PRIVATE BANKING – INVESTMENT RESEARCH
INVESTMENT POLICY
NOVEMBER 2014
EDMOND DE ROTHSCHILD (SUISSE) SA
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PRIVATE BANKING – NOVEMBER 2014
EDMOND DE ROTHSCHILD (SUISSE) SA - INVESTMENT COMMITTEE
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PRIVATE BANKING – NOVEMBER 2014
CONTENTS
Wrap-up ............................................................................................................................................................................. 4
Global economic outlook .........................................................................................................................................5
Bonds ................................................................................................................................................................................... 6
Equities................................................................................................................................................................................ 7
Currencies......................................................................................................................................................................... 8
Allocation grid
Contact:
.............................................................................................................................................................. 9
Alessandra Gaudio | Global Chief Investment Officer
+41 58 818 86 78
[email protected]
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PRIVATE BANKING – NOVEMBER 2014
WRAP-UP
 Even as private consumption, industrial production and job creation reach new record highs in the US, growth has
been slowing just about everywhere in the world for several months now. Indeed economic data and other
indicators in Europe, Japan and the emerging countries look worrisome. This dimming outlook has had a negative
impact on financial markets, which have pulled back sharply since mid-September.
 In view of the marked deterioration in investor confidence, central banks are trying to hold their generally
accommodative course. Yet the markets are starting to question their credibility, especially in Europe. The first
round of the European Central Bank’s Targeted Long Term Refinancing Operations (TLTRO) programme received
a disappointing response from Euro Zone banks, and expectations regarding the ECB’s promise to buy assetbacked securities and covered bonds have already been scaled back.
 Central banks’ actions and guidance have not subdued investors’
stress—quite the opposite. Risk aversion is at its highest level since
the start of the year. Implied volatility and prices of credit default
swaps (insurance against counterparties’ non-payment) are also on
the rise. And even though stockmarkets have recovered somewhat in
recent days, the trend is not subsiding.
 In fixed income, yields have reversed trend again after last month’s
upswing. The new downside movement has been prompted not only
by investors switching to bonds, following the steep corrections in
equities, but also by downward revisions of economic growth and
inflation.
Tactical buying
opportunities are
already on our
menu
 Having due regard for the deteriorating global economic outlook and the recent pullbacks in equity markets, the
Investment Committee has not changed its macroeconomic views or the main tenets of its investment policy,
which are protection and convictions. There is no chance of a recession in the US as things stand now. Moreover,
the correction in stockmarkets is a healthy development as it is drawing down part of their recent overvaluation,
providing benchmarks around the world with compelling scope for a rally. Having raised cash in late August and
mid-September by reducing the allocation to equities, we have decided to plough it back tactically into the US
stockmarket in general and into Zone Euro financial shares.
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PRIVATE BANKING – NOVEMBER 2014
GLOBAL ECONOMIC OUTLOOK
 The US economy continues to grow steadily. Most indicators have stabilised at high levels while, structurally,
America’s GDP growth is rising in tandem with job creation. In September the national unemployment rate eased
from 6.1% to 5.9%.
 Although the bulk of the US news flow is encouraging, inflation is barely rising. This is mainly due to the
deteriorating economic environment elsewhere in the world, but falling energy and food prices are also at work.
The Federal Reserve could therefore decide to put off the first uptick in short-term interest rates until wage growth
picks up significantly. If there is no fundamental challenge to tightening monetary policy, the round will probably
begin in late 2015 and continue gradually.
 Concern about slow growth in the Euro Zone is deepening. Over the past year industrial production has fallen
across the area, including in Germany, where order intake among manufacturers is tumbling. Moreover, the first
round of the ECB’s Targeted Long Term Refinancing Operations programme received a disappointing response
from the banking sector. That marked the start of the fall in Euroland’s stockmarkets, which are now at their
lowest levels year to date. If the second round of TLTRO, scheduled for December, turns out to be another letdown, the ECB will have to step up its programme of asset purchases to reach its money-printing objective.
Although Mario Draghi is maintaining an accommodative stance, there are doubts about the central bank’s ability
to fend off deflation effectively.
 Among the major emerging countries, China has just reported 7.3% third-quarter GDP growth. This is the slowest
pace since 2009, although the downturn has been orchestrated by the authorities, who are trying to wean the
country off exports and move instead towards a consumption-driven economy. In any case the third-quarter GDP
data are not weak enough to prompt the People’s Bank of China to inject more liquidity into the financial system.
Meanwhile Brazil is grappling with an all-out recession and Russia is doing its best to cope with Western sanctions
and the financial impact of falling oil prices.
ACTUAL INFLATION AND INFLATION EXPECTATIONS ARE BOTH TOO LOW IN EUROPE
5
5
Euro Area Inflation (%YoY)
10-Yr Breakeven Rate (%)
5-Yr Breakeven Rate (%)
4
4
3
3
2
2
1
1
0
0
-1
-1
04
05
06
07
08
09
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11
12
13
14
15
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BONDS
 The trend reversal that appeared to be taking shape a month ago was short-lived and yields headed back down in
October (see chart). Ten-year yields on US Treasuries and German Bunds both reached new 2014 lows.
 The recent decline in yields is largely due to inflation forecasts, which are trending downward. The US bond
market is ignoring other indicators that confirm the US economy’s good health.
 In the Euro Zone, debt markets are still getting a boost from the ECB’s promise of additional monetary easing.
 We continue to give preference to European issues. However, the dollar-denominated high-yield segment suffered
a sharp correction in recent weeks and deserves some consideration. We are watching for a good entry point.
 The emerging debt markets have been influenced a bit by the recent rise in risk aversion, which has caused credit
spreads to edge up. This segment remains attractively valued.
 Although the conflict between Russia and Ukraine drags on, the de-escalation process seems to be continuing.
Exposure to Russia and Eastern Europe still holds out the prospect of good performances provided valuations
return to levels that better reflect fundamentals. We are holding on to our positions.
10-YR US TREASURY AND GERMAN BUND YIELDS
-----
Bund 10 Year
UST 10 Year
Source: Bloomberg, EdR
EDMOND DE ROTHSCHILD (SUISSE) SA - INVESTMENT COMMITTEE
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EQUITIES
 The correction in stock prices has once again been swift and steep and
has three causes. The first is psychological: flaring geopolitical tensions
and fear of an uncontrolled spread of the Ebola virus. The second is
economic: signs of slowing growth just about everywhere in the world
except in the US. The third is financial: concern that, in these
circumstances, company earnings may fall short of forecasts and that
the valuation ratios that stocks have reached (exceeding long-term
average) are not sustainable.
PURCHASING MANAGERS INDICES
SHOW DIVERGING ECONOMIC
MOMENTUM
 A bear market occurs when equities fall more than 20%. Since the last
time this happened, in 2011, market stress has spiked four other times.
On each of those occasions the S&P 500 fell 8-10% and the Euro Stoxx
600 roughly 12%.
 The performance gap between equities in the US and the UK, on the one
hand, and the Euro Zone, China and even Japan, on the other, is
perfectly logical and, in our opinion, will continue to widen in the
coming months. It is attributable to differing monetary policies and
rates of GDP growth, with the Anglo-Saxon countries enjoying economic
expansion and preparing to raise interest rates while the others
experience slowdowns that require additional stimulus.
Source: Bloomberg, EdR
GROWTH IS SLOWING AROUND THE
WORLD, EXCEPT IN THE US
 In geographical terms, we prefer the USA over Europe, and the
defensive Swiss market will continue to occupy a central role in our
European investment strategy.
 As regards our approach, in the US we emphasise stock picking with a
strong domestic bias, both in terms of companies’ final markets (thanks
to the national economic upturn) and their logistics chains (thanks to
the advantages afforded by cheap energy and a flexible workforce).
These factors will additionally generate scope for margin expansion.
 In Europe our approach is thematic. For example, we like banking
stocks as the sector will benefit from the ECB’s quantitative easing.
However, investors should avoid the specific risks attaching to
companies that remain weakened by the debt crisis and recession. We
also recommend: multinationals that are capable of capturing whatever
growth is available outside their sluggish home markets and can also
benefit from the depreciating euro.
YEAR-TO-DATE RETURNS ON THE
S&P 500 AND THE DJ STOXX 600
 We also have two sector preferences. Technology, on the whole, looks
good owing to its attractive valuation, high profitability, robust growth,
surplus cash and seasonal strength. Financials also show promise. In
the US we like players with a strong domestic bias (cf. recovering
business volumes) but the whole industry will benefit from higher
interest margins, thanks to the steepening yield curve. Meanwhile this
sector is attractively valued, with a P/E ratio 20% below the cyclically
adjusted 2002-06 level. In Europe financials will automatically get a
boost from the ECB’s expected quantitative easing.
Source: Bloomberg, EdR
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CURRENCIES
 The dollar is powering ahead against the euro, the yen and the other major currencies. Year to date it has risen
against almost all of the 31 most heavily traded currencies. As a consequence it has contributed positively to our
portfolios’ performances.
 But although the dollar could make substantial additional progress until end-2015, it is bound to suffer sharp
pullbacks along the way. For this reason the Investment Committee has decided to take some profits, in view of the
greenback’s hefty gains, while remaining well exposed to the US currency.
 The euro on the other hand pulls back each time the ECB president, Mario Draghi, promises to inject liquidity into
the Euroland banking system. Those who doubted his determination to bring down the euro have been proved
wrong. Even though there could be a break in its fall near term, the trend is definitely bearish.
 More than the rise in the dollar and more than the euro’s weakness, both of which we anticipated, it is the yen’s
pullback that we find compelling. The Japanese currency has been impacted exogenously by the expectation of an
uptick in US interest rates and endogenously by the prospect of additional money printing by the Bank of Japan.
These issues are important to investors, since Japanese equities go up whenever the yen depreciates. As in 2013,
the Tokyo stockmarket is pricing in an automatic improvement in exporters’ profits.
 The Swiss franc is also influenced by the actions or inaction of its issuing bank. If the SNB wants to defend its floor
rate without sending its balance-sheet total through the roof, it will have to follow the ECB’s lead and charge
negative interest on the deposits it keeps on behalf of commercial banks.
35%
30%
PERFORMANCE OF THE DOLLAR YEAR TO DATE
THE GREENBACK HAS RISEN AGAINST ALL OTHER CURRENCIES.
30%
24%
USD Performance vs Currencies (Year to Date)
25%
1%
0%
CNY
SGD
IDR
0%
1%
1%
KRW
2%
2%
JPY
BRL
2%
2%
AUD
TWD
4%
PEN
5%
3%
5%
4%
NZD
GBP
6%
5%
ZAR
TRY
CAD
6%
6%
COP
8%
7%
ILS
CHF
8%
8%
DKK
NOK
9%
10%
9%
CZK
12%
10%
CLP
PLN
12%
12%
SEK
15%
HUF
20%
HKD
MYR
MXN
EUR
ARS
RUB
-5%
INR -1%
0%
0%
Source: Bloomberg, EdR
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ALLOCATION GRID
In summary, we have made the following TACTICAL changes to our balanced portfolio:




Exposure to US equities in general is increased
Exposure to European equities is increased via Euro Zone financials
We are taking profits on the US dollar
The cash position is reduced
Portfolio with hedge funds
EUR
CASH
BONDS
EQUITIES
HEDGE FUNDS
USD
CHF
%
%
0
0
0
Sovereign
5
5
2
Corporate Investment Grade
16
16
12
High Yield
0
Emerging
10
10
8
Convertibles
0
0
0
Euro Zone
11
6
4
Swiss
10
10
18
US
10
Japan
3
3
3
Emerging
3
3
3
Long / Short
8
Non-directional
31
37
0
31
15
37
8
10
38
8
25
17
22
0
25
17
25
17
REAL ESTATE
2
2
10
GOLD
5
5
5
100
100
100
TOTAL
CURRENCIES
EUR
USD
CHF
EUR
73
0
0
USD
20
100
20
CHF
7
0
80
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IMPORTANT LEGAL INFORMATION
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