ABN AMRO PBI Outlook Mid-year 2019 (English)

Investment Outlook | Mid-year 2019

Riding the Wave

ABN AMRO Private Banking

Contents

INTRODUCTION 3 RIDING THE WAVE

4

ADVANTAGES TO STAYING INVESTED

6

A WIN/WIN SOLUTION WITH SUSTAINABLE INVESTING

8

AN INCONVENIENT SURPRISE

10

EQUITY CROSS-CURRENTS

12

INVESTING IN WATER

14

BONDS: STRONG UNDERCURRENT OF LOW RATES

16

STILL POSITIVE ON GOLD

18

PRIVATE EQUITY: OPERATIONS ARE KEY

20

THE DOLLAR’S RESERVE CURRENCY STATUS

21

CONTRIBUTORS 22

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

2

Investment Outlook | Mid-year 2019

Introduction

Richard de Groot Global Head Investment Centre ABN AMRO Private Banking

May 2019

When looking forward, it is hard to not first look backwards. Particularly after a volatile and painful quarter as we saw at the end of last year. Growing concerns for a recession and a global trade dispute sent equity markets much lower – in some cases by more than 20%. The first quarter showed almost the opposite. Supported by central banks taking a different path, the fear of a recession slowly eased and markets rebounded from their lows.

And they did so convincingly. I am really pleased that investors, including our clients, have seen some compensation for the losses they suffered in 2018.

This triggers the question, what’s next? Will the fear for a recession return to the market? Or will the global economy continue to grow, although perhaps at a lower rate? We believe in the possibility of further growth.

With the consumer still spending, supported by low unemployment rates, and with interest rates and inflation at low levels, there appears to be little reason why the economy will not see a small pickup in growth. This is true, despite the rising tensions in the trade dispute between the US and China.

For investors, this means they will be able to ride the wave for a little longer; and we expect at least for the rest of this year.

In this Investment Outlook, we present our views on financial markets, including our view on macroeconomic developments, the changing stance of the central banks and the policy changes now being implemented by the Chinese government. In our view on equity markets, the recommended sectors and regions are presented, indicating where investors can best allocate their money. Emerging markets play an important role in this outlook as well, particularly for fixed-income investors. There is also a role for sustainable investing in emerging markets, where they present interesting possibilities for investors.

This Investment Outlook is prepared by the investment specialists of ABNÂ AMRO Private Banking. Your investment advisor will gladly support you with ideas on how best to benefit from what we expect for the rest of the year.

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Riding the wave The US economy has been expanding since 2009. It is a wave that is set to reach a new record in the coming months. The longer it continues, the more worry it creates about when it will end.

There is a word for an end to an expansion of economic

a growing Chinese economy will also benefit countries

growth. It is called a recession, and it is feared by many.

that export to China. That is valid for other emerging coun-

Particularly since recessions are almost always combined

tries in the region, but also for Germany, which will surely

with bear markets.

benefit from stronger exports.

months. There was even a short-lived inversion of the

Political risks are still present, but have little impact on financial markets

US yield curve, a classic signal that a recession might be

●●

Macroeconomic indicators have been declining in recent

While political risks were an important factor last year, we

coming. Still, we believe that there is no global recession

have now seen that they have had little impact. We do

in sight and that economic growth will continue, albeit, at

not expect political risks to flare up again, but we remain

a lower rate than we have experienced over the last few

watchful. The decisions and headlines related to Brexit

years.

have been postponed. In line with our previous expectations, we believe that the effect of Brexit is mainly concentrated in the UK. We do not think that it will jeop-

A number of positive changes will help the economy going forward….

Central banks have become more accommodative ●●

ardise the global economy.

… but not all our worries have been lifted.

The main reason why equity markets have recovered is

Weakness in global manufacturing

surely related to the change in policy by the US Federal

●●

Macro indicators, particularly on the manufacturing side,

Reserve. In October 2018, Federal Reserve Chairman

have been weak over the past few months. We believe

Jerome Powell was indicating that there were still a

that these indicators will bottom out and that we will

number of rate hikes to go. Over the last few months,

see some improvement in the second half of 2019.

however, this has changed. And now, no more rate hikes

Manufacturing remaining weak could be a threat to the

are currently expected and markets are even pricing-in a

continuation of the economic cycle.

rate cut. The fear of higher interest rates, which, in turn, will have an impact on profits, is therefore removed. We

Will the trade war really be solved?

expect this stance by the US central bank will remain an

●●

important support for risky assets.

Even though a deal between China and the US is expected, we still need to see the details of such a deal, especially now that tensions have once again escalated.

China starting a new wave? ●●

4

We also need to know whether it will indeed solve the

The Chinese government is, for now, focusing more on

trade dispute between these superpowers or will there

stabilising economic growth than it is on reducing debt

be many open ends that will keep investors worried? And

levels. Even though the stimulus efforts are much lower

what is the risk that US President Donald Trump picks a

than we have seen in previous years, we do see some

trade dispute with Europe? We do not believe this will

positive early signs. A strong Chinese economy is impor-

happen, as it would have a negative impact on the US

tant for many reasons. First, because it is the second-

economy. But it is difficult to predict the motives and next

largest economy in the world. But even more important,

moves of the US president.

Investment Outlook | Mid-year 2019

Bond market gave an important signal ●●

●●

Most high-quality bonds have a negative expected return,

In the first quarter of 2019, the US yield curve was

due to the low interest rates. We recommend focusing

inverted for a short time. This inversion means that inves-

on the bonds that can offer some return, including invest-

tors were requesting a higher rate for short-term bonds

ment-grade corporate bonds.

than for longer-dated bonds. In the past, an inverted yield curve has been a strong indicator of an upcoming reces-

Richard de Groot

sion. But it is important to emphasize that there is usually

Global Head Investment Centre

a long time between the inversion and the start of the recession (usually more than a year). We will be keeping a close eye on the yield curve for further signals. n e u t r al

ment levels, we expect the US consumer to remain an

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o ve

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●●

BON

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Information technology (IT) and communicaEQUITIES tion services sectors are attractive

ht

EQUITIES

over the rest of the world. With continued low unemployimportant support for the economy. The US t is also less h ig dependent on international trade, particularly compared

ig

s t r ong

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Within equity markets, we continue to favour the US

to emerging markets or Europe.

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US still favoured ●●

ig

ro

Possible opportunities for your portfolio

ne

BONDS

The IT and communication services sectors should do well in a scenario of lower growth, as companies in these sectors are less dependent on the economic cycle. Both sectors should benefit from the importance of digitalisation.

The competitive advantage these companies have will likely result in more pricing power and therefore higher margins.

Look for yield in bonds ●●

For bonds, one area of opportunity is emerging markets.

Even though emerging-markets debt is not cheap, the yields remain attractive. We recommend investing in hard-currency (US-dollar, for example) denominated bonds that are hedged into euros.

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Advantages to staying invested From time to time you are no doubt involved in discussions about when to enter the stock market or to leave it completely. Market conditions and the global macro environment become discussed, followed by trying to estimate the optimal point at which to make such an investment decision. This type of decision is known as market timing.

Average return affected by being uninvested Based on ABN AMRO’s risk profile 4, the average annual absolute return over the last 15 years was 5.6%. This was the return when clients invested in line with our recommended strategic asset allocation. This is before the return which came from active management via the tactical asset allocation that is steered by the ABN AMRO Investment

Everyone has a desire to be fully invested when markets are

Committee and implemented with the stock selection by

rising and to be out of the market when prices fall. And such

ABN AMRO’s experts. What this means is that EUR 100

a decision is not about only the direction of the market, but

invested in 2003 would have become EUR 231 at the end of

also the size of your position. These decisions rely on your

2018, based on our strategic asset allocation; and would rise

confidence about the market’s direction. A complete divest-

to EUR 263 with our active management.

ment would mean a 100% conviction in a market decline.

Being out of the market when it declines, also removes other return capabilities, such as positive stock selection, where it is possible that a stock rises, even in the midst of an overall

Exposure to the market’s best days significantly impacts returns

decline.

Now, consider if you were invested in just the ten best days

Staying invested is a good strategy

of each year. For our risk profile 4 the average yearly return would improve to 9.8% per year and with active asset allocation even rise to 10.4% per year. Over the last fifteen

An active investor has to decide day by day on their

years, this would transform EUR 100 into EUR 441 from our

investment position and to anticipate the next days’ price

strategic asset allocation, rising to EUR 483 with our active

movements. With such an approach, however, there is a

management.

high probability that this investor will miss the days with good performance or be invested on the days with bad

Given the large increase in returns, it becomes obvious

performance.

how important it is to be invested on the market’s best days. When trying to achieve market timing, however,

As shown in the Figure, it is crucial to be invested on the

the chances are very high that these days will be missed,

right days. Just a few days in a year are responsible for

which will substantially dent overall annual performance.

much of the overall performance. Missing out on them will

On average, the performance of risk profile 4 without the

drag down overall portfolio performance significantly.

market’s ten best days of each year melts down to -3.6% per year. You would have lost money when you were not invested on those days.

6

Investment Outlook | Mid-year 2019

It becomes obvious with these examples how overall performance is to a large extent determined by just some days. The same is true for whole markets, indices and stock

Not being invested on the market’s best days hurts performance 300

markets. Unfortunately, it is not possible to know in advance which will be the best days. It is therefore our advice to stay

Strategic Asset Allocation (SAA) 250

SAA minus ten best days per year

invested, and to set the magnitude of your positions according to your conviction in the expected market direction. With

200

active management, diversification and controlling for risk – as we do in our investment process – overall performance can exceed the market’s return.

Reinhard Pfingsten

150

100

Global Head Asset Allocation Services Thomas Domeratzki

50

Senior Strategist 0 2003

2007

2011

2014

2018

An indexed comparison between ABN AMRO risk profile 4 absolute performance invested according to the strategic asset allocation (blue) and performance of the same profile, with the ten best market days from every year removed (gray).

Source: Calculations based on ABN AMRO Strategic Asset Allocation (SAA) with index data from Bloomberg, FactSet, MSCI and Barclays on a total return net basis, gross of costs. Past performance is no guarantee of future results.

7

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A win/win solution with sustainable investing Sustainable investing is one way to help fund the transition to a more sustainable future. Certain regions of the world, including emerging markets, can be more challenging than others when taking a sustainable approach.

difference in the world. But while ESG factors are mostly

Sustainable investors with a global portfolio are faced with

The UN describes its SDGs as a blueprint to achieve a better

the issue of how to take sustainable investment decisions

and more sustainable future for all. There are 17 goals and

in countries or regions that may be known for controversy,

they address such issues as no poverty, affordable & clean

lack of transparency or environmental issues. Our answer is

energy and responsible production & consumption. (See

to select sustainable companies by including environmen-

Figure.)

about how a company is running its business, the SDGs enable us to target investment in companies with products offering solutions to climate change and other global challenges.

tal, social and governance (ESG) factors during financial analysis and by using thematic investing linked to the UN’s

Our thematic stock investments are therefore not limited

Sustainable Development Goals (SDGs).

to climate-change initiatives. For example, in addition to investing in one of Asia’s largest wind turbine suppliers

Choosing the best in terms of ESGs and SDGs

(SDG #7 Affordable and Clean Energy), we also invest in a Brazilian distance education provider, which supports SDG #4, Quality Education. In emerging markets, three of our

When a company scores well in terms of ESG factors, it is

key themes relate to education, sustainable transportation

not just positive for investors, even though recent research

and telecommunications. (Telecommunications is included

by index provider MSCI found that highly ESG-rated compa-

given its importance in developing economies to improv-

nies tended to show less systematic volatility, lower costs

ing access to health care and providing information, such as

of capital and higher valuations than other companies. ESG

weather forecasts to farmers.)

1

factors are equally important for their positive influence on employees, the environment, supply chains and customers. This is because within the three ESG components are

Making a difference with sustainable bonds

a variety of important topics contributing to a more sustainable world.

Bond investors also have sustainable investing options. One of the most interesting developments in the last ten years

The E for Environmental factors, for example, can include

is the growth of the green bond market. Green bonds are

air quality, biodiversity protection and water use and conser-

issued to finance environmentally friendly projects. Total

vation. The S for Social factors can include human rights,

issuance now exceeds USD 500 billion and the market

workplace diversity and labour conditions; and the G for

continues to grow.

Governance can reflect a company’s avoidance of anti-trust violations and the disclosure of material risks. While these

In emerging markets, green bonds have a track history in

issues are important the world over, they are particularly

supporting the transition to a low carbon economy. China

challenging in emerging economies.

and India, with more than USD 37 billion in green bonds issued, are the two largest emerging-markets green bond

It is reasonable that companies reporting and managing

issuers. The proceeds from green bonds from these two

their businesses in line with ESG goals can perform better

countries have prioritised solar and wind energy, low carbon

than their peers and will be more likely to make a positive

transport and low carbon buildings. While still small, there

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Investment Outlook | Mid-year 2019

are a growing number of fixed-income funds offering access to green bonds. Other options for sustainable bond investors in emerging markets are bonds selected using ESG or other sustainable investing criteria.

Conclusion The challenge that we face regarding the impact of climate change erases national boundaries and illustrates our dependence on each other. It underlines how the transition to a more sustainable world is a global issue requiring global solutions and investment. With EUR 100 trillion in assets, the financial sector offers huge potential in financing the transition. Sustainable investments in emerging markets can be a win/win solution. It unites investors looking for both social and financial returns from their investments with sustainable (and profitable) companies and projects around the world.

Richard de Groot Global Head Investment Centre Endnote 1 MSCI, Foundations of ESG Investing, November 2017.

UN Sustainable Development Goals

Source: United Nations

9

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An inconvenient surprise Global economic growth slowed markedly last year, and fears appeared that one or more key economies might soon sink into recession. Some headwinds that had depressed growth in 2018, however, are abating. As a result, it appeared reasonable to be optimistic that global growth would strengthen somewhat and that recessions were highly unlikely. Until US President Donald Trump tweeted‌

resulted from its deleveraging policy and the tightening of financial conditions worldwide – which had occurred from continued Fed tightening and dollar strength. Europe had, in addition, problems of its own in the car industry – an important sector in Germany.

Course change by central banks and China Chinese policymakers must have considered that their

A key development last year was the emergence and esca-

economy was slowing more than they found acceptable.

lation of the trade conflict, particularly between the US and

They changed tactics in the course of 2018. Deleveraging

China. Econometric models are not good at capturing the

got less priority and supporting economic growth got more.

effects of such a development, leaving economists guess-

The effects of this shift started to be seen in Chinese data in

ing at the magnitude of the impact.

recent months. (See Figure.)

With hindsight, we argue that the escalating conflict had

The US Federal Reserve has also changed its course.

strong negative effects on sentiment. This, in turn, limited

Instead of saying they will continue raising rates this year,

corporate capital spending in many economies and led to

Fed policymakers now seem to be firmly on hold. This has

weakness in markets for risky assets, such as equities,

led to some strengthening of emerging-markets currencies,

which depressed global economic growth. All this came

relieving pressure on these economies and contributing to

on top of the slowdown in the Chinese economy, which

some easing of financial conditions.

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Investment Outlook | Mid-year 2019

And last, the strong performance of risky assets in the first

collapse of the US/China talks would be very negative – but

couple of months of 2019 has also added to the easing of

that is not yet the case. The negative effects of a total break-

financial conditions.

down of the talks would harm President Trump’s chances of being re-elected next year. So he has an incentive to do a

But perhaps the biggest positive change compared to 2018

deal, eventually….

was that the Chinese and the Americans were involved in trade negotiations and appeared to be very close to a deal.

Inflation has remained remarkably subdued in most key

That would have been very positive for confidence. In fact,

economies, even in the US where the labour market is tight

market participants were probably assuming a deal would

and unemployment has fallen to levels last seen in the late

be done. Then, Trump tweeted. Talks broke down and the

1960s. Sustained low inflation means that there is no reason

US imposed further tariffs on imported Chinese goods. A

for central banks to tighten policy aggressively.

renewed tit-for-tat was underway.

Overall, while the frictions between the US and China imply risks to the global economic outlook, we think that the risk

Renewed trade dispute is a setback

of recession during the next couple of quarters is very low.

Sustained, albeit, modest economic growth, combined with

The re-escalation of the trade conflict is a major setback for

low inflation and central banks refraining from tightening

the global economy and for our cautiously optimistic view. It

creates a constructive environment for risky assets.

is still true, however, that some negative factors from 2018 are abating. We therefore still believe that global economic

Han de Jong

growth will pick up somewhat and that recessions remain

Chief Economist

unlikely. Having said that, the risks have increased. A total

Chinese economic data has improved 65 60

Forecasts: Economic growth and inflation (%)

55

24 May 2019

50 45 40 2017

2018

2019

Based on the China Business Conditions Index. The index takes 50 as its threshold, so an index value above 50 means that the variable that the index measures is expected to increase, while an index value below 50 means that the variable is expected to fall.

Source: Cheung Kong Graduate School of Business

GDP growth

Inflation

2019

2019

US

2.3

1.6

Eurozone

0.8

1.2

Japan

0.9

1.1

UK

0.8

1.4

China

6.3

2.5

World

3.3

3.7

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

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Equity cross-currents Market behaviour in 2019 has been impressive, characterised by strong returns without significant volatility. This is despite the deterioration of the economic outlook and a slowdown in earnings growth. This desynchronization between fundamentals and markets is not sustainable in the long run. The second half of this year will be decisive: either fundamentals recover, feeding the bull market that started in 2009, or fundamentals remain weak and volatility returns. For the time being, it is too early to know for sure, which is the reason we retain our neutral stance toward stocks.

below 5% for these two regions. Clearly, analysts integrated the slowdown of the world economy into earnings expectations. As a consequence of the performance seen in the first quarter, valuations have significantly recovered from the lows registered in December. In terms of the price/earnings ratio, the US equity market is trading at 18x and the European market at 15x, which are above their long-term averages. Valuations, however, remain below the levels reached in early 2018.

But investors are focusing on positive expectations

The first months of this year were very strong for risky assets.

For US stocks, the first quarter was the strongest quarter

Investors are expecting three main developments in coming

since 1998. This surge was unanticipated, certainly after the

months. First, that the world economy will recover in the

month of December, which was the worst December for

second half of 2019 and in 2020. Some green shoots have

the US equity market since 1931.

been seen, in particular in China, but uncertainties remain.

Secondly, investors expect that earnings growth will reac-

The main trigger for the reversal after December was the

celerate in the last quarter of this year and in 2020. Analysts,

U-turn taken by central banks, and, in particular, the US

for example, are expecting more than 10% of earnings

Federal Reserve. After claiming in December 2018 that the

growth for the US equity market next year. We believe this

Fed would keep on tightening monetary policy in 2019, Fed

is too ambitious, especially if the uncertainties regarding the

Chief Jerome Powell claimed on 3 January that a pause in

economic outlook are taken into account. Finally, a decrease

the rate hiking was necessary. The European Central Bank

in political risks is expected, in particular on the commercial

also intervened, announcing a new liquidity injection planned

side. So far, however, there is still no deal between the US

for September 2019.

and China, and the risk of a collapse in negotiations is slightly increasing. Given this seeming balance between upside and

Fundamentals have weakened The beginning of 2019 was characterized by weak economic momentum. Corporate confidence dropped significantly, in

downside risks, we prefer a neutral stance to equities.

US favoured over emerging markets and Europe

particular, for the European manufacturing sector, culminating in a slowdown for the world economy. On the earn-

We are upgrading our overweight position in US stocks.

ings side, expectations have been downgraded. In October

Despite higher valuations compared with other markets,

2018, analysts were expecting US and European 2019 earn-

the US stock market remains definitely the leader of the

ings growth to be above 10%. Currently, expectations are

bull market, based on a stronger economy, higher earnings

12

Investment Outlook | Mid-year 2019

growth and the dominance of the US information technol-

Sector view (24 April 2019)

ogy (IT) and communication services sectors. Emerging

Sector

View

markets have been downgraded to neutral. The rationale for

Communications services

Overweight

this decision is based on the escalation of the trade war,

Consumer discretionary

Neutral

which could generate higher risks for the economic outlook

Consumer staples

Underweight

and corporate earnings growth. Europe remains out of

Energy

Neutral

favour, because of low economic growth, anaemic earnings

Financials

Underweight

growth and greater political uncertainty.

Health care

Neutral

Industrials

Neutral

Information technology

Overweight

Materials

Neutral

Real estate

Neutral

IT and communications services favoured We recently decided to reduce the cyclicality of our sector

Source: ABN AMRO Private Banking

positioning by downgrading our view of the energy sector to neutral. The rebound in energy had been quite impressive since the beginning of the year, despite the economic slowdown fuelled by geopolitical uncertainties. Financials are still underweight because of global and specific uncertainties.

We would need to see stronger global growth and higher long-term interest rates before becoming more positive on the financials sector. Finally, the information technology and communication sectors have been upgraded (overweight), thanks to earnings growth resilience. These two sectors are leading the bull market, based on stronger earnings growth.

Olivier Raingeard

A strong run in stock markets since 2009

600 500 400 300 200 100

Global Head Equity

0 Jan ‘09

Aug ‘11

Mar ‘14

Oct ‘16

May ‘19

Based on the MSCI World Index 1 January 2009 – 10 May 2019 Source: Bloomberg

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Investing in water Much-needed water investments are on the rise.

One driver is demand, as unless changes are made, the world will need a 40% increase in supply by 2030. We see opportunities for investors in companies which provide solutions to improve water infrastructure, water access and water quality.

One of the growing concerns among consumers is the

intensive. For instance, 1 kilo of beef takes 15,400 litres of water to produce compared to 1,830 litres for 1 kilo of wheat. According to the UN, our current water consumption is unsustainable. If unchecked, then by 2030, the world will need 40% more water than is currently supplied.

Global warming severely affects water supply

quality of their water supply. From a survey conducted by the Water Quality Association in January 2019 among US

Higher temperatures and more extreme, less predict-

consumers, 51% are concerned or very concerned about

able weather conditions are projected to affect the avail-

their household water supply, up from 42% in 2017. And

ability and distribution of rainfall, snowmelt, river flows

according to the European Commission only 20% find drink-

and groundwater. Rising temperatures, for example, cause

ing water outside of their home country acceptable, while

higher evaporation from open surfaces and soils, which

11% of Europeans are affected by water scarcity. Statistics

reduces water availability. And, as the climate warms, the

such as these are the reason that the EU and the US have

predicted longer duration and severity of droughts requires

called for improvements to their water supplies.

more water storage. Today, 3.6 billion people spend at least one month of the year in conditions of severe water

Last October, the European Parliament agreed to finally

scarcity. According to the UN, this will rise to 5.7 billion by

change 20-year old water legislation, aiming to reduce

2050. Low-income communities are likely to be the worst

harmful lead and chromium by 50% in tap water. They are also

affected. The Intergovernmental Panel on Climate Change

targeting a 17% reduction in bottled water consumption in

calculates that with every one degree increase in global

10 years. Reducing the consumption of bottled water means

warming, 7% of the world population experiences a 20%

less greenhouse gas emissions and plastic waste. In the US,

decrease in renewable water resources.

there is finally some political support for badly needed water infrastructure improvements. The Democrats as well as the Republicans both aim to dramatically increase infrastructure

Water quality is under pressure

spending (including for water-related projects) as part of their political campaigning for the 2020 presidential elections.

Another issue related to the global water supply is poor quality. Based on UN calculations, 80% of all industrial and

Water demand is expected to grow to unsustainable levels.

municipal waste water is released into the environment without any treatment. For example, almost 40% of the surface water around Beijing is so polluted that it cannot be used for anything, including human consumption, agricul-

The demand for tap water is increasing by a steady 1% per

tural or industrial use (source: World Bank).

year. This increase is due to global population growth to over 9 billion in 2050. Two-thirds of all people will live in densely

Europe is not excluded from these problems; 15% of all

populated areas, and global GDP is expected to increase by

groundwater monitoring stations have nitrate levels above

2.5-times (source: UN 2018). As a consequence of rising

World Health Organization standards. The nitrates are

wealth, diets typically change to include more meat and

largely caused by agriculture fertiliser (source: UN Food and

less grains. Growing livestock, however, is far more water

Agriculture Organisation.)

14

Investment Outlook | Mid-year 2019

Old infrastructure leads to water loss

Goal related to achieving universal and equitable access to safe and affordable drinking water around the world (see Figure).

Another problem related to the water infrastructure is loss from leakage. US utilities lose approximately 15% of total

Researchers at Michigan State University calculated that if

drinking water owing to aged infrastructure and poor leak

US water tariffs would rise at the same rate as in the past,

detection. London, Dublin and Rome see leakage levels of

i.e. at 5% per year, then the number of US households unable

up to 30-40% (source: Smart Water Networks). But there are

to pay their water bills could triple to 41 million in five years.

solutions. Digitalisation of water infrastructure, for example,

It therefore seems obvious that government action is neces-

with smart meters, predictive maintenance and water

sary to ensure water remains affordable.

management, are effective tools to save water, make water more accessible and can lower utility operational costs.

Investment opportunities in water

Water tariffs need to grow

Investors are needed to fund the improvement in water access and quality around the world. Fortunately, the expected wave

The amount of investment needed for water and sanita-

in water spending provides opportunities. Companies focus-

tion infrastructure is far higher than the income water utili-

sing on providing water infrastructure, water treatment and

ties receive from water tariffs. Global Water Intelligence

water technology are expected to see strong earnings growth

calculated that water tariffs would need to be significantly

for the coming years.

increased in order to reach the UN Sustainable Development Piet Schimmel Senior Equity Thematic Expert

Yearly increase in tariffs needed to meet UN water sustainability goals (%) % 15

12

Southern Asia

North America

9 Sub-Saharan Africa East Asia Eastern 6 Europe/ Western Central Europe Asia

Middle East/ North Africa Latin America

3

0 Source: Global Water Intelligence

15

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Bonds: strong undercurrent of low rates The challenge for bond investors will be to find return in a lower-for-longer rates environment. We recommend focusing on reaping performance from corporate and emerging-markets bond spreads, rather than pursuing the direction of core government bond yields.

recession fears. While we also believe that this signal should be taken seriously, it needs to be seen in context. First, the inversion was temporary. Second, the 2-year to 30-year part of the yield curve did not invert. Third, a couple of potential political problems that could have been damaging for the economy have taken a turn for the better. Fourth, China’s fiscal stimulus policies are starting to pay off. But finally, and

Bond markets have had a change of heart because of the risk

maybe most important, is that the change in Fed policy itself

of a recession. Yields of core government bonds fell strongly

likely averts a recession.

in the last quarter of 2018, and credit spreads of riskier bonds widened. The market feared that the Federal Reserve would thereby pushing the US economy into a recession.

Lower rates for longer with two possible risks

The bond market was signalling strongly to the Fed that the

The way the shift to lower rates for longer has played out

central bank should not deliver the rate hikes that were still

in bond markets is that core government bond yields have

on its dot plot (i.e. the graph used to convey its interest-rate

continued to fall, and the risk spreads in the other bond

outlook). The Fed listened and changed its policy, taking a

segments recovered quickly. Normally, declining core yields

much more accommodative stance that signalled an end to

are a sign of a deteriorating economy, but these yields are also

its rate-hike cycle.

now falling because of the support that central banks once

keep on tightening rates even in the face of slowing activity,

again are extending. Central banks have plenty of room to act In the middle of all this, the US yield curve between 3

because inflation is so low. The lower-for-longer rates and the

months and 30 years inverted. This is typically seen as a

extension of the business cycle that the central banks are thus

strong precursor for a recession, and it added to the market’s

engineering is our base scenario for the remainder of 2019.

Yield to maturity

An inverted yield curve can be an indicator of a future recession 3.2% 2.7%

 US Treasury yield curve

constellation of low core rates and tightening credit spreads.

One risk is that a recession will actually materialise, because

1.7%

of the damaging actions of politicians. Escalating trade wars

1.2%

are the largest and most realistic cause in this respect. In German Bund yield curve

a recession, bond markets will not only price-in lower core yields, but also higher credit spreads. In this scenario, high-

0.2%

yield bonds are the most vulnerable, because their valua-

-0.3% -0.8% 0 Source: Bloomberg

16

A recession materialises There are two main risk scenarios that can disrupt this

2.2%

0.7%

Two key risks:

tions are the most stretched. High-yield issuers are very 5

10

15

20

25 30 Time to maturity

sensitive to economic growth, and these bonds are not part of the asset-purchasing programmes of central banks, meaning that they therefore have less price protection.

Investment Outlook | Mid-year 2019

Emerging-markets bonds are also on the frontline if a reces-

Enjoy the high tide for spreads

sion occurs owing to a protracted US/China trade war.

We attach a small chance to the scenario of a recession,

In an environment of rates being lower-for-longer, the game

however. And even if it would threaten to come about,

for bond investors changes, from positioning for changing

central banks still have ammunition to do more to fight it.

core yields to positioning to reap credit spreads. We recommend that eurozone peripheral government bonds and

There is an inflation surprise

investment-grade corporate bonds are the core holding of

Another risk is that inflation rises unexpectedly. This could

a bond portfolio in this environment. Even though corpo-

happen if politicians add fiscal stimulus to an economy that

rate spreads have tightened significantly, investment-grade

is already running at full capacity. This scenario is possible

bonds still have potential if markets remain convinced that

in the US but not likely in Europe. The USD 2 trillion recently

central banks will manage to avoid a recession. Emerging-

discussed in the US for infrastructure spending could be a

markets bonds have, in our base case scenario, also the

first step in this direction.

potential to perform. Positions in emerging-markets bonds and US high-yield bonds should be balanced with exposure

If inflation kicks off, then US Treasury yields will rise. Credit

to safer bond segments that can offer a little bit of spread,

spreads will not widen, and may even tighten in the first

such as covered bonds.

instance, until the corporate market (equities included) start to fear that the Federal Reserve will need to raise interest

Mary Pieterse-Bloem

rates quickly and forcefully to quell the rising inflation.

While fiscal stimulus now seems to be a topic of discussion in

Global Head Fixed Income

Forecasts: Interest rates and bond yields

the US, the political parties would first need to agree on what the stimulus will be used for. It will be a difficult discussion. In

Now 24 May

Year-end

2019

2019

Europe, the appetite for fiscal expansion is the lowest in the

US

countries that have the most room to do it, such as Germany

Fed funds range

2.50

2.50

and the Netherlands. So again, we attach a small probability

10-year Treasury

2.32

2.60

ECB policy rate

-0.40

-0.40

3-month Euribor

-0.31

-0,30

-0.114

0.20

to this scenario. Nonetheless, holding some inflation-protection in the bond portfolio is not a bad idea.

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

Still positive on gold Since the end of March, gold prices have fallen considerably. The recovery in US Treasury yields, the partial pricing-out of rate cut expectations in the US and a stronger US dollar were the main drivers of this weakness.

production cut will be extended and if other Opec members are capable – and willing – to fill the gap created by the drop in Iranian crude exports.

We believe that an increase in oil prices is limited given current levels. For a start, there is enough potential growth

Despite some near-term downside risks, triggered by a

in supply, for example from Saudi Arabia and Russia, to

potential squeeze on net long positions in gold, we remain

meet the expected drop in Iranian oil supply. Moreover,

positive on the outlook for gold prices. First, we continue to

slower economic growth will probably translate into lower

expect a weaker US dollar towards the end of this year and

oil demand growth. We also see that US gasoline prices are

next year; and gold prices have the tendency to rally when

nearing USD 3 per gallon. This is a psychological level at

the US dollar declines. This relationship has proved to be

which gasoline prices start to bite into consumer disposable

relatively strong and stable over time. Second, we expect

income. We expect Brent oil prices to stay in the price range

the Fed to remain on hold, and for other major central banks

of USD 60-80 per barrel, with an average price over 2019 of

to either hike less and/or later. Less hawkish central banks

USD 70 per barrel.

are also a positive development for gold prices.

Georgette Boele Third, since 2018 gold prices have become increasingly

Coordinator FX and Precious Metals Specialist

driven by developments in the Chinese yuan, which mainly reflects expectations for the Chinese economy and the US/ China trade conflict. We think that the Chinese authorities have taken measures to support their economy. This and a possible US/China trade deal will support the yuan and gold prices, but the risks of further escalation have risen. Finally, the technical picture of gold prices still looks positive. We are therefore confident that prices will stay above the 200-day moving average at around USD 1,250 per ounce. Our yearend 2019 forecast is USD 1,400 per ounce.

Forecasts: Commodities 24 May 2019

Spot

Avg 2019

End 2019 End 2020

Oil

Limited gains expected in oil prices

Brent USD/bbl

68.4

70

70

80

WTI USD/bbl

58.5

60

60

65

The US has announced an end to the waivers on Iranian

Metals

oil sanctions. The waivers had allowed selected countries

Gold USD/oz

1288

1.329

1400

1500

to import Iranian oil. After the waivers were cancelled, oil

Silver USD/oz

14.57

16.10

17.00

19.00

prices rose, and both Brent and WTI oil reached their highest

Platinum USD/oz

805

881

960

1100

levels in six months. Later, prices fell because US President

Palladium USD/oz

1326

1356

1200

1000

Donald Trump increased the pressure on Opec to increase

Aluminium USD/t

1802

1907

1930

2050

production. The next meeting of Opec and its partners will

Copper USD/t

5964

6534

6685

7350

be in late June. At issue is whether a previously agreed

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

18

Investment Outlook | Mid-year 2019

19

ABN AMRO Private Banking

Private equity: operations are key The heavy competition for assets among private equity investors and corporate acquirers has driven investment multiples to historical highs.

With limited potential for multiple expansion and growing jitters about an eventual economic downturn, private-equity managers need to drive returns through operational improvement.

the importance of multiple arbitrage and leverage has significantly decreased to 30% and 10% respectively.

While a decade ago, operating resources were concentrated at the largest shops, nowadays more managers, including smaller firms, have caught up and invested in dedicated operations capabilities. With this shift, the importance and role of in-house operational experts with experience in a

Operational value creation, especially sales growth and

broad variety of functional areas has evolved from a “nice

improvements in margins and the overall profitability of

to have� to a critical component for private-equity inves-

a business became an important part of private-equity

tors. Such capabilities have become essential to steering

manager skillsets in the aftermath of the global financial

the performance of the underlying companies and thereby

crisis.

generating attractive returns for investors in the years to come.

This finding is confirmed in an analysis from EY that examined to what extent different value creation drivers, namely

Although the operational improvement plans will be tailored

operational improvements, multiple arbitrage and leverage,

to each portfolio holding, the main drivers usually contrib-

have historically contributed to the overall value creation

uted by private-equity managers are international expan-

of private-equity investments. (Multiple arbitrage refers to

sion, buy-and-build strategies, digitalization and scalability.

increasing the value of a company between investment and sale typically without operational improvements.)

Operations dominate valuation creation

Operational experience is key To use operational resources most efficiently, private-equity managers tend to progressively deploy such experts, not

Today, operational improvements account for 60% of total

only to add value to a portfolio company during the post-

value creation in portfolio companies (compared to 36% in

acquisition phase, but also to help to build the investment

the 2000s and 22% in the 1990s), while at the same time

case and even to highlight value creation opportunities during the due-diligence phase.

Because of its importance, investors should put a strong focus on identifying managers who have dedicated operating resources and a strong track record in operational value creation.

Andreas HegedĂźsch, Senior Investment Professional Private Equity Florian Simmerer, Junior Investment Professional Private Equity

20

Investment Outlook | Mid-year 2019

The dollar’s reserve currency status Currently the US dollar has a dominant role in the global financial system. Over the long term, however, it is possible that the US dollar’s dominance could diminish.

US financial markets will remain well developed and deep.

Moreover, the US military and its geopolitical power are here to stay for decades. However, other dynamics could result in a less attractive dollar. These factors could be cyclical as well as structural. Cyclical forces will probably only result in

The central role of the US dollar in the global financial system

a temporary decline of the US dollar’s attractiveness, but

is based on a number of crucial pillars.

structural forces could trigger a long-term decline.

●●

The dollar is held in significant quantities by central banks and sovereign entities.

●●

It is widely used in global trade and in the pricing of commodities.

●●

●●

●●

●●

●●

Official sector a net seller US Treasuries since 2015

The US has the best developed and deepest capital markets.

It is likely that central banks with large FX reserves (most

The substantial military and geopolitical power of the US plays

notably China) will decide to diversify their reserves to

a crucial role in the reserve currency status of the dollar.

become less dollar dependent. This could result in similarly

The dollar is the most liquid currency, with markets deep

lower demand for the dollar from central banks. Indeed, this

enough to accommodate a broad range of investments as

looks already to be happening. FX reserve diversification is

well as periods of financial stress or crises.

generally a slow process, and there are other factors that

The US Federal Reserve and financial authorities have

have a more lasting impact on the value of the dollar. The

strong credibility.

key driver of dollar moves remains whether US assets are

The US dollar has been supported by a strong and rela-

relatively attractive to invest in.

tively stable US economy, political stability and strong institutions.

Georgette Boele Coordinator FX and Precious Metals Specialist

There is no other country that scores well on all of these points. As a result, the US dollar’s hegemony has not ever been really challenged.

Dollar’s role to diminish

Currency forecasts FX pair

Spot

30 June

Year-end

Year-end

23 May

2019

2019

2020

2019 EUR/USD

1.1137

1.10

1.16

1.25

We believe that the dominance of the US dollar will also not be

USD/JPY

110.29

110

108

105

challenged in the coming years. The US dollar is, however, likely

EUR/JPY

122.83

121

125

131

to lose some of its importance. This is because the dollar’s share

GBP/USD

1.2608

1.30

1.35

1.45

and turnover in foreign-exchange (FX) markets are at extremely

EUR/GBP

0.8833

0.85

0.86

0.86

high levels. At the end of 2018, 62% of the allocated central

USD/CHF

1.0094

1.05

1.01

0.96

bank FX reserves was in dollars; and the dollar accounted for

EUR/CHF

1.1242

1.15

1.17

1.20

one side of 88% of all FX trades, as of April 2016.

USD/CNY

6.91

6.65

6.60

6.60

USD/BRL

4.04

3.65

3.60

3.40

We think there is room for a modest decline in the US dollar’s

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

share of both reserves and turnover. There is no doubt that

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

Coordinator FX and Precious Metals Specialist

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

Joost Olde Riekerink

joost.olde.riekerink@nl.abnamro.com

Equity Research & Advisory Expert

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

Jeffrey Vonk

jeffrey.vonk@nl.abnamro.com

Opportunity Analyst Customized Advice

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

Matias Grinberg

matias.grinberg@nl.abnamro.com

Fixed Income Expert

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

Reinhard Pfingsten Paul Groenewoud

reinhard.pfingsten@de.abnamro.com paul.groenewoud@nl.abnamro.com

Global Head Asset Allocation Services Quant Risk Specialist

Martien Schrama

martien.schrama@nl.abnamro.com

Profile Manager

Chris Verzijl

chris.verzijl@nl.abnamro.com

Quant Risk Specialist

Romeo Chamman Arkadi Odintsov

romeo.chamman@nl.abnamro.com arkadi.odintsov@nl.abnamro.com

Quant Risk Specialist Quant Risk Specialist

Thomas Domeratzki

thomas.domeratzki@de.abnamro.com

Senior Strategist

Steffen Kunkel

steffen.kunkel@de.abnamro.com

Senior Strategist

Andreas Hegedüsch

andreas.hegeduesch@de.abnamro.com

Senior Investment Professional Private Equity

Florian Simmerer

florian.simmerer@de.abnamro.com

Junior Investment Professional Private Equity

Group Economics

Global Investment Centre

Private Equity

22

Investment Outlook | Mid-year 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.

information and is not oriented to your personal situation.

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

The information may therefore not expressly be regarded as

Securities Exchange Act of 1934, as amended (the ‘1934 Act’)

a recommendation or as a proposal or offer to 1) buy or trade

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

investment products and/or 2) procure investment services nor

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

investment advisory services provided by ABN AMRO, includ-

Conditions (Voorwaarden Beleggen ABN AMRO), which are

ing (without limitation) the investment products and investment

available on www.abnamro.nl/beleggen.

services described herein are not intended for U.S. persons.

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

Although ABN AMRO attempts to provide accurate, complete

taken into the United States or distributed in the United States

and up-to-date information, which has been obtained from

or to a US person.

sources that are considered reliable, ABN AMRO makes no representations or warranties, express or implied, as to whether

Other jurisdictions: Without limiting the generality of the

the information provided is accurate, complete or up-to-date.

foregoing, the offering, sale and/or distribution of the investment

ABN AMRO assumes no liability for printing and typographi-

products or investment services described herein is not intended in

cal errors. The information included in this document may be

any jurisdiction to any person to whom it is unlawful to make such

amended without prior notice. ABN AMRO is not obliged to

an offer, sale and/or distribution. Persons into whose possession

update or amend the information included herein.

this document or any copy thereof may come, must inform themselves about, and observe any legal restrictions on the distribution

Liability: Neither ABN AMRO nor any of its agents or subcon-

of this document and the offering, sale and/or distribution of the

tractors shall be liable for any damages (including lost profits)

investment products and investment services described herein.

arising in any way from the information provided in this docu-

ABN AMRO cannot be held responsible for any damages or losses

ment or for the use thereof.

that occur from transactions and/or services in defiance with the restrictions aforementioned.

Copyrights & distribution: ABN AMRO, or the relevant owner, retains all rights (including copyright, trademarks,

10:00 AM CET

patents and any other intellectual property right) in relation to

29 May 2019

all the information provided in this document (including all texts, graphic material and logos). The information in this document may not be copied or in published, distributed or reproduced in any form without the prior written consent of ABN AMRO or the appropriate consent of the owner. The information in this document may be printed for your personal use.

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