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.
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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 ABN 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
e
e
er w und s t r ong
e
er w und
ht
gh t
r w eig
r wei
o ve
er w
st
ng
o ve
und
ig
ht
ro
ng
s t r ong
st
ro
●●
BON
n e u t r al
n e u t r al
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
gh t
s t r ong
r wei
und
o ve
Within equity markets, we continue to favour the US
to emerging markets or Europe.
st
er w
e
ht
ng
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.
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ABN AMRO Private Banking
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
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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
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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.
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29 May 2019
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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