

edge from data and alter its behaviour (or learn) without

that data ownership will distinguish winners from losers.

specific programming. While traditional software predefines the logic governing its processes, AI discovers patterns

The second trend, started just a few years ago, is cloud

and continually improves processes. Although AI has been

data storage. When businesses store data in the cloud, it

developing for years, it is now on a growth path, owing to

can be easily shared, processed and analysed, regardless

technology advancements and increased computing power.

of location. It is also more easily secured with the most advanced cyber-security techniques and able to comply

Wide-ranging uses of AI

with the latest data-privacy regulations.

The third trend is the continuing advancement of technol-

There are a wide range of uses for AI technology. The home-

ogy and the increased effectiveness of AI. In December

entertainment streaming service Netflix, for example, has

2017, the world’s computer chess champion was defeated.

a recommendation system that suggests movies based on

The old model had been developed after years of extensive

past viewer behaviour. This system is so advanced that 80%

training, while the new champion learned the game within

of what people watch on Netflix is based on this AI-powered

a short period of time and with almost 900-times fewer

system. It is vital for the Netflix business model, as a typical

calculations per second.

viewer loses interest within approximately 90 seconds of choosing what to watch, with the risk of abandoning Netflix.

AI services expected to grow

AI is also being adopted by an increasing range of business segments. The German e-commerce retailer Otto, for example,

The big cloud-computing companies are now offering

uses AI to predict what customers will buy before they place

a variety of AI business applications to analyse data on a

an order. Otto’s AI system is 90% accurate in forecasting what

subscription basis. As a result, AI applications are increas-

the firm will sell over the next 30 days. It has enabled the

ingly possible with less hardware investment and becoming

retailer to cut surplus stock by 20% and has reduced product

increasingly accessible to non-scientists.

returns by more than two million items a year.

AI as a service is expected to be massively adopted in the New business models are also evolving based on AI. The

coming years. Research firms, such as IDC and Gartner,

AI-powered self-driving vehicles from Waymo (Alphabet’s

expect the biggest impact of AI to occur in financial services,

14

Investment Outlook 2019

e-commerce, digital platforms, health care, IT services, utili-

development of AI. We like the big online platforms which

ties and manufacturing. These industries already have large

are offering cloud computing and AI apps, and also prefer IT

volumes of data and are savvy adapters of technology.

services, digital security companies, data centres and semiconductor manufacturers. In addition, the companies that are

A full 75% of the executives queried in an Economist

first to effectively employ AI to improve their businesses will

Intelligence Unit survey said AI would be “actively imple-

likely create a competitive advantage over peers, improving

mented” in their firms within three years, while 3% said that

their investment case.

it had already happened. PwC research shows global GDP could be up to 14% higher in 2030 as a result of AI.1

Piet Schimmel Senior Equity Thematic Expert

For investors, we believe that the first AI investment opportunities will be among companies that enable the

Endnote 1 Economist Intelligence Unit, “Artificial intelligence in the real world: the business case takes shape,” 2016.

AI-as-a-service is expected to be massively adopted

1 Data

2

Cloud computing

3AI

innovations

as-a-service I A

15

ABN AMRO Private Banking

Bonds: adapting to change The bond market’s challenge in 2019 will be to adapt to changing growth patterns and political developments, particularly in Europe. We will likely recommend that investors start rebuilding core government bond positions in 2019 and continue to diversify corporate credit risk. We also recommend that investors join the movement to invest in sustainable bonds.

Higher US yields made bonds a relatively more attractive investment than they had been for many years. As yields rose, we saw some rotation out of equities and into bonds and even US-dollar-denominated money market funds. We expect that this rebalancing of investment portfolios will continue in 2019, especially if investors come to realise that US yields are close to their peak. We have capitalised on this situation by adding US mortgage-backed securities into the portfolio. We will continue to look for similar opportunities

In 2019, we expect growth to slow in the second half of the

in the coming year.

year, while it is expected to remain above trend in the first half of the year. The debate regarding how much yields can still rise will therefore continue to dominate bond markets.

What to expect in 2019

This debate is fuelled by central bank actions. In the US, the Federal Reserve is expected to continue to raise short-term

As growth slows in 2019, the bond market will be pulled

rates while growth remains decent. While these hikes are

between two fears. The first is the fear that inflation may

mostly priced-in to markets, there is the potential that yields

surprise by rising higher than expected. Any sign of this in

will rise somewhat, but not by much.

the US has the potential to push yields higher, as the bond market will immediately suspect that the Fed will hike rates more than is currently priced-in. The second fear is that growth in the US will slow sooner and by more than markets are currently expecting. Any sign of an equity bear market will push bonds in the opposite direction. If investors sense a significant decline in stocks, US Treasuries will suddenly look very attractive at yields of close to 3%.

All eyes are on Europe In 2019, all eyes will be on Europe. The main question in bond markets is by how much can yields really rise? The answer depends primarily on growth, inflation and what the European Central Bank (ECB) believes it can do to normalise rates. In terms of growth, Europe has suffered from the slowdown in world trade. Price levels have gradually picked up, but core inflation remains subdued and is nowhere close to the ECB’s 2% target.

16

Investment Outlook 2019

Political and other challenges in 2019

Rebuild core government bond positions

There are also additional issues in Europe, such as the

In 2019, we may recommend rebuilding core government

effect of the expected slowing of the US economy in the

bond positions for extra portfolio protection. Inflation-linked

second half of the year, the possibility of a messy Brexit

bonds can also be used, given that they remain attractively

and the ongoing heated discussions between Italy and the

priced and are a buffer if inflation turns out to be higher than

EU. Europe also has a busy election calendar in 2019. There

expected. We also recommend reducing risk by trimming

are general elections in several countries, such as Belgium,

large positions in corporate credits and investing in other

Denmark, Finland, Greece and Portugal, where populism

pockets of the bond market with attractive valuations, such

may sway voters. There will also be European parliamentary

as emerging-markets debt.

elections and Prime Minister Angela Merkel’s departure as CDU leader in Germany. At the ECB, both the president,

The year ahead will also see the acceleration of sustainable

Mario Draghi, and the chief economist are stepping down.

investment opportunities in bond markets. The green bond

The changing of the guard throughout Europe could either

market is growing substantially. Mainstream issuers, such as

propel Europe forward or hold Europe back – if newcomers

the Dutch government, are increasing the issuance of green

focus on their own agendas and cooperation breaks down.

bonds. We recommend that investors join this movement and divert funds to the bonds of governments with durable

Time to readjust

policies and corporates with durable business models or that are funding sustainable projects. Bond funds with such tilts will increasingly become available. You earn a return on your

In 2019, we will learn which path Europe will take in terms of

investment and also contribute to a better world.

growth, politics and the ECB’s response. We do not expect the ECB to raise rates until 2020. For these reasons, bond

Mary Pieterse-Bloem

investors will likely need to start adjusting to the idea that

Global Head Fixed Income

we may be closer to the peak in yields than we, or many other investors, previously thought.

This is despite European yields still being unbelievably low,

Forecasts: Interest rates and bond yields

and even negative in many places. Over the last few years, an investment portfolio of risk-less cash and risky corporate bonds and other credits did well, as core government

Now

Year-end

30 Nov 2018

2019

US

bond yields were pulled lower. But as we transition to a new

Fed funds range

2.0 - 2.25

2.5 - 2.75

environment, investors need to rethink their bond portfolio

10-year Treasury

3.01

2.70

ECB policy rate

-0.40

-0.40

3-month Euribor

-0.32

-0.33

0.31

0.50

strategy.

Europe

10-year Bund

Updates to ABN AMRO forecasts can be found at https://insights.abnamro.nl/en/ Source: ABN AMRO Group Economics, Thomson Reuters Datastream

17

ABN AMRO Private Banking

Positive outlook for commodities A number of factors pushed commodities prices, and oil prices, in particular, lower in the last months of 2018. Improvement, including rising oil prices, are expected in the year ahead.

We expect supply-related factors to continue to dominate oil prices, resulting in a renewed price increase in 2019.

Moreover, the supply-demand balance for most metals will become tighter or, in some cases, the balance will tip to a supply shortage. This is occurring against a background of

The CRB Index, which tracks commodities markets, fell

a continuation of trade tensions, but no further escalation

under pressure at the end of 2018. An important reason for

between the US and China, and a slowdown in US growth.

the decline was the spillover from the negative sentiment

The outlook for both industrial and precious metals is also

seen in equity markets, as well as worries regarding the

supported by the measures China is taking to protect and

potential trade war between China and the US.

support its economy.

The CRB Index tends to decline if equity markets and other risky assets are under pressure or if the US dollar strengthens. Commodities are positively correlated with stocks

Course of the US dollar positive for commodities

because they both tend to perform well in an environment where there is strong growth and investors hold an optimis-

The weakness of the US dollar and somewhat lower ten-

tic outlook about the future.

year US Treasury yields are also positive for commodity prices overall. Expectations of supply shortages, a better

With a 23% share, West Texas (WTI) crude oil is the largest

demand outlook from China and an improved investment

contributor to the CRB Index. The index was therefore

case – because of a lower US dollar and lower ten-year US

affected when oil prices significantly declined after US

Treasury yields – is expected to result in higher commodity

President Donald Trump provided waivers to eight countries

prices in 2019.

to import oil from Iran. As a result, the US sanctions on Iran’s oil business seem less harsh than anticipated. The waivers

Hans van Cleef

triggered a sell-off in speculative long positions.

Another reason for the pressure on oil prices is increasing US oil inventories. This is seen as a risk in terms of market

Senior Energy Economist

Forecasts: Commodities 27 November 2018

Spot price

Avg 2019

End 2019

oversupply. But while we believe that US inventories will

Oil

indeed continue to rise, we nonetheless believe that infra-

Brent USD/bbl

60.48

85

85

structure bottlenecks will prevent them from significantly

WTI USD/bbl

51.63

80

76

Gold USD/oz

1,222

1,325

1,400

Silver USD/oz

14.24

18

18

843

981

1,000

contributing to answering the global demand for oil.

Metals

Metals and oil face similar short-term pressures

Platinum USD/oz The inability of US and China to come to a trade deal has

Palladium USD/oz

1,145

950

1,000

also put base metals under pressure. The fundamentals are

Aluminium USD/t

1,951

2,150

2,150

still solid, however, in most base metal markets. This means

Copper USD/t

6,165

6,900

6,920

that as soon as trade tensions ease, fundamental drivers will

Updates to ABN AMRO forecasts can be found at https://insights.abnamro.nl/en/

likely send base metal prices higher.

Source: ABN AMRO Group Economics

18

Investment Outlook 2019

19

ABN AMRO Private Banking

Private Equity: playing it safe Distributions from private-equity investments remain buoyant, due to continued strong exit activity. It is therefore not too surprising that new commitments to private-equity funds remain strong and committed, resulting in a build-up in uninvested capital.

Ample investment capital affects valuations

before interest, taxes, depreciation and amortization at the end of August 2018 according to S&P, it is hard to expect that further multiple expansion will reach 12x, 13x or more over the next few years.

Adapting to more competitive conditions The good news is that the investment cycle to come will still offer attractive investment opportunities for the most

Undrawn or uninvested investment capital (‘dry powder’)

disciplined and skilled private-equity managers. The funds

continues to pile up globally. For buyout funds, uninvested

that have been raised will be invested over the next few

investment capital rose to more than USD 640 billion by the

years. This means that the large amount of available capital

end of the third quarter of 2018, according to Preqin. The

to invest could benefit from a more favorable pricing envi-

question is if this huge amount of capital could impair returns.

ronment in the future.

Historically, performance tended to be lower when large amounts of capital were chasing deals. This increased uncer-

We now see some managers extending their investment

tainty, and many investors preferred to stay on the sidelines.

period from five to six years, in order to be in a position to capture the best deals at the right time and conditions, with

One reason for this behaviour lies in the cyclical variation of

no pressure to deploy capital too quickly. Furthermore, in

entry prices. When financial sponsors have ample invest-

sourcing deals in a highly competitive environment, where

ment capital — thanks to strong fundraising — and strategic

multiple expansion can be negative, private equity managers

buyers are looking for attractive targets to grow inorgani-

appear to act more prudently and to ensure that sufficient

cally, such as through mergers & acquisitions, purchase-

value – and ultimately attractive investment returns – can be

price multiples tend to rise. This limits the room for multiple

created through margin improvements and earnings growth.

expansion.

Looking at buyout acquisition prices on both sides of the

Using private equity for diversification

Atlantic, which stood, on average, at around 10x earnings In this environment, investors should continue to be selective when choosing a private-equity manager and concentrate on managers that have demonstrated historically that they possess the requisite skills to unlock operational value in investment companies and can generate attractive returns even without soaring valuations. To this extent, private equity is a safe diversification strategy in a more volatile financial market environment. As an asset class, it can capture investment opportunities that are not available through more liquid assets, such as stocks and bonds.

Geoffroy Catrice, Global Head Private Equity

20

Andreas Hegedüsch, Senior Investment Professional Private Equity

Investment Outlook 2019

EUR/USD to strengthen We expect the EUR/USD to rally in 2019 and 2020.

There are a number of factors supporting this expectation, including narrowing yield spreads and a rising US fiscal deficit.

economist expects that the US fiscal deficit will rise sharply.

This is also an important negative factor for the US dollar.

No new eurozone crisis because of Italy

We expect the EUR/USD exchange rate to bottom out before it hits 1.10 and to rally in 2019 and 2020. One reason for

As the US dollar weakens, there is some support for the euro

this is that in 2019 and 2020, we expect narrowing spreads

to be found. We expect, for example, no crisis between Italy

between Germany and the US. That is, the spread between

and the eurozone regarding the 2019 fiscal budget target. In

ten-year Bunds and ten-year US Treasuries will narrow, as will

fact, we expect the yield difference between ten-year German

the spreads between two-year German government bonds

Bunds and ten-year Italian bonds to remain in the range of

and two-year US Treasuries. This is despite our expectation

250-300 basis points. This means that although investors will

of no interest-rate hike by the European Central Bank (ECB)

remain concerned about Italy, we expect no panic.

until March 2020. These narrowing spreads are a reflection of a variety of drivers. Foremost, the US economy is now at its strongest point. We therefore expect that ten-year US

Speculative positioning also supportive

Treasury yields will peak before too long and then decline.

The position of speculators is also supportive for the EUR/USD. It is also likely that two-year US yields will decline after the

Speculators currently hold sizeable net-long dollar positions and

Fed halts its tightening cycle, due to the market’s anticipation

are net-short euros. These positions are not at extreme levels,

of rate cuts by the Fed. While we think that it is unlikely that

but we think that there is limited room for a sharp increase.

the Fed will cut rates in our two-year forecast horizon, financial

Instead, we believe that there is room to liquidate net-long posi-

markets are nonetheless expected to start pricing-in rate cuts

tions in the US dollar and net-short positions in the euro.

as soon as the Fed stops its hiking cycle. Expectations regarding the ECB’s policy are in the opposite direction. We expect

Georgette Boele

the ECB to start its hiking cycle in March 2020. Therefore, two-

Senior FX Strategist

year German bond yields are expected to start rising towards the end of 2019, and we expect this to continue in 2020.

Currency forecasts FX pair

Deterioration in US dollar expected

Spot

Q4 2019

Q4 2020

14 Nov. 2018 EUR/USD

1.1287

1.25

1.30

USD/JPY

113.85

105

100

We also expect US-dollar fundamentals to deteriorate. This

EUR/JPY

128.50

131

130

is owing to our expectation that the US economy will peak

GBP/USD

1.2967

1.45

1.50

and then slow down considerably in the course of 2019. We

EUR/GBP

0.8705

0.86

0.87

think the weakness in the eurozone economy that was seen

USD/CHF

1.0077

0.96

0.92

in recent months is already priced-in to the euro. We expect

EUR/CHF

1.1374

1.20

1.20

that the Fed will hike rates in December 2018 and just once

USD/CNY

6.9552

6.70

6.70

USD/BRL

3.8095

3.40

3.20

in 2019. While this would normally add upward pressure to the US dollar, we believe the hikes have already been

Updates to ABN AMRO forecasts can be found at https://insights.abnamro.nl/en/

roughly priced-in to financial markets. And finally, our US

Source: ABN AMRO Group Economics

21

ABN AMRO Private Banking

Contributors ABN AMRO Global Investment Committee Richard de Groot

richard.de.groot@nl.abnamro.com

Global Head Investment Centre

Han de Jong

han.de.jong@nl.abnamro.com

Chief Economist

Reinhard Pfingsten

reinhard.pfingsten@de.abnamro.com

Global Head Asset Allocation Services

Olivier Raingeard

olivier.raingeard@fr.abnamro.com

Global Head Equity

Mary Pieterse-Bloem

mary.pieterse-bloem@nl.abnamro.com

Global Head Fixed Income

Georgette Boele

georgette.boele@nl.abnamro.com

Senior FX Strategist

Hans van Cleef

hans.van.cleef@nl.abnamro.com

Senior Energy Economist

Olivier Raingeard

olivier.raingeard@fr.abnamro.com

Global Head Equity

Arthur Boelman

arthur.boelman@nl.abnamro.com

Equity Advisory Expert

Paul van Doorn

paul.van.doorn@nl.abnamro.com

Senior Portfolio Manager, Equities

Bastian Ernst

bastian.ernst@nl.abnamro.com

Portfolio Manager, Equities

Eric Lafrenière

eric.lafreniere@fr.abnamro.com

Senior Portfolio Manager, Equities

Esther van Munster

esther.van.munster@nl.abnamro.com

Senior Portfolio Manager, Equities

Sandra Saidi

sandra.saidi@fr.abnamro.com

Senior Portfolio Manager, Equities

Piet Schimmel

piet.schimmel@nl.abnamro.com

Senior Equity Thematic Expert

Guido Stiel

guido.stiel@de.abnamro.com

Senior Portfolio Manager, Equities

Jan Wirken

jan.wirken@nl.abnamro.com

Senior Equity Expert

Mary Pieterse-Bloem

Mary Pieterse-Bloem@nl.abnamro.com

Global Head Fixed Income

Roel Barnhoorn

roel.barnhoorn@nl.abnamro.com

Senior Fixed Income Thematic Expert

Florian Bardy

florian.bardy@fr.abnamro.com

Fixed Income Portfolio Manager

Willem Bouwman

willem.bouwman@nl.abnamro.com

Senior Fixed Income Portfolio Manager

Chris Huys

chris.huys@nl.abnamro.com

Senior Fixed Income Portfolio Manager

Fidel Kasikci

fidel.kasikci@de.abnamro.com

Senior Fixed Income Portfolio Manager

Torben Kruhmann

torben.kruhmann@de.abnamro.com

Fixed Income Portfolio Manager

Thomas Smid

thomas.smid@nl.abnamro.com

Senior Fixed Income Expert

Jacques Verdier

jacques.verdier@fr.abnamro.com

Senior Fixed Income Portfolio Manager

Reinhard Pfingsten

reinhard.pfingsten@de.abnamro.com

Global Head Asset Allocation Services

Paul Groenewoud

paul.groenewoud@nl.abnamro.com

Quant Risk Specialist

Martien Schrama

martien.schrama@nl.abnamro.com

Profile Manager

Chris Verzijl

chris.verzijl@nl.abnamro.com

Quant Risk Specialist

Romeo Chamman

romeo.chamman@nl.abnamro.com

Quant Risk Specialist

Arkadi Odintsov

arkadi.odintsov@nl.abnamro.com

Quant Risk Specialist

Thomas Domeratzki

thomas.domeratzki@ de.abnamro.com

Senior Strategist

Steffen Kunkel

steffen.kunkel@de.abnamro.com

Senior Strategist

Geoffroy Catrice

geoffroy.catrice@fr.abnamro.com

Global Head Private Equity

Andreas Hegedüsch

andreas.hegeduesch@de.abnamro.com

Senior Investment Professional Private Equity

Group Economics

Global Investment Centre

Private Equity

22

Investment Outlook 2019

Disclaimers General: The information provided in this document has been drafted by ABN AMRO Bank N.V. and is intended as general

US Person US Securities Law Disclaimer: ABN AMRO Bank N.V.

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(‘ABN AMRO’) is not a registered broker-dealer under the U.S.

The information may therefore not expressly be regarded as

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and under applicable state laws in the United States. In addi-

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tion, ABN AMRO is not a registered investment adviser under

as an investment advice. Decisions made on the basis of the

the U.S. Investment Advisers Act of 1940, as amended (the

information in this document are your own responsibility and

‘Advisers Act’ and together with the 1934 Act, the ‘Acts’), and

at your own risk. The information on and conditions applicable

under applicable state laws in the United States. Accordingly,

to ABN AMRO-offered investment products and ABN AMRO

absent specific exemption under the Acts, any brokerage and

investment services can be found in the ABN AMRO Investment

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Neither this document, nor any copy thereof may be sent to or

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23

Offices ABN AMRO MEESPIERSON AMSTERDAM Jan Willem Hofland jan.willem.hofland@nl.abnamro.com BANQUE NEUFLIZE OBC S.A. PARIS Olivier Raingeard olivier.raingeard@fr.abnamro.com BETHMANN BANK AG FRANKFURT Thomas Henk thomas.henk@bethmannbank.de ABN AMRO PRIVATE BANKING ANTWERPEN - BERCHEM Erik Joly erik.joly@be.abnamro.com ABN AMRO PRIVATE BANKING CHANNEL ISLANDS Patrick Millar patrick.millar@gg.abnamro.com

This publication is produced by the Global Investment Communications team. If you have questions or comments, contact the team at I-Comms.Global@nl.abnamro.com.

www.abnamroprivatebanking.com