Everything’s a proxy for QE - we favor European bank capital (Alternative Tier 1), leveraged loans, U.S. high yield bonds and emerging market local currency bonds.
Asset allocation for a world of trend-like growth - As broad-based growth and favorable financial conditions combine to create a supportive backdrop for risky assets, we remain overweight equities, acknowledge the full valuations of U.S. stocks while keeping a small overweight, downgrade credit from overweight to neutral, and underweight duration.
Bank of England Inflation Report: A brighter outlook for the UK economy, but post-Brexit policy fog lingers
1 Source: Morningstar, data as of 18 May 2016.
2 Source: Morningstar, data as of 18 May 2016.
In our base case scenario of muddle-through growth, with a gradual recovery of EM growth alpha and moderately tighter financial conditions, we prefer to base our core exposures on higher quality credit names with stronger balance sheets and fiscally prudent positions. This reflects our more cautious longer-term view, given the still- considerable downside structural risks from commodities, China and U.S. monetary policy normalisation. For the second quarter, however, the prospect of lower market volatility and a cyclical stabilisation leads us to favour tactical positions in idiosyncratic high yield stories.
From a sector perspective, we remain constructive on duration, as the challenging growth backdrop, global easing bias, currency stability and generally moderate inflation dynamics should continue to support local currency rates. While yields have rallied this past quarter, we still believe there is further room for compression.
China’s economic transition from investment-driven growth towards a more sustainable market-based model focused on services and consumption appears to be well underway. However, achieving a smooth transition is being made more challenging by several structural obstacles.
In this paper, Emerging Market Debt portfolio managers Ai Ling Ngiam and Derek Traynor look at some of these structural issues, focusing on how excessive levels of leverage and industrial overcapacity have the potential to derail China’s economic transition. We also examine how China’s capital account is coming under pressure as the country embarks on a programme to liberalise its exchange rate regime.
This week's report is authored by a guest contributor, Benjamin Mandel, Executive Director Global Strategist Multi-Asset Solutions.
While we do not believe an EM crisis is under way or inevitable, we believe emerging markets equities are still range-bound, constrained by the triumvirate of headwinds. Valuations are not sufficiently cheap to prompt a tactical "buy today" mentality. However, they are cheap enough (including consideration of the EM currency de-rating) to encourage investors to be setting valuation or fundamental "guideposts" to add to the asset class rather than run from it because of the news flow and worries that have overtaken investors.
As written in this week's Thought of the Week, October was a good month for equities but most markets outside the US remain some way below their highs for the year. We think that this is probably the start of a year end "Rudolph Rally" and that the opportunity to add to equities hasn’t been missed. The latest Eurozone PMIs have shown no sign of a slowdown in European growth.
The US ISM surveys have rebounded with the non-manufacturing new orders component bouncing back strongly to 62, suggesting US growth remains robust. The IMF forecast that Chinese growth will slow next year but still remain healthy at over 6% and that global growth will actually accelerate to 3.6%. Furthermore the ECB have made clear that they could deliver an early Christmas present in the form of additional stimulus, whilst a Fed rate rise would signal US economic strength.
As written in this week's Thought of the Week, last week was central bank week – The US Fed, the Bank of Japan, and the oldest central bank in the world: the Sveriges Riksbank. On Wednesday, Sweden’s central bank left rates unchanged but added more (from SEK 135bn to SEK 200bn) to its quantitative easing (QE) programme. The extra six months of purchases will run from January to June 2016.
While central banks often see their currency depreciate after an easing announcement, the Swedish krona actually rose versus its major peers. Perhaps because policy makers didn’t increase the probability of a rate cut by year-end and inflation in the country is actually starting to come through. Bond markets did react in the expected way: 2-year bond yields in Sweden, France, Finland and Belgium fell during the week. The era of unconventional monetary policy continues.
As written in this week's Thought of the Week, the latest ECB Bank lending survey highlighted a gradual improvement in Eurozone credit demand despite the rising global headwinds. As we can see in this week's chart taken from page 18 of the Guide to the Markets, total credit demand has declined from last quarter's results but the overall trend is encouraging.
The latest results also highlighted significant improvement in credit demand in Italy and Spain, additional evidence that the periphery is beginning to drive economic momentum in the Eurozone. Overall, we continue to remain constructive on the growth prospects for the region especially, if sustainable drivers of the economy such as credit conditions, continue to pick up speed.
As written in this week's Thought of the Week, last week was a tough week for the European Auto sector as Volkswagen’s US business admitted to rigging emissions tests. Concern surrounding the consequences for Volkswagen and other automakers has led the European Auto and Parts index to fall 6.9%. Weak pricing power and exposure to emerging markets such as China, where growth is slowing, has led to increased uncertainty and pressure in the market.
This chart shows that during the past 12 months automakers initially outperformed the market but recently have underperformed. European car manufacturers are perhaps in the slow lane, but it’s not all bad news for these companies with the potential for further euro weakness being viewed as a positive.
As written in this week's Thought of the Week, whilst all focus was on the Fed last week, some important European data points will be released this week. Eurozone consumer confidence is released on Tuesday and PMIs on Wednesday. Consumer confidence is close to pre-crisis highs but we believe it can rise further in the medium term. Eurozone unemployment has been falling steadily over the last two years and is now showing signs of falling at a faster pace.
Our chart shows that the change in the unemployment rate is closely linked with consumer confidence. As consumer confidence increases consumers spend more, which boosts the economy and reduces unemployment. This in turn further boosts consumer confidence creating a virtuous cycle. This positive feedback loop still has plenty of room to run in the eurozone given that unemployment remains very high and therefore has the potential to fall much further.
Roberts Grava and Rafael Silveira define the prerequisites for successful long-term investing and review its unique opportunity set. Long-term institutional investing, as practiced by the leading sovereign wealth funds, enjoys large strategic advantages and a decisive tactical edge over investing with a shorter time horizon:
James Liu discusses three simple principles that can help investors maintain this balance: keeping market volatility in perspective, focusing on longer investment time horizons and maintaining portfolio discipline:
Dr. Kelly's Commentary for August 2015:
The July U.S. jobs report was solid and mostly in line with expectations. However, it is notable that, in a steadily improving job market, both labor force growth and wage growth remained weak. We have argued in the past that most of the labor force problem is structural rather than cyclical. That is to say, it is largely due to the retirement of babyboomers, a surge in disability benefits and a growing number of Americans who are essentially excluded from the job market due to prior felony convictions, educational deficiencies and issues with addiction. All of these are important issues and deserve the urgent attention of the government.
However, unlike a general lack of economic demand, they cannot be fixed by monetary or fiscal stimulus. Wage growth also remains very weak with wages of production and nonsupervisory workers up just 0.1% in July compared to June and up just 1.8% year-over-year. This is remarkably different from the last three economic expansions. The July jobs report showed only a marginal drop in the unemployment rate from 5.28% to 5.26%. However, the last three times the unemployment rate hit 5.3% on the way down, wage growth was much stronger, achieving year-over-year gains of 3.3% in November of 1988, 3.4% in June 1996 and 2.6% in January 2005.
So why are wages so weak, this time around? A full explanation is elusive. However, statistical analysis suggests that, as is in the case of labor force participation, the problems are largely structural or else due to factors that are mostly independent of demand in the economy.
Bond yields remain at or near historic lows around the world, leading to a substantial increase in the value of plan liabilities. Expected asset returns have also been falling, affecting both corporate earnings and the value of public pension liabilities. Even as plans seek to de-risk over time, new mortality tables—taking into account people's longer life spans—are also boosting the value of liabilities. Together, these trends have resulted in a deterioration in funded status experienced by many defined benefit (DB) pensions globally.
In this article, we discuss the long-term trend for growth across asset classes and the implications, as well as potential solutions, for pension funds. Michael Cembalest, Chairman of Market and Investment Strategy, looks forward at global growth, productivity and demographic trends and examines the consequences for long-term interest rates.
Lisa Coleman, Portfolio Manager, Head of Global Investment Grade Corporate Credit in the U.S., discusses the challenges facing credit managers and the benefits of a multi-sector approach in this video from August 2014.
See how TDFs offer the flexibility critical for today's pension savers. Today's pensions market never stands still, and defined contribution funds need to be flexible enough to keep up.
The pensions landscape is evolving, with new government legislation, changes in the behaviour of plan members and ongoing market uncertainty. The 2014 Budget announcement meant pension savers no longer have to buy an annuity at retirement. This is a radical shift that will have a significant impact on defined contribution pension plans. DC plans need to be able to adapt quickly and efficiently to this dramatic change so that members can benefit from the new opportunities that it creates. Target date funds flexibly adjust their asset allocation over time, ensuring members always have an appropriate mix of assets in their portfolios as they move towards retirement.
Our handy guide and short video show how TDFs deliver this flexibility by adapting quickly and efficiently to plan members' needs, market trends, regulatory change and new investment opportunities.
Senior portfolio manager Deepa Majmudar analyzes why effective inflation protection requires a flexible approach across a range of inflation-sensitive assets in this video from May 2014. She answers these two questions: 1) why not just invest in TIPs when inflation is looming? And 2) why take a diversified approach to inflation protection?
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