ASSET allocation insights September 2016
YOUR MONTHLY “RENDEZ-VOUS” WITH THE MULTI-ASSET TEAM HIGHLIGHTS •• Data released in July confirmed the rebound we witnessed in June in the US economy, removing for now the short-term threat of a pronounced slowdown in the world’s largest economy. Besides a few exceptions, most of the global economy is growing at a decent rate, albeit not strongly. In the emerging world, we are also seeing improving trends in some of the weak links of recent years. •• September may be an inflexion point to recent market trends : we don’t expect a strong reversal of these trends but just some pause. In this context, the dollar may stop weakening, rates should grind marginally higher, spreads shouldn’t tighten further and emerging markets outperformance could be challenged. •• The strong performance of gold since January was driven by risk aversion at the beginning of the year and by the sharp fall in real yields, given the Federal Reserve’s wait and see mode since then. Going forward, as the Federal Reserve starts reassessing their monetary stance, risk aversion is most likely driven by rising real yields. In such a scenario gold will most likely come under pressure as well.
Global risk sentiment Risk taker
Asset class preference Equity
Government Bonds
Risk adverse
Fabrizio Quirighetti
Hartwig Kos
Adrien Pichoud
Chief Investment Officer Co-Head of Multi-Asset
Vice-Chief Investment Officer Co-Head of Multi-Asset
Chief Economist
The last sip at the Fed’s punch bowl So far, so good! Since mid-February, recession fears have receded, oil prices have stabilized, emerging market economies have bottomed out and risky assets have performed well – surprisingly for most of us. Forget about valuation levels and geopolitical risks as very loose monetary policy has pushed prices up. While this has served to postpone or reduce deflationary pressures, it has failed (once again) to reflate the economy. In other words, the many troubles and concerns haven’t really disappeared, they have just been drowned again in the Fed’s massive punch bowl. As a result, we believe the Fed’s intentions are still the main market risk and driver. It is a chicken and egg situation : market expectations about the US’s monetary policy path makes it quite challenging for the Fed to actually normalise rates without automatically triggering the uncertainty that would in turn require easing back. Fortunately, talk is cheap and we suspect Fed members will use rhetoric to ease/tighten at the margin, or at least restore some uncertainty regarding their intentions. Given the current strong consensus on an overall dovish stance by the main central banks, a few positive US economic data, especially on the labour market, wages or inflation, may be enough to engender a re-pricing of assets resulting from a more hawkish Fed. If we are right, it means that September may be an inflexion point to recent market trends : we don’t expect a strong reversal of these trends but just some pause. In this context, the dollar may stop weakening, rates should grind marginally higher, spreads shouldn’t tighten further and emerging markets outperformance could be challenged. While we are keeping an overall mild preference for risk, we are reallocating our preferences within our asset classes in order to benefit from a last sip at the Fed’s punch bowl. The strategy is to concentrate our risk budget in European equities (especially banks), HY short duration bonds and emerging market local currency debt, where there is still some upside potential, and to reduce current asymmetrical risk-reward assets such as US equities, IG credit, emerging market hard currency bonds or gold as these still carry some risks but haven’t any significant upward potential left based on our economic scenario and asset valuation analysis. This risk reshuffling, which consists of selling/reducing the most expensive “risky” assets and marginally reallocating towards less expensive ones, may be seen in the same vein of last month’s recommendation to buy cheap protection while keeping the overall portfolios’ risk stance unchanged. This should help us to smooth the transition towards the end of this current party as the music volume has already been turned down somewhat and the punch bowl may soon be taken away. At least temporarily.
Fabrizio Quirighetti Credit
Chief Investment Officer Co-Head of Multi-Asset
1 SYZ Asset Management (Suisse) SA info.syzam@syzgroup.com
For professional, qualified and institutional investors only Please refer to the complete disclaimer
ASSET ALLOCATION INSIgHTS September 2016
Economic backdrop in a nutshell PMI Manufacturing trends and level 57 56 55
54 53 52
Markit PMI manufacturing level
The global economy has entered another period of respite. US economic data have rebounded after the worrisome spring soft patch. Europe remains on its early cycle growth dynamic path. China and the emerging world at large have stabilized. Inflation is very gradually edging up and dissipating deflationary fears, but not strongly enough to alter the ultra-accommodative stance of central banks. Neverthless, the background remains one of desperately weak nominal growth in the developed world, making the dynamic fragile and sensitive to any sort of negative shock. As in the recent past, such periods of respite might prove short-lived given the lack of underlying cyclical momentum at the global level. This summer truce is nonetheless welcome after the growth concerns seen in the first half of the year.
GER US ISM mfg CAN IND
ITA
51
MEX
SPA
50
49 IDO
48 47
KOR FRA
UK
US
CHI S.AFR JPN RUS HKG
TUR
BRA
46
Growth Data released in July confirmed the rebound we witnessed in June in the US economy, removing for now the short-term threat of a pronounced slowdown in the world’s largest economy. Besides a few exceptions, most of the global economy is growing at a decent rate, albeit not strongly. In the emerging world, we are also seeing improving trends in some of the weak links of recent years.
Inflation A gradual reflation process is still under way, fuelled by growth and a rebound in energy prices. The core of the Eurozone has seen renewed growth with a very mild positive dynamic while peripheral economies remain so far in a deflationary situation. In the US, a very gradual increase in wage inflation is also contributing to the trend. Nevertheless, the global inflationary picture remains particularly soft.
45
44 43
Markit PMI manufacturing 3M chng
-5
-4
-3
-2
-1
0
1
2
3
4
5
Source : Markit, SYZ Asset Management
“
The global economy has entered another respite period that might prove short-lived given the lack of underlying cyclical momentum.
”
Adrien Pichoud Chief Economist
Monetary policy stance
Inflation trend and deviation from Central Bank target 6
Inflation deviation from central bank target
In this context of fragile growth and subdued inflationary pressures, central banks have little choice but to maintain their very accommodative stance. The current respite in activity indices, coupled with the mild positive trend in inflation, may lead the Fed to contemplate a rate hike again in the months ahead but the environment is so fragile that any disappointment on the job or inflation front is likely to keep it on the side of cautiousness.
BRA
5 TUR
4 3
NOR
2
RUS
IND
S.AFR
1 -9
-8
-7
-6
-5
-4 IDO
-3
-2
0 CAN -1 0 1US 2 3 -1SWE TWA
MEX
AUS EMU -2
4
5
6
UK CHI SWI
JPN KOR
-3 -4
-5 -6
Yearly inflation 12m change
Source : Markit, SYZ Asset Management
2 Please refer to the complete disclaimer
ASSET ALLOCATION INSIgHTS September 2016
Developed economies
Emerging economies
US indicators have continued to reassure in the past few weeks and the economy appears to be back on its mild expansionary track, with price and wage inflation slowly moving higher. However, the lack of cyclical momentum still makes a Fed decision on rates tough to take given the degree of fragility in the current trend.
In the emerging world, existing trends have continued : growth stabilization in China, a contained slowdown in India and Mexico, further deterioration in South Africa and early signs of activity bottoming out in Brazil and Russia. For these last two, inflation remains too high and is preventing their central banks from easing a tight monetary policy for the moment.
In the UK, the first measures of post-Brexit sentiment and activity have confirmed a pronounced negative impact of the leave vote, which has already triggered a strong monetary policy reaction. In the eurozone, early surveys have shown limited (if any) negative impact from the Brexit vote. Germany remains a solid powerhouse. France and Italy lag behind but benefit from the supportive European context. Activity in Japan is still weak but has recently shown signs of a modest pick up, with the help of fiscal support to come. In Australia, higher commodity prices, stabilization in China and ongoing monetary policy easing are supporting strong economic growth.
The Turkish economy, while still growing, continues to suffer from falling tourist activity, which the political turmoil will only exacerbate. With its sizeable current account deficit and the threat of a Moody’s downgrade, the downside risks remain high.
Adrien Pichoud Chief Economist
Economic surprises have recently turned positive in the developed world 100 80
60 40 20 0 -20
-40 -60 -80 -100 Jan-15
Apr-15
US
Jul-15
EURO AREA
Oct-15
UK
Jan-16
Apr-16
Jul-16
JAPAN Source : Citi, Bloomberg
3 Please refer to the complete disclaimer
ASSET ALLOCATION INSIgHTS September 2016
Investment Strategy Group : KEY takeaways Risk and Duration Fears about Brexit and the Italian banking crisis all seem long past. Major central banks across the globe have reinforced their accommodative stances and economic growth is improving, particularly in Europe, while inflationary pressures remain muted and risk factors such as the US election and the Italian referendum are still far out. Moreover, investors remained too bearish for too long and sat on the side-lines as markets were grinding higher. Now many of them are finally waking up to the fact that the world is not such a gloomy place as it was at the beginning of the year, and are squeeze themselves into risk assets “as long as the music plays.” Having sat on the right side of this market rally, i.e. having upgraded our risk preference in a very timely manner, we have taken the difficult decision to take to the dance floor once more before finally leaving the ballroom. Our view is based on the fact that while economic activity is improving, in the very near term at least it will not be strong enough to spark fears about US rate rise. Moreover, technical indicators for major equity markets suggest that the stars are aligned for further upside gains, which means that even the most cautious investor has started to get a bit greedy. It is not unfeasible therefore to see this complacent and almost bizarre market environment lasting a little longer. We are therefore maintaining our risk score at a mild preference. When it comes to duration our negative stance also remains intact. While we are not overly concerned about bond markets, it is hard to get too excited about them given current yield levels.
“
Moreover, two of the three potential risk factors that could unhinge market sentiment before the end of the year are US- related (the Fed and the presidential election). When it comes to the UK we have already highlighted the improvement in the relative attractiveness of some parts of the market last month, namely home builders, construction related stocks and financial services offer value. This has now been followed through with an upgrade in our market stance.
“
The strong performance of gold since January was driven by risk aversion at the beginning of the year and by the sharp fall in real yields, given the Federal Reserve’s wait and see mode since then. Going forward, as the Federal Reserve starts reassessing their monetary stance, risk aversion is most likely driven by rising real yields. In such a scenario gold will most likely come under pressure as well. Hartwig Kos Vice-Chief Investment Officer Co-Head of Multi-Asset
”
Bond Markets When it comes to high yield the short duration segment in the US market looks appealing at this point.
”
Hartwig Kos Vice-Chief Investment Officer Co-Head of Multi-Asset
Equity Markets We have not changed our view of equity markets as regards equity valuations. The rise in equity prices has been accompanied by falling bond yields, while corporate earnings have remained soft, leaving equity risk premium levels broadly unchanged. On the positive side, when it comes to corporate earnings we are seeing the first signs of improvement. While earnings growth has remained negative across western equity markets over the course of the year, realised earnings have on average come in better than analysts’ expectations. This is a clearly encouraging and, considering base levels, we might well see positive year-on-year earnings growth from late autumn onwards. Yet for developed market equities, analysts have not altered their forecast so far. In emerging markets, however, analyst earnings revisions have already turned positive. This has only happened a few times since 2010, and provides a very positive fundamental backdrop to the current macro-driven EM equity theme. Within equities the two most important changes in assessment were a downgrade to the US and an upgrade to the UK. The fact that US equities have been the default developed equity market for many investors since the “Brexit” referendum is a concern. Implied US equity volatilities have remained at historic lows for most of the last two months, and suggest a great deal of complacency in the market.
Given the very strong gains seen in investment grade and high yield credit over the summer period both segments were downgraded by one notch, leaving emerging markets local government bonds at a mild preference. Within investment grade credit the US and the UK look somewhat more attractive than Europe. When it comes to high yield, the short duration segment in the US market looks appealing at this point. Firstly, the shorter-term segment of the US high yield market has a higher proportion of lower quality issuers than the rest of the market, thereby carrying a higher level of credit risk. In a mildly positive scenario for the US economy, paired with subsiding fears about default risks (given the recovery in the oil price), this segment offers good carry with the potential of further spread compression. Secondly, given its very low duration this segment of the US high yield market will most likely prove to be quite defensive should the Federal Reserve unexpectedly decide to hike interest rates (which is a significant risk in our view). Western government bonds are expensive across the board, UK and German government bonds are even very expensive right now and emerging market hard currency bonds are continuing to lose their appeal.
Forex, Alternatives and Cash Gold has been downgraded to a very unattractive stance. The strong performance of gold since January was driven by risk aversion at the beginning of the year and by the sharp fall in real yields, given the Federal Reserve’s wait and see mode since then. Going forward, as the Federal Reserve starts reassessing its monetary stance, risk aversion will most likely be driven by rising real yields. In such a scenario gold will most likely come under pressure as well. Otherwise, we have made no changes in our assessment.
Hartwig Kos Vice-Chief Investment Officer Co-Head of Multi-Asset
4 Please refer to the complete disclaimer
ASSET ALLOCATION INSIghts September 2016
INVESTMENT VIEWS
UK Germany France Italy
Equities
EM Latam
Spain
US
Switzerland
Japan
Australia
Canada
EM Asia
Sweden
Norway
EEMEA
IG Credit HY Credit
Bonds asset allocation
EM Hard CCy
Real Govies
EM Local Ccy
Nominal Govies
Canada UK United-States
Indexed-Linked Government Bonds
Government Bonds
Germany
Italy
France
Australia
Canada
US
France
UK
Italy
Japan
Germany
UK United States
IG Credit
Europe
Europe
HY Credit
United States
Indonesia
(LC)
South Africa (LC)
South Africa (HC)
Turkey (LC/HC)
Mexico
Russia
Russia
(LC)
Mexico
(LC)
(HC)
(HC)
(HC)
Poland
(HC)
Brazil
(HC)
Hungary
(HC)
Brazil
(LC)
Poland
Poland
Emerging Bonds Hard (HC) and local currency (LC)
Indonesia
South Africa (HC)
(LC)
(LC)
Hungary
(LC)
GBP EUR
Currencies Alternatives
Property
JPY
CHF
CAD
AUD
Gold
Change from last month
5 Any reference to SYZ Asset Management in this marketing document should be construed as being a reference to one or more of the legal entities, listed below, dependent on the particular jurisdiction and media in which the marketing document is published being: SYZ Asset Management (Europe) LTD, SYZ (France) SAS, SYZ Asset Management (Luxembourg) SA or SYZ Asset Management (Switzerland) Limited. This marketing document has been produced purely for the purpose of information and does not therefore constitute a contractual document or an offer or a recommendation to purchase or sell any investment whatsoever or other financial product. The analysis developed in this marketing document is based on numerous hypotheses. The use of different hypotheses might lead to significantly different results. Any opinion expressed is valid only on the date on which it is published and may be revised at any time without prior notice. All the information and opinions set out in this marketing document have been obtained from sources deemed reliable and trustworthy but no declaration or guarantee, whether express or implicit, is provided as to their accuracy or completeness. SYZ Asset Management refuses to accept any liability in the event of any losses or damage of any kind resulting from the use of this marketing document. Reproduction and distribution of all or part of this marketing document is subject to prior permission from SYZ Asset Management.