For professional investors Asset Allocation Monthly November 2014 MARKET REVIEW Joost van Leenders, CFA Chief Economist, Multi Asset Solutions [email protected] Economy The US economy stayed more or less on the trend it has followed since the end of the recession in mid-2009, i.e., weaker growth than during previous expansions but still relatively solid. The first estimate of third-quarter GDP (+3.5%) came in above forecasts. Domestic private demand exinventories was a little less solid, with an annualised increase of 2.3% after 3.8% in the previous quarter, as growth slowed in private consumption (+1.8%) and investment (+1.0%). +31 20 527 5126 ● Central banks moving in opposite directions ● Equity markets bounce from the dip ● Asset allocation: overweight equities and investment- US real GDP grade Multi-asset Active weights Oct-14 Equities Duration Investment grade Nov-14 ∆ active weight 7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0 (%-point contribution to growth) 08 09 Consumption Net export 10 11 12 Government Inventories 13 14 Investment GDP (% yoy) Source: Datastream, BNPP IP High yield Emerging market debt Real estate Commodities In flagging the end of its asset purchases, the Fed began the process of normalising its monetary policy, which it plans to conduct very conservatively while providing a slightly more For professional investors only Asset Allocation Monthly | November 2014 – 2 optimistic scenario on the job market at a time when wages are showing their first signs of acceleration and consumer confidence is improving. In the euro zone, purchasing manager and European Commission surveys stabilised in October after several months of declines. The composite PMI index (i.e., both manufacturing and services) for the euro zone as a whole thus came to 52.2 vs. 52 in September – the year’s low point – and vs. almost 54 in July. The preliminary estimate showed a slight uptick in inflation to 0.4% year-on-year in October. Equity markets1 October featured a peak in nervousness and central bank activity. Although the markets dropped spectacularly in midmonth, they quickly rallied. The MSCI AC World index, down 6% between the end of September and 16 October, ultimately ended the month in positive territory (+0.6% in dollars). Emerging markets also posted gains vs. the end of September (+1.1% for the MSCI Emerging index expressed in dollars), driven by Asia. Eurozone HICP MSCI World (ex EM) & MSCI EM (% yoy) 4 1800 3 1600 2 1400 1 0 1200 ECB target 1000 -1 800 01/12 05/12 09/12 01/13 05/13 09/13 01/14 05/14 09/14 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 HICP HICP-core MSCI World Source: Datastream, BNPP IP MSCI EM Source: Datastream, BNPP IP Given the further decline in energy prices, inflation is likely to remain weak over the next few months, and the later acceleration in prices driven by the expected improvement in the economy will be held back by a wide output gap. The transmission of highly accommodating monetary policy to the economy through the credit channel is likely to improve, driven by the various measures announced by the ECB. In Japan, the improvement in industrial output in September confirmed the upturn in manufacturing activity that had been pointed to by the surveys. The recovery has been slow and remains tentative, but productive investment is likely to turn up. Consumption is likely to remain sluggish due to the weakness in wages. The BoJ decided on 31 October to accelerate the pace of its government bond purchases. Exports from emerging markets are still showing no signs of a clear acceleration, even in those economies that historically are the most responsive to global activity. Manufacturing surveys remain encouraging in Asia, and a sudden slowdown is unlikely in the Chinese economy. Emerging Europe (in particular Russia) and Latin America look less solid but reforms may be undertaken in Brazil, now that the presidential election is over. The quickness of these shifts, both downward and upward, suggests that hedge funds were very active. For, while investor nervousness may be due to the release of rather disappointing economic data early in the month – in particular in the euro zone – and the downward revision in global growth forecasts, there was really no change in the economy within a few weeks. Similarly, the end of Fed quantitative easing (announced on 29 October) is no surprise, and the normalisation of key rates will remain very conservative and steady. The (nice) surprise came from the Bank of Japan, which on 31 October announced that it was raising its monetary base target to 80,000 billion yen (from 60-70,000 billion previously). This announcement helped spark a steep rally in the main equity indices actions at the end of the month. Meanwhile, earnings season is playing out rather well in the US and more chaotically in Europe in the case of some major companies. And, finally, the full assessment of euro zone bank balance sheets is rather reassuring. Equities moved very erratically, including during the upward phase. The solidity of the US economy (and the Fed’s slightly more positive analysis) led US indices to gains on the month. Within the S&P 500 index (+2.3%), defensive sectors (discretionary consumption, healthcare, and utilities) were the top 1 Unless otherwise mentioned, all indices are in local currency. For professional investors only Asset Allocation Monthly | November 2014 – 3 outperformers. The steepest decline was in the energy sector, driven down by falling oil prices (-11.6% in one month for WTI). In the euro zone, despite the rally in the second half of the month, the indices ended the month down sharply (-3.5% by the Eurostoxx 50), due to worsening economic indicators (in particular in Germany). Boosted by the BoJ decision and announcements by the GPIF public pension fund, which raised its target weighting in Japanese equities (from 12% to 25%), the Nikkei 225 gained 1.5% on the month (after rallying by 4.8% on 31 October). Unless otherwise stated, all indices are in local currencies. Bond markets US government bonds in October mostly tracked equity trends. A spectacular pullback in long bond yields thus sent the 10year US T-note yield under 2.15% at the 15 October close, in reaction to the sudden drop in equities. During this session, the yield underwent unprecedented shifts (-35bp), falling briefly below 1.90%. The release of lower retail sales on top of rather disappointing figures (ISM manufacturing index and regional surveys) cast doubt on the true state of the US economy and made investors believe that the Fed could postpone the normalisation of its monetary policy. A rumour on Janet Yellen’s confidence in the growth outlook partly reassured market participants. The extent of the pullback called for a correction, which ultimately came against a backdrop of the equity rally and more solid indicators (industrial output, consumer confidence, and GDP growth). The Fed’s rather optimistic diagnosis in the FOMC communiqué led investors to slightly raise their anticipations of a tightening in monetary policy. The two-year T-note yield fell to 0.31% on 15 October, ending the month at 0.49%, or 8bp lower than at the end of September. Two-year government bond yield 0.6 0.5 0.4 0.3 0.2 0.1 0.0 -0.1 01/12 05/12 09/12 01/13 05/13 09/13 01/14 05/14 09/14 US Germany Source: Datastream, BNPP IP The 10-year yield fell to 2.34% on 31 October (-15bp in one month). European bonds contributed to the sharp mid-month pullback: the 10-year Bund yield hit a new all-time closing low at 0.76% on 15 October (after approaching 0.70% intraday). Greece’s inclination to exit the assistance programmes earlier than expected had investors worried, triggering sharp upward pressure on Greek long-term yields, which spilled over into peripheral markets and sent investors retreating to the German market against a backdrop of a still weak European economy and very low inflation. Market movements then returned to normal. The 10-year Bund yield ended the month at 0.84% (11bp), the Italian yield at 2.35% (+2bp), and the Spanish yield at 2.08% (-6bp). The credit market was affected by receding risk appetite in mid-month. As in other asset classes, shifts were very sudden but short-lived, in particular in high yield (HY) bonds in which spreads hit a high for 2014 in both the US and Europe before pulling back. Investment grade (IG) bonds in Europe quickly erased their mid-October declines. INVESTMENT CLIMATE Market volatility has not yet returned to the low levels of the summer, but it has fallen. The market correction from midSeptember to mid-October has been mostly undone, with the US taking the lead in the bounce. The S&P500 equity index even ended October at a record high. European and Japanese equities also rallied, but emerging equities lagged. Bond yields rose by more in the US than in Germany, but fell in Japan. We increased our exposure to risk at the start of the month through a long global equity position and a long position in European investment-grade corporate bonds. Cross-currents Markets are facing strong cross-currents at the moment. The growth scare that caused the recent selloff in equity markets looks overdone to us. Third-quarter growth in the US slowed from the frantic pace of the second quarter, but was still strong at 3.5% QoQ annualised. This overstates the trend somewhat in our view, but the main message is that the US economy is doing well. The eurozone definitely looks weaker. Third-quarter growth data has yet to be released, but the economy clearly struggled. That said, there are signs that growth will improve. Japan has had difficulties regaining momentum after the second-quarter plunge, while growth in China still seems to be For professional investors only Asset Allocation Monthly | November 2014 – 4 moderating. Elsewhere in Asia, growth is relatively uninspiring. Among the BRICs, India has lost some lustre as the reform process is slower than expected, while Russia and Brazil are in recession. The economic outlook is mixed and the same goes for monetary policy. Ending its asset purchase programme, the US Federal Reserve was more hawkish than expected in its outlook, causing market expectations for rate hikes to be brought forward. We think the first hike will occur at the end of next year’s second quarter. (Index, January 2008 = 100) 600 500 400 300 200 100 0 09 US 10 11 Eurozone 12 13 UK Since we felt the negative market sentiment was overdone, we went long global equities, long US versus European equities and long European investment-grade corporate bonds. After equity markets sold off further, we increased our long equities position. US equities recovered more swiftly than European equities due to a better economic performance and a strong corporate earnings season. We later took profits on our US versus Europe equity overweight. Our overweight in European investment-grade credit is strongly driven by monetary policy. ECB asset purchases may lead to portfolio adjustments away from ABS and covered bonds, as the ECB pushes up prices, and into corporate bonds. The ECB could even start to buy these bonds directly, which would support the asset class. Central bank balance sheets 08 Increased risk in our asset allocation 14 Japan Source: Datastream, BNPP IP The ECB is still busy implementing new policy measures. The programme to buy asset-backed securities (ABS) and covered bonds may fall short of its target, so it could be expanded to corporate bonds. We think purchases of government bonds are less likely, although the chances of this happening have increased as disinflation proceeds. The Bank of Japan surprised markets with an earlier-than-expected increase in its asset purchases. The move does not change the outlook. The impact of QE on the real economy has so far been limited. However, the drop in the Japanese yen and its impact on exports should be watched. The Brazilian and Russian central banks both hiked rates (by a larger-than-expected 150bp in Russia), which was a bold step for both of them given the weakness of their domestic economies. Eurozone option-adjusted corporate spread 160 (basis points) 500 140 450 120 400 100 350 80 300 60 250 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Investment-grade (lhs) High-yield (rhs) Source: Bloomberg, BNPP IP When the opportunity presented itself, we closed our tactical short duration position in US Treasuries. Currently, we do not see any short-term trend in bond yields. They may be low given the growth outlook, but low inflation and extremely loose monetary policy should keep a tight lid on yields. We see the recent decline in oil prices as positive on balance since it increases purchasing power. But the downward impact on already low headline inflation could fan fears of deflation in some parts of the global economy. For professional investors only Asset Allocation Monthly | November 2014 – 5 Asset allocation2 Active weights Multi-asset Oct-14 Nov-14 ∆ active weight Active weights Fixed income Oct-14 Nov-14 ∆ active weight Euro Govies Equities Euro Govies AAA Duration Euro Short Dated Investment grade Corporate bonds (EUR) High yield Euro Inflation Linked High Yield (EUR) Emerging market debt High Yield (USD) Real estate Emerging Bonds USD Commodities Emerging Bonds Local Ccy Active weights Equities Oct-14 Nov-14 ∆ active weight Foreign exchange Active weights Oct-14 Nov-14 ∆ active weight AUD European large caps CAD European small caps CHF US large caps DKK US small caps EUR Japan GBP Emerging markets HKD JPY Active weights Real estate Oct-14 Nov-14 ∆ active weight European Real Estate NOK NZD SEK SGD US Real Estate USD Asian Real Estate EM FX * In foreign exchnage we are overweight CAD vs NZD and JPY and overweight MXN vs GBP, AUD and NZD. KEY Overweight: Increase: Neutral: No change: Underweight: Decrease: Summary outlook • Fed asset purchases ended in October. First rate hike in Q1 2015 at the earliest, more likely in Q2. Cautious Fed tapering and an improving outlook reduce the risk from the normalization of monetary policy in the US. Moving gradually, the Fed is keen to prevent sudden increases in longer-term yields. • Europe’s fragile recovery has been undermined by geopolitical tensions, but the economy will not slide into recession. Fundamental improvement in some peripheral countries and strength in Germany and the UK will prevent this. Fiscal drag is fading. The ECB has contained systemic risks, but monetary policy support is still needed. Downward price pressures should abate slowly. Main risks are lack of growth and reforms in some Eurozone members. Bond yields will stay low for an extended period. • China’s trend growth rate has fallen and there are downside risks from the property and financial sectors. Growth in other emerging markets is modest by historical standards. • Liquidity and monetary policy supportive for equities, but only cheap areas of the market are attractive. Better longer-term opportunities in some fixed income markets. The tables reflect net positions versus the benchmark within the MAS strategy model portfolio. Views on a particular asset class should not be seen in isolation but in the context of the overall portfolio. * Duration risk is managed independently of the underlying fixed income allocation using government bond futures. 2 For professional investors only Asset Allocation Monthly | November 2014 – 6 Equities Overweight Changed. We still view the global economic cycle as negative on balance, with a rosy US outlook offset by the struggle of the eurozone, Japan and emerging economies to regain momentum. Monetary policy is positive, especially with new stimulus measures in the eurozone and Japan. Most importantly, we felt the selloff in September and October was overdone. We opened the overweight in early October and expanded it around the middle of the month. In early October, we also went overweight US versus European equities, but took profits when US equities outperformed, partly on a solid earnings season. Small-cap equities: Underweight Unchanged. We are underweight European small caps versus large caps. Small caps are more exposed to the weak European economy, while large caps should benefit from stronger growth abroad. We also regard European small caps as relatively expensive. Now that the M&A cycle has slowed, small caps should benefit less as targets. Momentum and seasonal factors are negative, in our view. Government bonds: Neutral duration Unchanged. Bond yields have remained low in Germany and the US. Falling inflation expectations, disappointing growth and the outlook for low official rates largely explain the level of eurozone yields. We see no clear trend in yields, as expressed in our neutral duration position. Yields look low relative to projected growth, but disinflation and extremely stimulative monetary policy prevent strong increases, in our view. We closed the tactical short duration position in the US which we had in our flexible multi-asset portfolios. Investment-grade corporate bonds: Overweight Changed. The ECB will not buy investment-grade corporate bonds directly, but its purchases of asset-backed securities and covered bonds may lead to investors adjusting their portfolios in favour of this asset class. The ECB may even buy investment-grade credit directly in a later stage. Direct or indirect ECB support should outweigh unattractive valuations, in our view. High yield bonds Overweight Unchanged. We hold a small overweight. We expect defaults in the European segment to remain generally low. Ultra-loose monetary policy by the ECB should also be beneficial. We like the coupon yield. Fed tapering may cause yields to rise, but since we have implemented our overweight versus government bonds, which usually have a much longer duration, any yield increase should be hedged. Emerging market bonds Neutral Changed. The economic outlook for emerging markets is clouded and the prospect of tighter US monetary policy weighs on emerging currencies and spreads. At this point, we do not see a strong catalyst to reverse these trends, so we prefer to be neutral. Real estate securities: Neutral Changed. We like certain fundamentals of US and European real estate such as falling vacancy rates and limited construction activity. But we think the asset class is expensive in Europe and vulnerable to an increase in yields in the US. As we closed our underweight European real estate versus European equities, we are now neutral in this asset class. Commodities Neutral For professional investors only Asset Allocation Monthly | November 2014 – 7 Changed. We are neutral overall, but we are overweight oil versus industrial metals. Although oil prices have fallen despite geopolitical risk in the Middle East, we still expect this risk to drive prices higher, with added impetus coming from the pricing power of the OPEC cartel and tight inventories. We think industrial metals markets are oversupplied already and further supplies can be expected which are unlikely to be taken up given that global growth is modest. A recovery in metals prices does not look imminent. For professional investors only Asset Allocation Monthly | November 2014 – 8 Disclaimer This material is issued and has been prepared by BNP Paribas Asset Management S.A.S. (“BNPP AM”)* a member of BNP Paribas Investment Partners (BNPP IP) **. This material is produced for information purposes only and does not constitute: 1. An offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. Any investment advice. Opinions included in this material constitute the judgment of BNPP AM at the time specified and may be subject to change without notice. BNPP AM is not obliged to update or alter the information or opinions contained within this material. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the Financial Instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for a client or prospective client’s investment portfolio. 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The performance data, as applicable, reflected in this material, do not take into account the commissions, costs incurred on the issue and redemption and taxes. * BNPP AM is an investment manager registered with the “Autorité des marchés financiers” in France under number 96-02, a simplified joint stock company with a capital of 64,931,168 euros with its registered office at 1, boulevard Haussmann 75009 Paris, France, RCS Paris 319 378 832. www.bnpparibas-am.com. ** “BNP Paribas Investment Partners” is the global brand name of the BNP Paribas group’s asset management services. The individual asset management entities within BNP Paribas Investment Partners if specified herein, are specified for information only and do not necessarily carry on business in your jurisdiction. For further information, please contact your locally licensed Investment Partner. www.bnpparibas-ip.com For professional investors only
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