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GIM SOLUTIONS—GMAG
SOLUTIONS
Monthly Investment Outlook
April 2015
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This document is produced by the Global
Strategy Team within the Global Investment
Management Solutions - Global Multi-Asset
Group (GIM Solutions-GMAG). All assessments
are made using data and information up to 16
April 2015.
AUTHORS
Patrik Schöwitz
Michael Albrecht
John Bilton
Michael Hood
Beth Li
Jonathan Lowe
Benjamin Mandel
David Shairp
IN BRIEF
We expect growth in developed economies to strengthen in 2015. Within
this bloc the U.S. economy remains the growth leader. In spite of recent
temporary weakness the U.S. is moving into a mid-cycle
mid
phase, with
growth modestly above trend but inflation and wages contained. While
Europe and Japan should both narrow the growth gap with the U.S., this
expectation remains reliant on aggressive monetary stimulus. In contrast,
U.S. interest rates look set to rise later in 2015, leading to increasing policy
divergence across developed economies. Meanwhile, growth in many
emerging market (EM) economies is likely to remain challenged by rising
U.S. interest rates, a stronger U.S. dollar and low commodity prices.
This environment should be supportive for the U.S. dollar and developed
market (DM) equities, while the combination of rising U.S. interest rates
and low global inflation suggests the U.S. yield curve should flatten
further. Despite the expected pickup in global growth, central bank
demand for duration will continue, leaving room for both stocks and bonds
in multi-asset
asset portfolios. We are cautious on commodities and EM equities,
in spite of the recent bounce in the latter. We see continued headwinds in
credit markets, even though they are attractive from a carry perspective.
In our multi--asset portfolios, we remain moderately overweight risk
assets, including equities. In fixed income, we retain a reduced overweight
on duration and stay positioned for U.S. yield curve flattening. In credit,
we are neutral high yield and overweight investment grade. Within
equities, we are generally positive on developed markets, with overweight
positions in the U.S., Japan and the euro area as well as a small
overweight in Australia. We remain underweight EM and UK equities.
Investment outlook
Since our last Monthly Investment Outlook, there have been some early signs
of renewed momentum in risk assets, with U.S. high yield bonds returning
about 2% and global equities (as measured by the MSCI All Country World
Index) rising by 1.7% in dollar terms, hitting a new record high at the time of
writing (16 April). This has largely been driven by the strong performance of
EM equities, and to a lesser degree developed European equities, while U.S.
equities have been roughly unchanged. Asian equity strength has been partly
driven by Chinese policy loosening, but a pause in the U.S. dollar’s uptrend has
also been a driver, and this, in our view, is likely to be proven transitory once
the U.S. economy comes out of its recent soft patch. Meanwhile, the combined
impact of the European Central Bank’s (ECB) and Bank of Japan’s bond buying
programmes has seen government bond yields fall to record lows across the
euro area and move moderately lower in both Japan and the U.S. At the time
of writing, German 10-year
10
government bonds yield less than 10 basis points
(bps), while the U.S. equivalent yields around 1.9%.
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The key features of our 2015 outlook remain in place.
Developed economies as a whole should experience
stronger growth this year, while growth in emerging
economies is likely to remain weak relative to trend.
Among the developed economies, the U.S. remains the
growth leader and should be moving from the early to
the middle part of the business cycle. Admittedly, the
soft patch in the U.S. economy has lasted longer and
been deeper than we expected, but our view remains
that it is temporary, and there are early signs that U.S.
economic surprises are now bottoming. Lower energy
prices and resilient underlying labour market trends – in
spite of the disappointing March payrolls – point to a
positive outlook for the U.S. economy over 2015.
However, this will not prevent the U.S. economy’s
growth lead over Japan and Europe from narrowing this
year as the latter two recover from a disappointing
2014. In Europe, the ECB has surprised markets
positively with the aggressiveness of its quantitative
easing (QE) programme at a time when economic
momentum was already recovering. In our view euro
area growth is likely to accelerate to trend or even
slightly above over the course of the year. Political risks
for the economic outlook from the protracted wrangling
over Greece’s finances and the ongoing Ukraine crisis
should not be ignored, but look unlikely to derail the
economic recovery in progress. In Japan, too, the
ongoing recovery from last year’s consumption tax hike,
as well as continued stimulus from the Bank of Japan
(BoJ) and a weak yen, should spur growth decidedly
above trend this year. But despite the expected growth
improvement, it remains to be seen whether the BoJ’s
policies can meaningfully reverse deflationary trends.
With much of the developed world growth pickup
outside the U.S. driven by central bank monetary
accommodation, policy divergence across developed
economies should become even more pronounced. The
self-sustaining nature of the U.S. recovery should cause
the Federal Reserve to finally begin raising interest
rates in the second half of this year. In contrast, BoJ and
ECB policy loosening is in full swing, and with weak
commodity prices adding to disinflationary pressures
around the globe, they are increasingly being joined by
other DM and EM central banks.
As a result, we expect duration assets to remain well
supported in 2015. Long-end yields should remain
contained even in the U.S., as they stand to be affected
by the rest of the world’s loose monetary policies.
Therefore, we expect the flattening of yield curves that
we saw during the second half of 2014 to regain
momentum through 2015. In the U.S., we expect rising
front-end rates to increasingly drive this trend.
Meanwhile, in Europe and Japan, the bid for duration
will remain, even at these extremely low yield levels.
For DM equity markets, the combination of continued
monetary stimulus in large parts of the world with solid
earnings growth points to another year of positive
performance. In the U.S., equities have recently faced
headwinds as low oil prices and the strengthening dollar
have reduced earnings growth expectations for 2015 to
barely above zero. However, outside the troubled
energy sector, earnings growth should remain
respectable, in the mid to high single digits. The bulk of
earnings downgrades is likely already behind us, leaving
scope for better performance for the remainder of the
year. Conversely, despite attractive valuations in several
cases, the outlook for EM equities remains weak as a
result of still-slowing earnings growth and the economic
problems associated with low commodity prices and
rising U.S. interest rates. Chinese equities may turn out
to be the exception as stimulus becomes more
aggressive, but this is the result of a weaker real
economic situation and in our view does not change the
outlook for the asset class as a whole.
In our multi-asset portfolios, positioning remains
unchanged on the month. We are moderately
overweight risk assets, including equities. In fixed
income, we retain a reduced overweight on duration
and stay positioned for U.S. yield curve flattening. In
credit, we are neutral high yield and overweight
investment grade. Within equities, we are generally
positive on developed markets with overweight
positions in the U.S., Japan and the euro area, as well as
Australia. We remain underweight EM and UK equities.
2 | Monthly Investment Outlook
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Chart of the Month – There’s just something about Q1: Since 2010, U.S. first quarters have looked especially weak
GDP, QoQ%, saar - average deviation from trend*
1
0
-1
Q1
Q2
Q3
Q4
-2
1980s
1990s
2000s
2010s
There’s just something about Q1. For many northern economies, growth is notoriously difficult to seasonally adjust in the first
fir quarter of the
year; historically in the U.S., cold winter weather and fewer working days have caused the economy to contract a whopping 15%-20%
15%
on a nonseasonally- adjusted (NSA) annualized basis. The Bureau of Economic Analysis has not published NSA numbers since 2004, but as the Chart of
the Month shows, in nearly all of the past five years the ostensibly seasonallyseasonally adjusted Q1 result has disappointed, averaging 1.5% below
trend*. Looking forward, we expect U.S. domestic consumption to rebound in the easier-to-measure
easier
second quarter, driven by pent-up income
gains from lower gasoline prices, currently high savings rates, moderate job growth and high consumer confidence.
Source: J.P. Morgan Asset Management GIM Solutions–GMAG
GMAG calculations, U.S. Bureau of Economic Analysis (BEA). Data as of 15 April
Apri 2015
* Trend based on HP filter with quarterly =5
3 | Monthly Investment Outlook
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Key asset class views:
Stock/bond—overweight equities relative to bonds. Global growth should show
sh further improvement in 2015, mostly driven by the
U.S. economy, recent weakness notwithstanding. Japan and Europe should also see better growth, driven to a large degree by continuing
co
aggressive monetary policy stimulus even as we move towards a gradual tightening of U.S. monetary policy. Inflation risks remain
rem
contained, however, helped by weak commodity prices. This combination should support risk assets and keep bond yields contained.
contain
Equity valuations have risen but remain attractive relative to bond yields.
Duration—overweight. Largely due to stimulus from the BoJ and the ECB, international growth should catch up somewhat relative to
the U.S. this year. This pickup in growth should keep global policy loose at the same time that new financial regulations come
com into play.
This should keep demand for long-duration risk-less
less assets high. A negative stock/bond return correlation supports a diversified stock
and bond approach. We expect yield curves to resume flattening, but increasingly from the front end, and we are positioned accordingly.
ac
Credit—overweight. Valuations in both investment grade and high yield are attractive from a carry perspective, and fundamentals in
many ways still look solid. Negative
egative spread correlation to yields offers protection if rates rise. However, the rout in the energy-exposed
segments has revealed poor structural liquidity in credit, and there may be further pain to come in energy.
Commodities—underweight. Commodity oversupply, notably in oil, has driven prices lower, and production will have to be cut further
to support prices. A weak demand outlook due to less-commodity-intensive
intensive growth models in Asia should counterbalance any global
growth pick up.
Equity markets
U.S.—overweight. The U.S. is still the growth leader within developed markets. With the economy moving into mid-cycle,
mid
equities should
outperform. Earnings are suffering from energy weakness and the stronger U.S. dollar (USD), but fundamentals still look decent
decen and
earnings momentum is showing signs of stabilising. Valuations are stretched relative to other regions but are justified given higher quality
and profitability. A flattening yield curve favours large caps over small caps.
Europe (ex-UK)—overweight. Europe (ex-UK)
UK) is benefitting from stronger-than-expected
stronger
stimulus by the ECB and improving economic
momentum, although political risk remains elevated. Earnings growth momentum in 2015 is improving strongly, helped by the weak
wea euro,
and earnings revisions are now positive in the euro area. Valuations look attractive on anything other than earnings spot multiples.
mul
Japan—overweight. Aggressive
ggressive monetary stimulus by the BoJ is set to continue in 2015, keeping the yen weak and boosting corporate
earnings growth. Earnings should also benefit from economic acceleration on the back of stimulus and as the impact of the consumption
con
tax
hikes fades. Japanese domestic institutional asset allocation shifts into equities should continue to be supportive.
Emerging markets—underweight. Cyclical headwinds due to the unwinding of loose U.S. monetary policy, a stronger dollar, a weaker yen
and lower commodity prices look set to continue, while structural problems in many EM economies persist. More-aggressive stimulus has
pushed Chinese equities higher, but this is in the context of further economic weakness and should not be a signal for the wider
wi
asset class.
Bond markets
U.S.—underweight short end, overweight long end. The yield curve is likely to flatten further, driven by rising short-end
short
yields as the
Federal Reserve’s tightening nears. Long-dated
dated bonds remain very attractive in an international context and offer diversification
diversificatio benefits to
an equity overweight.
Europe—overweight periphery, neutral core. The ECB’s quantitative easing programme is likely to drive further yield convergence in the
euro area’s periphery. Core yields are already very low but could go further in the context of QE.
Emerging markets debt (EMD)—neutral. Economic fundamentals remain challenged despite pockets of macro stimulus and reasonable
sovereign debt dynamics. Hard currency debt is vulnerable to a higher USD and lower oil prices.
Currencies
USD—overweight. Both growth and interest rate differentials favour the dollar and should continue to do so as U.S. policy normalises
earlier than elsewhere. Recent moves have begun to push the currency into overvalued territory, but powerful flows are likely to continue.
EUR—underweight. Anticipation of the ECB’s QE programme has already pushed the euro much lower. This is likely to continue even
though the persistent current account surplus may provide some support to the euro.
GBP—underweight. The UK faces the widest current account deficit relative to GDP among the DM economies. Political
P
risk from the May
election is not fully priced into valuations or reflected in positioning, and negative momentum points to further weakness.
JPY—underweight. Aggressive policy from the BoJ has already driven the yen much lower. Although some valuation metrics now suggest
undervaluation, given the BoJ’s commitment to quantitative and qualitative easing (QQE), this trend is likely to persist for much longer.
4 | Monthly Investment Outlook
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GIMS-GMAG asset allocation view summary*
Asset class Opportunity set
Δ Negative
Duration
Credit
Commodities
U.S.
Equities
Europe ex-UK
UK
Japan
Pacific ex-Japan
Emerging markets
U.S. bonds – short end
U.S. bonds – long end
Euro, core
Fixed income
Regional views by asset class
Rationale
Global economy is still in the early/mid-cycle
early/mid
phase, with global policy stimulus
and weak oil prices to boost DM consumption. It remains attractive to take
directional bets.
Move towards global QE: Weaker international growth vs. U.S. plus broad policy
stimulus results in high demand for long-duration
long
risk-less assets.
Attractive from a carry perspective, decent fundamentals but vulnerable to bouts
of illiquidity once U.S. policy starts to tighten.
Oversupply in some commodities and falling EM demand, but prices have already
moved a long way.
U.S. leads global growth, and we have the most confidence in the U.S. outlook for
2015. Flattening curve supports U.S. large caps.
ECB stimulus having a strong impact. Macro momentum is building and easing
monetary conditions point to more ahead. Weak euro should support earnings.
The UK is Europe's “emerging market,” given peaking economic cycle,
deteriorating external balances and rising political risk pre-election
pre
in early 2015.
BoJ remains “all in”. Equities are helped by continuing currency depreciation,
rising earnings and attractive valuations. Shifts in domestic asset allocation
provide a boost to the Nikkei.
Australian equities offer diversification benefits within DM and should benefit
from continued domestic monetary easing.
EMs are vulnerable to exogenous shocks from falling JPY, rising U.S. rates and
commodity prices. Valuations are not low enough to compensate for the risk.
Yield curve flattener set to shift from bull to bear flatteners, as Fed approaches
rate hikes in latter half of 2015.
Long
Long-dated
bonds are more attractive than they appear, and also offer portfolio
diversification benefits.
German Bund yields already look very low, but ECB QE should anchor them for an
extended period.
Peripheral spreads over Bunds should compress further on the back of ECB bond
buying.
Relative valuations look less attractive. BoE tightening now priced out until later
in 2016, while UK Gilts have yet to reflect growing political risks
JGBs unattractive even after the back-up
back
in yield, but still supported by BoJ
buying. Australian bonds offer a nice real yield pickup.
IG valuations are more attractive with low default rates and balance sheet
strength. Negative spread correlation to yields offers protection if rates rise.
Attractive carry in a low-rate
low
environment. Default rates should remain very low,
but the asset class is vulnerable to pockets of illiquidity.
EM debt is vulnerable to higher USD and lower oil price despite pockets of macro
stimulus and reasonable sovereign debt dynamics.
Growth and interest rate differentials in favour, but USD looking increasingly
overvalued, suggesting the “easy money” has been made
ECB QE has led to another leg down in the euro. The euro now looks undervalued
but weakness is likely to continue for some time.
The pound is hurt by weak trends, the worst current account deficit in the G-10,
and high political risks not fully reflected in valuations or positioning.
QQE is still pushing the JPY weaker. It has already fallen a long way and is
undervalued, but investors shouldn’t fight the longer-run
longer
downtrend.
Equities/Bonds
Main asset
classes
Positive
Euro, periphery
UK bonds
Other DM bonds
Investment grade
U.S. high yield
Emerging markets
USD
FX
EUR
GBP
JPY
Key:
Max negative;
Neutral;
Max positive;
Upgrade;
Downgrade
Source: J.P. Morgan Asset Management GIM Solutions-GMAG; assessments are made using data and information up to 16 April 2015. For illustration purposes only.
* These asset class views apply to an intermediate-term
term horizon (that is, six months to three years). Up/down arrows indicate a positive or negative change in view since
the prior Monthly Investment Outlook. These individual asset class views show absolute direction and strength of conviction, and are independent of portfolio
construction considerations. They should not be construed as a recommended portfolio. This monthly asset allocation summary is
i distinct from the product of the thriceyearly GIM Solutions-GMAG Strategy Summit meeting.
5 | Monthly Investment Outlook
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