Investment outlook Bnp Paribas IP

– GIST –

GLOBAL INVESTMENT STRATEGY THEMES

DANIEL MORRIS Senior Investment Strategist

This document is for professional investors

TOPICS Macro outlook

U.S.

EUROPE

JAPAN

EMERGING MARKETS

Asset classes

EQUITIES

FIXED INCOME

2

INVESTMENT THEMES

Macro

Bear watch

Equity

Show me the money

Bonds

It’s all about inflation

3

Lofty PMIs in Europe and US Composite PMIs (Purchasing Manager Indices) Index level; value greater than 50 indicates expansion 58 57 56

European Union United States Emerging markets Japan

58 57 56

55

55

54

54

53

53

52

52

51

51

50

50

49

49

48 ott 15

48

apr 16

ott 16

apr 17

• US data a bit weaker but still and high level • EU on an upswing • More ammunition for both Fed and ECB

ott 17

Data as at 1 December 2017. Note: US average of ISM and Markit series; China average of Caixin and China Federation of Logistics series. Latest emerging markets reading for China if EM composite unavailable. Latest reading for European Union is eurozone and UK (if available) if EU not yet published. Sources: Markit, ISM, BNP Paribas Asset Management.

4

Good time for the markets with results beating forecasts Surprise indices

150

US hard data Eurozone hard data

US soft data Eurozone soft data

150

120

120

90

90

60

60

30

30

0

0

-30

-30

-60 nov 16 gen 17mar 17mag 17 lug 17 set 17 nov 17

-60

• Best combination of hard and soft data surprises, both in Eurozone and US • Note: Soft data are sentiment indicators, hard data is real money

Data as at 7 December 2017. Sources: Citigroup, BNP Paribas Asset Management.

5

Flattening yield curve doesn’t mean recession imminent US yield curve Number of months is time from spread at current level to subsequent recession

bps

Recession

• Yield curve has to decline before it can turn negative

350 300

2-30 year spread

250 200 150

14 months

28 months

79 months

36 months

100 50 0 -50

• But based on past experience, a recession is likely not on the immediate horizon

-100 -150 -200 -250 1978

• Yield curve has been flattening as market prices in short-term rate hikes

1988

1998

2008

Data as at 11 December 2017. Sources: Factset, NBER, BNP Paribas Asset Management.

6

Third quarter US GDP not quite as good as headline Composition of 3q US GDP growth and forecasts Net Exports

%

0.4

Gov't.

Residential Spending Invest.

-0.2 0.1

3.0

Forecast*

0.6 2.5 2.0

0.8

Business Invest.

Inventory Change

3.3

1.5

2.6 2.2

1.0 1.6

2.4

Consumer Demand

0.5 0.0 Total

4q17

2017

2018

Data as of 30 November 2017. *Consensus forecast. GDP = Gross Domestic Product. Note: Data is SAAR (seasonally adjusted annual rate). Any economic and market trend, prediction, projection, or forecast is not necessarily indicative of future or likely performance. Sources: BEA, Focus Economics, BNP Paribas Asset Management.

7

Falling savings boosting consumer spending in US Retail sales and savings rate % 5%

Retail sales change YoY (2-mo MA, left)

4,5

Savings rate (reverse, right)

3,5 4,0

4,0

4,5

• Stock market gains, home price appreciation, rising income expectations could keep savings rate low, but not indefinitely

3,5 5,0 3,0 5,5

2,5

6,0

2,0 1,5 mag 15

nov 15

mag 16

nov 16

mag 17

6,5 nov 17

• Ultimately, need pickup in hiring/participation, and/or stronger productivity to maintain current levels of consumption growth

Data as at 15 November 2017. Sources: BEA, US Census Bureau, BNP Paribas Asset Management.

8

CapEx outlook has brightened Business investment Private fixed investment quantity indices, seasonally adjusted, rebased

190

Election

Intellectual property products 25%

190

Equipment 35% 175 160

175

Structures (ex-energy) 14% Structures (energy) 2%

160

145

145

130

130

115

115

100

100

85

85

70 2002

70 2004

2006

2008

2010

2012

2014

• End of corporate profit recession – especially for energy firms – continues to bode well for capital spending • Survey measures of CapEx plans point in the same direction • Follow-through on tax reform would also provide a tailwind

2016

Data as at 6 November 2017. Note: Energy Includes petroleum and mineral exploration. Sources: US BEA, BNP Paribas Asset Management.

9

For internal use only

Inflation: Sort-term and structural factors Core CPI components Year-on-year and last three month annualised percent change

Last 12 months

Last 3 months (annualised) 1.8% 2.7%

CORE CPI Housing

50%

Other

4%

Education

4%

Medical

• Recent weakness suggests no progress this year toward Fed’s 2% inflation objective • In theory, fundamentals in place for gradually firming inflation

11%

Recreation 7%

• tightening labor market

Transport 15%

• weaker dollar

Apparel

4%

Comm

5%

• firming purchaser prices -5

-4

-3

-2

-1

0%

1

2

3

Data as at 24 November 2017. Sources: Bureau of Economic Analysis, Federal Reserve Bank of Dallas, Bureau of Labor Statistics, BNP Paribas Asset Management.

10

Wage growth has disappointed Wage indicators %

%

Atlanta Fed wage growth tracker Average hourly earnings

4,0

4,0

3,5

3,5

3,0

3,0

2,5

2,5

2,0

2,0

1,5 2007

1,5 2009

2011

2013

2015

• With labor market tightening, wages should be picking up

• But trend is at best flat

2017

Data as at 11 December 2017. Sources: Bureau of Labor Statistics, Federal Reserve Bank of Atlanta, BNP Paribas Asset Management.

11

But it’s not completely a mystery Growth in real compensation and productivity during expansions

• Disappointing wage growth stems in part from low productivity gains in this expansion, and recent profit recession

Recession Productivity Real compensation

125

120

115

110

105

100 1991

1996

2001

2006

2011

2016

Data as at 30 June 2017. Note: Shading indicates NBER recessions. Sources: US Bureau of Labor Statistics, BNP Paribas Asset Management.

12

Outlook for tax reform? Two out of three chance US budget surplus / deficit and Treasury yields Budget deficit/surplus as % of GDP; 10-year Treasury yields Obama

% 8 7 6 5 Trump?

4

GW Bush

3 2

Yes • Republicans love tax cuts • They need a win • May loose control of Congress • Could get some Democratic support

1 0

Reagan

-1

-2 -3 1950

Clinton

1960

1970

1980

1990

2000

2010

2020

Data through FY 2017 (est.). Sources: Federal Reserve of St. Louis, US Treasury, BNP Paribas Asset Management.

No • Busy calendar • Conflicting objectives • Procedurally difficult • Vested interests 13

TOPICS Macro outlook

U.S.

EUROPE

JAPAN

EMERGING MARKETS

Asset classes

EQUITIES

FIXED INCOME

14

Eurozone growth outlook broadly positive Forecasted 2018 GDP growth rates

• Consensus growth rate in 2018 expected to be 2.0%, above trend

Ireland Sweden Spain Austria Greece Norway Germany Portugal Netherlands Denmark Euro Area Finland Switzerland France Belgium Italy UK

Euro

• Demand growth remains strong and almost certainly stronger than growth in supply

Non-euro

2.0%

0%

0,5

1,0

1,5

2,0

2,5

3,0

3,5

Data as of 27 November 2017. Sources: FocusEconomics, BNP Paribas Asset Management.

15

Japan’s QE has been the biggest Central bank balance sheet as % of GDP %

Eurozone (left) %

US (left)

85

UK (left) 30

Japan (right)

75 65

25

55 20

45

• Discussion now is sequencing of ECB tapering and raising the deposit and refi rates • Japan cannot maintain the current pace, but BoJ is committed for now

15 35 10 5 2008

25 15 2010

2012

2014

• US will be running down its balance sheet this year

2016

Data through March/June 2017. Sources: US Federal Reserve, European Central Bank, Bank of Japan, Bank of England, Haver, BNP Paribas Asset Management.

16

Real trade-weighted exchange rate has jumped Eurozone net exports and currency 1,6 1,4 1,2 1,0 0,8 0,6 0,4 0,2 0,0 -0,2 -0,4 -0,6 -0,8 -1,0 -1,2 -1,4 2007 2009 2011 2013

Net exports GDP contribution (left)

112 110 108

Euro REER (right)

106 104

• Net trade did not make a positive contribution to growth over the recent past despite the weak exchange rate

102

100 98 96

• Now a stronger euro poses a potential downside risk to growth

94 92 90 88 2015

2017

Data through 27 November 2017. REER = Real effective exchange rate index. Sources: Haver, Factset, BNP Paribas Asset Management.

17

But growth outlook is getting worse UK indicators GDP NTM forecast (right)

110 108

Sterling REER (left)

106

104

%

2,5

2,0

102 Referendum

100

1,5

• GDP growth estimates recovered sharply from Brexit overreaction

• Now a more sobre evaluation is bringing forecasts back down

98 96

1,0

94 92

0,5

90 88 2013

0,0 2014

2015

2016

2017

Data as at 10 November 2017. REER = Real effective exchange rate index. Sources: Haver, JP Morgan, BNP Paribas Asset Management.

18

TOPICS Macro outlook

U.S.

EUROPE

JAPAN

EMERGING MARKETS

Asset classes

EQUITIES

FIXED INCOME

19

Japanese GDP growth currently best in a decade Japan GDP composition and consensus forecasts Business invest

4,2 3,6

Government

%

Household demand

3,0

Household invest

3,0

2,5

Net exports

2,4

2,0

Inventories

GDP

1,8

1,5

1,2

1,0

0,6

0,5

0,0

0,0

-0,6

-0,5

-1,2

-1,0

-1,8

-1,5 3q17

2017

2018

2019

2020

• Japan is benefitting from the global, cyclical upswing

• Net exports a big boost despite 3% gain in yen this year • Forecasts still downbeat, however

2021

Data as at 11 December 2017. Note: Values for most recent quarter are versus prior quarter annualised, yearly figures are annual change. Sources: Japanese Cabinet Office, Factset, FocusEconomics, BNP Paribas Asset Management.

20

TOPICS Macro outlook

U.S.

EUROPE

JAPAN

EMERGING MARKETS

Asset classes

EQUITIES

FIXED INCOME

21

Depreciating dollar helping EM returns Dollar indices Yuan indexed to 100 as of latest value

164

164

US$ vs EM currencies US$ vs DM currencies Yuan

148

148

132

132

116

116

100

100

84

84

68 2000

2003

2006

• Post-election rally in dollar has stalled

2009

2012

2015

• At least against EM currencies, dollar looks overvalued • Fed hikes crucial, but so is ECB policy

68 2018

Data as at 1 December 2017. Sources: J.P. Morgan, Thomson Reuters, BNP Paribas Asset Management.

22

Changes in Standing Committee and reform outlook Current Standing Committee (July 2017)

Former

Xi Jinping

Li Keqiang

Wang Qishan

Yu Zhensheng

Zhang Dejiang

Zhang Gaoli

Liu Yushan

• Before, only 3 proreform members

• Xi’s supporters now 5 = reformer and Xi supporter = erring on the side where the wind blows

source: BNPP AM (Asia)

New

• Reform will progress faster and deeper than in the first term

Chart 2: The new Standing Committee (announced on 25 October 2017) Xi Jinping 64

Li Keqiang 62

Li Zhanshu 67

Wang Huning 62

Wang Yang 62

Zhao Leji 60

Han Zheng 63

• Growth to slow towards 6.5% by year-end; 6.0%-6.5% in 2018

= reformer and Xi supporter numbers under names = age of the SCP member

source: BNPP AM (Asia)

Data as at 31 October 2017. Sources: CEIC, BNP Paribas Asset Management.

23

Steady expansion in service sector Manufacturing and services PMIs Index level; value greater than 50 indicates expansion

62

Services

62

60

Manufacturing

60

58

58

56

56

54

54

52

52

50

50

• Services account for 50% of China GDP, though most people focus on manufacturing • Sector has been steady for the last several years • Need stronger growth to compensate for manufacturing weakness

48 48 2003 2005 2007 2009 2011 2013 2015 2017 Data as at 8 December 2017. Note: Manufacturing values are average of official government series and HSBC series. Sources: National Bureau of Statistics of China, HSBC, BNP Paribas Asset Management.

24

Emerging markets — and China — now a tech index Sector weightings in MSCI Emerging Markets

Technology

%

% Commodities

30

30

25

25

20

20

15

15

10

10

5

5

0 dic 94

0 dic 99

dic 04

dic 09

• Technology is now the dominant sector in the EM index • We need to think differently about EM, and about China

dic 14

Data as at 30 August 2017. Sources: MSCI, BNP Paribas Asset Management.

25

Chinese debt levels are average, and growth is better Debt levels and GDP growth 400

• China’s level of foreign debt is low and the country is a net creditor to the world

Eurozone United States China

350

Debt / GDP (%)

300 250

• Foreign exchange reserves are very high

200 150

• Domestic savings rate is nearly 50% of GDP (if anything, too high)

100 50 0

-5

-4

-3

-2

-1

0

1

2

3

4

5

GDP growth rate (average last 4 quarters, YoY, %)

6

7

8

• Closed capital account limits risk of debt crisis

Data as at 14 June 2016. Sources: Factset, BIS, BNP Paribas Asset Management.

26

TOPICS Macro outlook

U.S.

EUROPE

JAPAN

EMERGING MARKETS

Asset classes

EQUITIES

FIXED INCOME

27

Equity shows value vs bonds, less vs inflation Expected earnings risk premium and real earnings yield

%

Equity risk premium Real earnings yield

7

Median Median

% 2011

1974 2008

7

6

6

5

5

4

4

3

3

2

2

1

1

0

0

-1

-1

-2 -3 -4 1955

• How expensive bonds are depends on estimations of future GDP growth and inflation

-2

1999

1987

• Equity price-to-earnings and price-to-book multiples are high

-3 -4

1965

1975

1985

1995

2005

2015

Data through 24 October 2017. Note: S&P 500 earnings yield less 10-year US government bond yield; earnings yield based on earnings exectations from 1984, trailing earnings prior.

Sources: Robert Shiller, US Federal Reserve, Standard & Poor’s, IBES, BNP Paribas Asset Management.

28

Volatility remains subdued Equity and bond market expected volatility VIX and MOVE indices

0,00

0,00 Equities

-0,25

-0,25

Treasuries -0,50

-0,50

-0,75

-0,75

-1,00

-1,00

-1,25

-1,25

-1,50

-1,50

-1,75

-1,75

-2,00 dic 16

mar 17

giu 17

set 17

• There are occasional jumps in vol, but the quickly pass

-2,00 dic 17

Data as of 11 December 2017. Note: Normalised 2-day moving average. Equity volatility average since 1990, fixed income since 2002. Sources: CBOE, BofA Merrill Lynch, BNP Paribas Asset Management.

29

VIX correlation with future returns is positive Vix and forward 1-month S&P 500 returns

VIX

• Not clear that low VIX presages a market correction

%

65 55

• It signals more that realised vol has been low

45

35 25 15

5 -30 -25 -20 -15 -10

-5

0

5

10

15

% S&P

Data as of 2 August 2017. Sources: CBOE, BNP Paribas Asset Management.

30

Equity markets pricey on most metrics Region and country relative valuations Chart shows P/E, table shows z-score

United States

26

US ex-Tech+

19

P/E

P/B

P/S

P/CE

PEG

DY

ROIC

1.0

0.8

1.3

1.5

0.2

0.9

0.3

0.9

US Tech+

11

-0.1

Europe

11

0.3

0.1

0.7

1.1

-0.8

0.5

0.7

Asia ex-Japan

9

0.7

-0.4

0.9

-0.2

0.0

0.0

0.7

Developed Markets

9

0.0

0.5

1.5

1.3

-0.6

0.6

0.2

-0.2

0.0

0.6

0.9

-0.2

0.5

0.2

-0.9

-0.7

1.4

-0.1

-0.7

-0.4

-0.7

Emerging

3

Japan** (11)

-18 -12 -6 0% 6

12 18 24 30

Data through 1 December 2017. Note: Valuation based on current price to next-twelve-month earnings relative to long-run median. *MSCI World ex-US until 2001, ACWI thereafter. For priceto-book, multiple based on IMI indices from 1974. **Japan value calculated only since 2001, otherwise from 1987. Price-to-book ratio is relative to median since 1974 except EM which is from 1995. Colors indicate z-score, with threshold at +/- 1 and +/- 0.5. Tech+ = IT sector plus Internet & Direct Marketing Retail. Sources: IBES, MSCI, FactSet, BNP Paribas Asset Management.

31

Little value left in the market Relative forward P/Es S&P 500 Energy

Industrials Capital Goods

Discretionary* Autos & Compon.

Cons. Durables & Apparel Consumer Services Media

Staples Food & Staples Retailing Food, Beverage & Tobacco

Health Care Health Care Equipment & Services

Financials Banks

Pharmaceuticals, Biotechnology & Life Sciences

Diversified Financials

InformationTechnology Software & Services

Utilities

Retailing*

Insurance

Technology Hardware & Equipment

Materials C&P Svcs Transportation

Relative P/E: -35% -30%

-25%

Household & Personal Products

-20%

-15%

-10%

Telco Svcs

Real Estate Semiconductors & Semiconductor Equip.

-5%

0%

5%

10%

15%

20%

25%

30%

35%

Data as of 23 October 2017. C&P Svcs = Commerical and Professional Services; Telco Svcs = Telecommunication Services. Note: Valuation based on current price to next-twelve-month earnings relative to long-run average (trimmed mean) since 1984, except Energy and Materials (Price-FY3 earnings) and Real Estate (Price-FFO). *Exluces Amazon. Size of rectangles reflects market capitalisation. Sources: Standard & Poor’s, IBES, BNP Paribas Asset Management.

32

US corporate leverage has jumped Leverage ratios S&P 500 ex-financials

%

Debt / equity (left) Average debt/equity (left) Interest expense / EBITDA (right)

%

110

26

100

22

90

18

80

14

70

10

60

6

• Debt levels rose sharply in 2015, but levels are not average

• With low interest rates, the ability of companies to service debt is high • Reduces risk (or at least impact) of a rise in rates

1992 1995 1998 2001 2004 2007 2010 2013 2016 Data as at 12 October 2017. Sources: Standard & Poor’s, Factset, BNP Paribas Asset Management.

33

Companies have used the debt to buy back shares Debt levels and share buybacks S&P 500 ex-financials

• Companies have substituted (cheap) debt for equity

Change in debt level $bn

Share buybacks

400

• Whether this is good or bad depends on which one you own

300 200 100 0

*

-100 2000 2002 2004 2006 2008 2010 2012 2014 2016 Data as at 30 October 2017. *Latest quarterly data available. Sources: Standard & Poor’s, Factset, BNP Paribas Asset Management.

34

Impact of share buybacks on earnings growth falling Earnings growth and share buybacks MSCI USA Index (excludes Energy sector)

Buybacks

%

%

Net income growth

9

9

EPS growth

8

8

1

1

0

0

-1

-1

• Share buybacks were crucial in 2016 to boosting earnings growth, but less so now

3q17

2

1q17

2

3q16

3

1q16

3

3q15

4

1q15

4

3q14

5

1q14

5

3q13

6

1q13

6

3q12

7

1q12

7

• Before the GFC, companies were you diluting shareholders; not now

Data as at 30 October 2017. Sources: MSCI, Factset, BNP Paribas Asset Management.

35

Risk in US small caps can be valuation Relative forward PEs Forward PE relative to S&P 500 vs long run average (average=100)

115

115

112

112

109

109

106

106

103

103

100

100

97

97

94

94

91

91

88

Small cap relative PE

88

85

Mid cap relative PE

85

• Mid caps should benefit from the same factors as small caps: domestic focus for investment, strong dollar, trade worries — but they get less attention from investors

• Relative valuations currently favour mid caps

82 82 2002 2004 2006 2008 2010 2012 2014 2016 2018 Data as at 11 December 2017. Sources: IBES, BNP Paribas Asset Management.

36

Flattening yield curve has boosted growth stocks Yield curve and equity style returns US Treasuries and Russell 1000 indices

bps

200

350

190

300

180

250

170

200

160

150

150

100

140

50

130

0

120

-50

2-30 year spread (left)

-100 -150

Value vs growth (right)

-200 -250 1978

110

• Growth generally outperforms value when the yield curve is flattening • Given potential for further gains in short rates, growth may continue to outperform

100 90 80 70

1988

1998

2008

Data as at 11 December 2017. Sources: Factset, BNP Paribas Asset Management.

37

Expectations for margin expansion Forecasted net margins Emerging % % markets 12 12 11 11 10 10 US* 9 9 UK 8 8 7 7 Europe ex-UK 6 6 5 5 Japan 4 4 3 3 2 2 1 1 2004 2006 2008 2010 2012 2014 2016 2018

• EM margins are below the long-run average • US margin expectations have not risen for 4 years • Europe finally starting to recover

Data through 27 November 2017. *Excludes Tech and Internet and Direct Marketing Retail. Sources: Factset, BNP Paribas Asset Management.

38

Steady increase in earnings revisions Forward earnings estimates Emerging markets

115 112

115

Japan

US Tech+

112

Europe ex-UK

109

• Slope of the line represents year-on-year EPS growth rate

US ex-Tech+

109

• Big divergence in US by sector

UK

106

106

103

103

100

100

97 nov-16

• UK hindered by energy sector • Japan earnings rising despite yen strength

97 feb-17

mag-17

ago-17

nov-17

Data through 27 November 2017. *Excluding Energy sector. Note: Indices in local currency, 100=31-Dec-2016. Sources: Bloomberg, BNP Paribas Asset Management.

39

For internal use only

Analysts very optimistic for next year 2018 earnings growth forecast (bottom up, year-on-year) 13,4

EM Asia

12,9

Emerging Markets United States

11,4

Bottom up Top down

• Japan forecast similar to Asia ex-Japan, so Japan year-to-date market performance difficult to sustain

8,7 10,8

EM Latin America 9,7

Developed Markets

8,9

Europe

8,3

EM Europe

Ex Tech+ 10.6% Tech+ 13.8%

3,9

Asia 0

• Growth rates are generally lower than for 2017 but still high

5

10

• In Europe, divided between the continent (+10.1%) and UK (6.4%)

15

Data as at 1 December 2017. Note: US dollar terms. Sources: IBES, Factset, BNP Paribas Asset Management.

40

US outperformance explained by tech Equity indices US Tech+ 140

USA

140

135

Europe

135

US ex-Tech+*

130

130

125

125

120

120

115

115

110

110

105

105

100 dic 16

100 feb 17

apr 17

giu 17

ago 17

• European equities had actually outperformed US equites this year, excluding the Tech+ sector • More recently, tax reform has dominated

• But hard to be underweight US given importance of Tech+

ott 17

Data as at 8 December 2017. Note: Tech+ = Information Technology sector + Internet Retail industry. Sources: Bloomberg, BNP Paribas Asset Management.

41

Bank of Japan has stepped up its buying Stock market purchases and index level ¥bn

BoJ ETF purchases (left)

40

Foreign purchases (left)

35

Nikkei 225 (right)

30

k 20

Yen index (right)

• BoJ purchases have heavily outpaced foreign investor purchases of Japanese equities

18

25

16

• Target is ¥6 tr. a year vs. a market cap of ¥400 tr.

20 14 15 12

10

5

10

0 2010

8 2011

2012

2013

2014

2015

• BoJ now owns 74% of ETFs • But it could slow next year

2016

Data as at 8 November 2017. Sources: Ministry of Finance, Bank of Japan, BNP Paribas Asset Management.

42

What happened to eurozone equity outperformance?

Relative equity returns and exchange rate

106 105

US vs eurozone equities (left) Dollars per euro (right)

104

$/€ 1,19 1,17

103 102

1,15

101

1,13

• After politics drove the markets for the first half of the year…

• It’s been all about currencies and now tax cuts in US

100 99 98

1,11 1,09

97

96 95 dic 16 feb 17 apr 17 giu 17 ago 17 ott 17

1,07 1,05

Data as of 11 December 2017. Sources: Bloomberg, MSCI, BNP Paribas Asset Management.

43

EM still has a lot of catching up to do Relative emerging market profitability and index return

350

300

Index return: EM vs DM (left) Return-on-equity: EM less DM (right)

%

2,4 1,8 1,2

250

0,6 200

0,0

• EM had underperformed for years

• Recent recovery is small in comparison • Turnaround in ROE bodes well for the future

-0,6 150 -1,2

100 1999

-1,8 2002

2005

2008

2011

2014

2017

Data through 1 December 2017. Note: Index returns in US dollar terms. DM = Developed Markets. ROE based on next-twelve-month consensus estimates.

Sources: Factset, BNP Paribas Asset Management.

44

TOPICS Macro outlook

U.S.

EUROPE

JAPAN

EMERGING MARKETS

Asset classes

EQUITIES

FIXED INCOME

45

Robust demand ahead, especially from non-OECD Oil supply / demand and prices 4

160

Supply / demand (left)

mil. bbl/ day

$/bbl

Oil price (right)

3 2

80

• Market balance going into slight deficit in H2

40

• See OPEC supply rising 1% / year, OECD supply 5% / year through 2018

1 0 -1 -2

20

• Expect crude $40-60 per bbl in next few months

-3 -4 1996

• US shale is winning the tug of war vs OPEC

10 1999

2002

2005

2008

2011

2014

2017

Data as at 10 October 2017. Sources: IEA, BNP Paribas Asset Management.

46

High yield default rates rising in the US High yield default rates %

% US excommodities

14

Europe

12

14 12

10

10

8

8

6

6

4

4

2

2

0 1998

0 2001

2004

2007

2010

2013

• Excluding commodities, default rates in US rising • Not surprising given how late economy is in the cycle • Europe, on the other hand, is improving, though spreads reflect this

2016

Data as at 27 November 2017. Sources: BofA Merrill Lynch, BNP Paribas Asset Management.

47

IG credit outlook improving in Europe Investment grade credit upgrade/downgrade ratio Trailing six months

%

US recession

• Accelerating eurozone recovery boosting outlook for IG credit

Europe US

1

• US is stable, though tax reform could be positive

0

-1

-2

-3

-4 1997

2000

2003

2006

2009

2012

2015

2018

Data as at 27 November 2017. Sources: BofA Merrill Lynch, BNP Paribas Asset Management.

48

Dovish ECB has pulled yields back down Government 10-year bond yield 2018 futures %

2,80

0,90

2,70

0,80

2,60

0,70

2,50

0,60

2,40

0,50 0,40 0,30 giu 17

2,30

Bunds year-end (left) Latest Bund yield Treasuries year-end (right) Latest Treasury yield lug 17

ago 17

set 17

2,20

• Market expects 10-year Bunds to be at 0.7% by 2018 year end and US Treasuries at 2.5% • Just 20-30bps higher than today • Perhaps low relative to inflation and stimulus risk in US

2,10 ott 17

nov 17

Data as at 24 November 2017. Sources: Bloomberg, BNP Paribas Asset Management.

49

Inflation expectations rising more in eurozone

%

Eurozone (left)

%

United States (right)

1,80

2,30

1,75

2,25

1,70

2,20

1,65

2,15

1,60

2,10

1,55

2,05

1,50

2,00

1,45 gen 17 mar 17 mag 17 lug 17

1,95

• Inflation expectations began to decline once Fed started withdrawing accommodation and signaling future rate hikes • Surveys also show a drop in inflation expectations

set 17 nov 17

Data through 7 December 2017. *Five-day moving average of average of 5-year 5-year currency inflation swap rate and breakevens. Sources: Bloomberg, BNP Paribas Asset Management.

50

Inflation expectations also a function of oil prices Inflation expectations and oil prices US inflation expectations (left) Oil price change* (YoY, right)

2,30 2,25

% 70

60 50

2,20

40 30

2,15

20 2,10

10 0

2,05

-10 2,00 dic 16

-20 giu 17

dic 17

• Forward inflation expecations should be insenstive to short-term changes in oil prices • But there is nontheless a correlation • “Base effects” suggest oil prices, and hence inflation expectations, would be weaker from here

giu 18

Data through 7 December 2017. Note: Inflation is five-day moving average of average of 5-year 5-year currency inflation swap rate and breakevens. Sources: Bloomberg, BNP Paribas Asset Management.

51

Gap between Fed and market very wide Central bank benchmark rates Forecast %

%

US Federal Funds Target Rate

4,5 4,0

4,5 4,0

FOMC participants' median

3,5

3,5

3,0

Eurozone Main Refinancing Rate

3,0

2,5

Linear (Forecast)

2,5

2,0

2,0

1,5

1,5

1,0

1,0

0,5

0,5

0,0 2004

• Market is 50 bps below Fed forecast for 2018 • 99% probability of only one hike in December • 63% probability of a 2nd hike in March • Fed not likely to hit 2.9% by 2020 but futures market too pessimistic

0,0 2006

2008

2010

2012

2014

2016

2018

2020

Data as at 8 December 2017. Note: FOMC = Federal Open Markets Committee. Sources: Bloomberg, Federal Reserve, BNP Paribas Asset Management.

52

Loans, corp IG and emerging market debt appealing Government bond yields (10-year)

Bond spreads (10-year for government)

Max

%

%

bps

3,5

3,5

150

3,0

3,0

125

2,5

25th-75th percentile

2,0 1,5

2,5 2,0 1,5

Latest

1,0 0,5

Min

0,0 -0,5

1,0

0

-0,5 Trsy

Bunds

Gilts

800

400

400

200

200 100

25 US

Euro

CEMBI

EMBI

3,5

3,0

3,0

2,5

2,5

200

2,0

2,0

100

1,5

1,5

0

1,0 IT

ES

PT

High yield bond spreads

800

50

3,5

MBS

Investment grade bond spreads

100

4,0

300

-25

JGBs

4,0

400

50

0,0

%

500

75

0,5

%

bps

100

25

Breakeven inflation (5yr-5yr swaps)

1,0 US

Euro

UK

Leveraged loans and EMD* bps

bps

2400

2400

1400

1400

1200

1200

1200

1200

1000

1000

600

600 800

800

600

600

50

300

25

150

300 150 US

Euro

CEMBI EMBI

400

400 L-Loans

GBI-EM

Data as of 11 December 2017. Note: Range since index inception except for government bond yields, from 1-Jan10. *Spread for loans, yield for GBI-EM. Sources: J.P. Morgan, Barclays, BNP PAM.

53

Lower for ever High-quality bond yields

%

% High quality bond yield*

12

12 Average

10

10

8

8

6

6

The future?

GFC

4 2

4 Average real yield

2

0 -2 1800

0 60 years

1825

1850

1875

1900

1925

1950

1975

-2

2000

Data as of 23 March 2017. Note: High-grade municipal bond yields used for certain years between 1800 and 1920. US government bond interest rate through 1975, then Bloomberg Barclays US Aggregate through 1989, the Global Aggregate to present. Sources: Jeremy Siegel, “The real rate of interest from 1800-1990”, Homer & Sylla, “A History of Interest Rates”, Ibbotson SBBI, Federal Reserve, Univ. of Michigan, Bloomberg, BNP Paribas Asset Management.

54

Summary

Macro Equities Bonds •

Global, sychronised, cyclical upswing

•

Important to remember in times of volatility

•

Biggest risk is inflation spike and overzealous central banks

•

US equities already priced in best case scenario

•

Central banks tightening despite apparent lack of inflation

•

Republicans have to deliver

•

Waiting for an opportunity to add risk

•

Tech+ in US but Europe otherwise

•

Opportunities in leveraged loans, IG credit and EMD

•

EM threats (dollar, trade) receeding and outlook positive

55

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