Capital Markets Outlook

Transcription

1 Q4 2015» Putnam Perspectives Capita Markets Outook Jason R. Vaiancourt, CFA Co-Head of Goba Asset Aocation Key takeaways Correcting the misinterpretations of the third-quarter correction Goba indicators point toward continued growth Risk assets appear attractive with caution for emerging markets Asset aocations Arrows in the tabe indicate the change from the previous quarter. ASSET CLASS EQUITY FIXED INCOME U.S. arge cap U.S. sma cap U.S. vaue U.S. growth Europe Japan Emerging markets U.S. government U.S. tax exempt U.S. investment-grade corporates U.S. mortgage-backed U.S. foating-rate bank oans U.S. high yied Non-U.S. deveoped country Emerging markets COMMODITIES CASH Underweight Sma underweight Neutra Sma overweight Overweight Correcting the misinterpretations of the third-quarter correction Voatiity returned to goba markets during the summer months, reaching the highest eves in years. The VIX Index rose to its highest eve since October 2011 whie the S&P 500 Index gave up 6.4% and the MSCI Word Index (ND) fe 8.5% in the quarter. Anyone trying to understand the cause of this renewed voatiity was poory served by media headines and reports, in our estimation. It is important to step back and gain a more accurate perspective on the thirdquarter correction before caibrating portfoio strategies. We see three interreated possibiities for interpreting the correction: First, to pace it in context, there were the usua comparisons of the duration and magnitude of the current bu market to historica norms. This interpretation took form with headines about the number of trading days since a previous 10% correction had occurred. A second possibiity is that the correction was a reaction to the Federa Reserve s ongcommunicated pans to raise the federa funds rate off the zero bound for the first time in seven years. From this perspective, the end of poicy accommodation woud aso mean the oss of the moderating effect that it had on voatiity. The third possibiity is that markets were discounting a downturn in the goba economy. This view gained adherents in the weeks CURRENCY: U.S. DOLLAR VERSUS EURO POUND YEN STRATEGY: Favor doar (unchanged from ast quarter) Favor doar (unchanged from ast quarter) Favor doar (unchanged from ast quarter)

2 Q Capita Markets Outook The Fed unintentionay fueed pessimism by passing on the opportunity to begin normaizing monetary poicy in September. foowing the correction, based on a more pessimistic assessment of the economic sowdown in China. Fears that China woud import fewer commodities and fewer consumer goods was seen as a probem that coud spi over to both deveoped and emerging markets. The Fed unintentionay fueed the pessimism associated with the third possibiity by passing on the opportunity to begin normaizing monetary poicy in September. Markets disike uncertainty, and the Fed s communications coming out of its September meeting cast new doubt on the reiabiity of the interest-rate expectations it had been setting. What s more, the Federa Open Market Committee s statement and Janet Yeen s post-meeting press conference cited internationa deveopments as a reason for hoding off on rate increases, a rare acknowedgement of any consideration outside of the institution s dua mandate. In assessing these three possibiities, we think it is important in turn to understand the internationa deveopments the Fed mentioned. We see a confuence of three deveopments that are, quite possiby, unreated. The first is the seoff of cass A shares isted on China s stock exchanges; second is the drop in commodity prices, incuding oi, in particuar; and third is the devauation of the yuan. The turmoi in China s A shares began in June and persisted for much of the summer. It was preceded by a breathtaking rise in the number of retai brokerage accounts in China and the amount of margin ending to those accounts. The officia numbers may even have been understated due to the amount of shadow ending that takes pace outside the officia, reguated accounting practices. Whie the punge in prices was unquestionaby serious, we do not beieve it was a case of a market anticipating a future downturn. We saw another factor at issue. The initia decines in the A-share market came on the hees of an announcement by Morgan Staney Capita Internationa (MSCI) that it woud not be incuding mainand Chinese Whie the punge in China s A-share prices was unquestionaby serious, we do not beieve it was a case of a market anticipating a future downturn. equities in the MSCI Emerging Markets Index (ND). This decision meant that a new source of demand for A shares woud not be materiaizing in the near term. As for energy, the narrative in the media is that a bursting bubbe in the Chinese stock market and a severe seoff in the price of energy must be evidence of an emerging hard anding in the Chinese economy. Here again, there is evidence of some key suppy-side events that are so uncanny in their timing that they cannot be ignored. Oi prices reacted to the June 5 OPEC meeting and its subsequent decision to maintain current output eves, and to the Juy 14 Iran nucear agreement, which may aow Iranian oi suppies back on to word markets. Perhaps the greatest misperception, we beieve, surrounds the Peope s Bank of China s (PBOC) devauation of the yuan on August 11, 2015, which served as the trigger for the punge in equity prices that spread to markets wordwide. Many commentators decared the start of new currency wars, depicting the devauation move as a desperate, ast-ditch effort to hep revive the export sector of a coapsing Chinese economy. Let s keep this devauation in perspective. Through the end of September, the currency s vaue had faen by ess than 3% from where it stood before the move. A devauation this sma provides itte stimuus to exports. We therefore regarded it as reasonabe to beieve the justification provided in the PBOC s announcement that it was moving in the direction of a market-driven vauation for the currency as a show of good faith on its intentions toward the Internationa Monetary Fund (IMF). China is keen to have the yuan incuded in the IMF s Specia Drawing Rights (SDR) basket and counted among the word s major reserve currencies. For incusion, the IMF requires that a currency be both widey used and widey traded. The steps that China has taken to widen the bands around which it aows the currency to foat may now be enough for the IMF to acquiesce. Through the end of September, the yuan s vaue had faen by ess than 3% from where it stood before the devauation. The devauation, ike the drop in oi prices and in China s A shares, have been widey misunderstood, we beieve. Any concusion based on these misperceptions that the word economy is in peri woud be fawed. 2

3 PUTNAM INVESTMENTS putnam.com Goba indicators point toward continued growth The modes and factors that we monitor to assess the heath of the goba economy continue to paint a reativey stabe picture, abeit with a sight tick down in recent months within goba manufacturing. But we have seen these sight cycica variations manifest themseves many times over the past five years. In each case, staying the course has been the correct ca, and we continue to beieve that strategy wi be the correct one in the current environment. We woud point to the continued strength of services and the deveoped-market consumer as particuar areas of strength to offset the somewhat bad news in the industrias sector. Figure 1. Dips in manufacturing since 2009 have been short-ived U.S. ISM Manufacturing Index 2-month average 60 Recession ISM Non-Manufacturing Index 2-month average /05 12/07 12/09 12/11 12/13 9/15 Source: Institute for Suppy Management. Risk assets appear attractive, with caution for emerging markets We are marginay and tacticay more buish on risk assets heading into the fourth quarter based on vauation driven by the recent puback. There wi be a greater amount of focus on the third-quarter earnings season to carify corporate views on what managements are seeing in emerging markets. In addition, seasona patterns tend to be more favorabe into the end of the year. In genera, we continue to favor deveoped markets over emerging markets. Figure 2. Consumer confidence is on an upward trend Conference Board Consumer Confidence Index, 12/89 9/15 Recession /30/15 Source: The Conference Board. 3

4 Q Capita Markets Outook Asset cass views U.S. equity: A eyes on earnings after jump in voatiity U.S. equities endured their most chaenging quarter in years, and the market s extraordinary advance of previous quarters came to an end with significant voatiity. The turbuence peaked in August with some of the biggest swings in the history of the market, incuding a historic 1,000-point intraday punge for the Dow Jones Industria Average on August 24. Stocks recovered from the August ows and ended the quarter with a decine of 6.4%, as measured by the S&P 500 Index. A downturn was not particuary surprising. For severa quarters, we have observed that equity vauations were approaching the top quartie of their historica averages, Market trends Index name (returns in US$) Q months ended 9/30/15 EQUITY INDEXES Dow Jones Industria Average -6.98% -2.11% MSCI EAFE (ND) MSCI Emerging Markets (ND) MSCI Europe (ND) MSCI Word (ND) Nasdaq Russe Russe Russe 3000 Growth Russe 3000 Vaue S&P Tokyo Topix FIXED INCOME INDEXES Barcays Government Bond 1.71% 3.68% Barcays MBS Barcays Municipa Bond Barcays U.S. Aggregate Bond BofA ML 91-day T-bi CG Word Government Bond ex-u.s JPMorgan Deveoped High Yied JPMorgan Emerging Markets Goba Diversified JPMorgan Goba High Yied S&P LSTA Loan COMMODITIES S&P GSCI % % The two greatest pressures on corporate profitabiity have been the strong U.S. doar and weak oi prices. and we beieved that investors shoud be cognizant of the risk of a market correction. Athough such turbuence can be unsetting, we now see many investment opportunities that were nonexistent just a few months ago. As we anticipated, 2015 is aso shaping up to be a fairy weak year in terms of earnings growth for U.S. corporations. So far, profits for S&P 500 companies have been fat to modesty positive. The two greatest pressures on profitabiity have been the strong U.S. doar and weak oi prices. More than 40% of the profits of S&P companies come from internationa markets. The strong doar has hurt many of these businesses, which rey on revenues from markets with much weaker currencies. And the negative effects of pummeting oi prices can expand beyond oi and gas companies to the wide array of industries that provide products and services to them. Our outook for U.S. stocks remains mixed. It is quite ikey that voatiity may persist as we face a few headwinds, incuding concerns over strugging emerging markets, especiay China, the word s second-argest economy. Aso, the equity market continues to wreste with uncertainty over the timing and potentia impact of an interest-rate hike by the Federa Reserve. We beieve it is pretty cear that the Fed wants to raise interest rates, but aso wants to ensure it is done at a time when the U.S. economy can support it. As we approach the next severa Fed meetings, it wi be critica to monitor U.S. gross domestic product growth, infation pressures, and the strengths and weaknesses of non-u.s. economies. There are many variabes in the equation, and it is a considerabe chaenge for the Fed. As for the impact of a rate increase on stocks, we coud see some short-term voatiity at the outset. However, history shows that equities tend to perform we when interest rates are rising from very ow eves. Non-U.S. equity: Optimism for Europe and Japan, doubt for China China s surprise currency devauation sparked the recent seoff in goba equities, but market observers are sti strugging to gauge the true eve of China s economic distress. Ominousy, the Chinese government empoyed a variety of poicy tactics, incuding interest-rate cuts, stock market interventions, and more spending, but these efforts to re-stimuate growth and cam investors 4

5 PUTNAM INVESTMENTS putnam.com generay faied to hat the market rout. So whie it is difficut to say if the worst is over, we think it warranted to expect more voatiity in the months ahead. A severe deceeration in China has negative impications for markets around the word. Some of the impications are knowabe and hence easier to mode; others are much harder to predict. The Chinese sowdown of the past severa years has had increasingy arge effects on the country s key trading partners most notaby, Asian emerging markets and Brazi and we think it is ikey to spread further around the gobe. The good news is that, unike the financia crisis of 2008, which spread reativey quicky, China has given rise to an economic contagion that has spread more sowy. Some estimates suggest China s debt increased by neary $20 triion since 2008, but the vast majority of that debt is owned domesticay; consequenty, the abiity for financia contagion to spread quicky is ow. In August, the yuan devauation had a surprising impact on S&P 500 companies. The heath-care sector, for exampe, was particuary hard hit as the increase in equity voatiity caused by China ed to seing in the sector. In addition, investors who had ong positions reative to the U.S. doar and short positions reative to the euro which was a common trade were hurt as the doar sank whie the euro strengthened foowing China s currency move. At some point in ate 2015 or eary 2016, we expect the Fed to raise interest rates. The market expects this, too, and this has bostered the consensus view that the doar wi continue to rise. This deveopment woud aso exert upward pressure on China s currency, the yuan, which woud consequenty depress China s export sector. That may cause more troube for China s growth outook and thus contribute to more voatiity across goba markets. Internationa investors shoud aso be aware that the era of European austerity has ed to poitica poarization, with the proiferation of far right as we as far eft parties. In addition, the huge wave of refugees from paces ike Syria, Iraq, and Eritrea has put, and wi continue to put, added pressure on the poitica environment in Europe. In our view, this ampifies certain risks for investors in European stocks incuding, most prominenty, the risk of an increasingy fractured eurozone. Unike the financia crisis of 2008, which spread reativey quicky, China has given rise to an economic contagion that has spread more sowy. Overa, however, there are reasons for optimism in the near term. We expect, for exampe, that economic data wi sowy continue to improve in Europe, the United Kingdom, and Japan. In this context, we remain open to adding new positions in internationa and goba portfoios whenever our fundamenta research uncovers compeing investment opportunities. Fixed income: Soid growth keeps Fed move on the tabe The recent and significant seoffs in asset markets around the word have raised concern that goba growth is weakening. Whie market deterioration is unsetting, we do not beieve the recent downturns portend a sowdown of growth in the United States. In our view, the U.S. economy is returning to a more norma expansion foowing years of positive but tepid growth. The nation s gross domestic product, the broadest measure of economic output, grew at a 3.9% seasonay adjusted annua rate in the second quarter, after a patry 0.6% pace in the first quarter. Unempoyment is at its owest eve since eary And recent data indicate that consumer spending, a major growth driver, is improving. Given what we see as a normaizing growth backdrop in the United States, we think poicy interest rates are too ow. Consequenty, we beieve the Federa Reserve is ikey to begin raising its target for short-term interest rates in the near future. In ight of our expectations for stronger growth and higher U.S. interest rates, we pan to continue de-emphasizing interest-rate risk by keeping portfoio durations beow those of their respective benchmark indexes. Additionay, we think the recent voatiity in risk assets has created attractive entry points in various market sectors. That said, we are aware that the goba macroeconomic environment remains highy uncertain and periods of voatiity are ikey. In the high-yied market, we beieve most issuers excuding those in more commodity-sensitive industries are in reasonaby good shape from a credit perspective. Marketpace iquidity has been constrained but not overy so, aowing us to accompish our trading objectives. With vauations more attractive foowing recent market turbuence, and an abundance of new high-yied issuance on the horizon, we continue to have a constructive outook for the asset cass overa. 5

6 Q Capita Markets Outook Tax exempt: Fed poicy sti the big question We see a compex macroeconomic environment that is ikey to contribute to heightened market voatiity for the foreseeabe future, as the Fed weighs its domestic poicy agenda against a backdrop of sowing growth abroad. With the 2016 campaign season in fu swing and the presidentia candidates better defining their poicy agendas, we are hearing chatter about individua and corporate tax reform and the eimination of some oophoes and tax deductions. We woud caution municipa bond investors from overreacting to discussions about changes to the tax code unti after the 2016 eection, when we wi better know if reform is to become a bona fide priority. As we have seen in previous instances, headines about isoated municipa credits can ead to investor overreaction and temporary price disocation. Such price action often resuts in investment opportunities. Commodities: No signs of price rebound Whie price momentum and ro yied, the most important quantitative signas for the broad commodity market, continue to ook negative, we somewhat temper that view with risk to the upside from recent eves. However, the suppy picture remains a concern. In the energy sector, suppy overhang and the perception of possiby more suppy coming on ine in 2016 have been the drivers of the doube-digit percentage fa in front-month crude oi futures. And whie rig counts in the United States have decined markedy, production has not responded as quicky. After three years of domestic crude output growing at over 17% per annum, we woud need to see a stronger suppy response or evidence of goba growth re-acceerating to become buish. Currency: Doar advantages ikey to persist Within active currency, our U.S. doar position is a sight overweight. The piars for U.S. doar strength are based upon reative GDP growth outperformance, the subsequent impications for the attractiveness of U.S. assets, and reative monetary poicy. U.S. rea yieds remained near the highest eves over the past severa years and shoud remain eevated. The U.S. growth story has stabiized at more moderate eves, but on a reative basis it is not the standout eader, as other major deveoped economies have seen improvement as we. In aggregate, this is a headwind to a rate hike by the Fed. When couped with a weaker infation outook, the timing of iftoff is ess certain and the path of rate hikes is ower than the Fed currenty expects. If the U.S. abor market, GDP growth, and core infation progress as we expect over the medium term, the market wi have to adjust its Fed outook and price a more aggressive path of rate increases. This shoud ift shortterm rates in the United States and continue to support the broad U.S. doar over the course of the coming year. The euro positioning remains a modest short, mainy versus the British pound. Growth in the eurozone has stabiized at modest eves, but forward-ooking indicators show no acceeration. At the atest meeting of the European Centra Bank (ECB), bank president Mario Draghi said it was too eary to te if renewed downside risks to growth woud ast, and he emphasized that the ECB coud ater the size, composition, and duration of its quantitative easing. Europe s ow nomina rates, couped with the ECB sovereign bond purchases and investors moving toward riskier assets, shoud contribute to driving capita out of Europe, providing a modest downtrend for the euro over the medium term. The British pound stering positioning is a sight ong. In the United Kingdom, growth eves remain soid, and whie infation and infation expectations have come down consideraby, they appear to have troughed. Additionay, abor market data are showing signs of wage pressure, which wi prompt the hawks on the Monetary Poicy Committee to start voicing the need for rate hikes in the coming meetings. However, U.K. poitics argue for waiting to move unti after the Fed does. We are modesty short the Japanese yen. Bank of Japan Governor Haruhiko Kuroda continues to argue that infation woud reach the 2% target around the first haf of fisca year 2016 without additiona easing. However, the ikeihood of achieving this target ooks quite ow. The recent shift in the U.S. doar China yuan currency regime adds further impetus for the Bank of Japan (BoJ) to take action, as the trade-weighted yen has now appreciated and Japan, much ike the United States, wi import coregoods disinfation from China. The timing and composition of the BoJ poicy change are quite hard to predict, but Kuroda has shown that he understands that the BoJ wi need to surprise the market in order to ease financia conditions by weakening the currency. If risks to growth persist, the ECB coud ater the size, composition, and duration of its quantitative easing. 6

7 PUTNAM INVESTMENTS putnam.com The Barcays Government Bond Index is an unmanaged index of U.S. Treasury and government agency bonds. The Barcays Municipa Bond Index is an unmanaged index of ong-term fixed-rate investment-grade tax-exempt bonds. The Barcays U.S. Aggregate Bond Index is an unmanaged index used as a genera measure of U.S. fixed-income securities. The Barcays U.S. Mortgage-Backed Securities (MBS) Index covers agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The BofA Merri Lynch U.S. 3-Month Treasury Bi Index consists of U.S. Treasury bis maturing in 90 days. The Citigroup Non-U.S. Word Government Bond Index is an unmanaged index generay considered to be representative of the word bond market excuding the United States. The Dow Jones Industria Average Index (DJIA) is an unmanaged index composed of 30 bue-chip stocks whose one binding simiarity is their hugeness each has saes per year that exceed $7 bi ion. The DJIA has been price-weighted since its inception on May 26, 1896, refects arge-cap companies representative of U.S. industry, and historicay has moved in tandem with other major market indexes such as the S&P 500. The JPMorgan Deveoped High Yied Index is an unmanaged index of high-yied fixed-income securities issued in deveoped countries. The JPMorgan Emerging Markets Goba Diversified Index is composed of U.S. doar-denominated Brady bonds, eurobonds, traded oans, and oca market debt instruments issued by sovereign and quasi-sovereign entities. The JPMorgan Goba High Yied Index is an unmanaged index of goba high-yied fixed-income securities. The MSCI EAFE Index is an unmanaged ist of equity securities from Europe and Austraasia, with a vaues expressed in U.S. doars. The MSCI Emerging Markets Index is a free-foat-adjusted market-capitaizationweighted index that is designed to measure equity market performance in the goba emerging markets. The MSCI Europe Index is an unmanaged ist of equity securities originating in any of 15 European countries, with a vaues expressed in U.S. doars. The MSCI Word Index is an unmanaged ist of securities from deveoped and emerging markets, with a vaues expressed in U.S. doars. The Nasdaq Composite Index is a widey recognized, market-capitaization-weighted index that is designed to represent the performance of Nasdaq securities and incudes over 3,000 stocks. The Russe 1000 Index is an unmanaged index of the 1,000 argest U.S. companies. The Russe 2000 Index is an unmanaged ist of common stocks that is frequenty used as a genera performance measure of U.S. stocks of sma and/or midsize companies. The Russe 3000 Growth Index is an unmanaged index of those companies in the broad-market Russe 3000 Index chosen for their growth orientation. The Russe 3000 Vaue Index is an unmanaged index of those companies in the broad-market Russe 3000 Index chosen for their vaue orientation. The S&P GSCI is a composite index of commodity sector returns that represents a broady diversified, uneveraged, ong-ony position in commodity futures. The S&P/LSTA Leveraged Loan Index (LLI) is an unmanaged index of U.S. everaged oans. The S&P 500 Index is an unmanaged ist of common stocks that is frequenty used as a genera measure of U.S. stock market performance. The Tokyo Stock Exchange Index (TOPIX) is a market-capitaization-weighted index of over 1,100 stocks traded in the Japanese market. You cannot invest directy in an index. 7

8 NOTES This materia is provided for imited purposes. It is not intended as an offer or soicitation for the purchase or sae of any financia instrument, or any Putnam product or strategy. References to specific asset casses and financia markets are for iustrative purposes ony and are not intended to be, and shoud not be interpreted as, recommendations or investment advice. The opinions expressed in this artice represent the current, good-faith views of the author(s) at the time of pubication. The views are provided for informationa purposes ony and are subject to change. This materia does not take into account any investor s particuar investment objectives, strategies, tax status, or investment horizon. Investors shoud consut a financia advisor for advice suited to their individua financia needs. Putnam Investments cannot guarantee the accuracy or competeness of any statements or data contained in the artice. Predictions, opinions, and other information contained in this artice are subject to change. Any forward-ooking statements speak ony as of the date they are made, and Putnam assumes no duty to update them. Forward-ooking statements are subject to numerous assumptions, risks, and uncertainties. Actua resuts coud differ materiay from those anticipated. Past performance is not a guarantee of future resuts. As with any investment, there is a potentia for profit as we as the possibiity of oss. Diversification does not guarantee a profit or ensure against oss. It is possibe to ose money in a diversified portfoio. Consider these risks before investing: Internationa investing invoves certain risks, such as currency fuctuations, economic instabiity, and poitica deveopments. Investments in sma and/or midsize companies increase the risk of greater price fuctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund s bond investments are ikey to fa if interest rates rise. Bond investments aso are subject to credit risk, which is the risk that the issuer of the bond may defaut on payment of interest or principa. Interest-rate risk is generay greater for onger-term bonds, and credit risk is generay greater for beow-investment-grade bonds, which may be considered specuative. Unike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yieds in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities invove the risks of changes in market, poitica, reguatory, and natura conditions. You can ose money by investing in a mutua fund. Market update putnam.com/markets Research putnam.com/perspectives putnam.com/white-papers Find us Investors shoud carefuy consider the investment objectives, risks, charges, and expenses of a fund before investing. For a prospectus, or a summary prospectus if avaiabe, containing this and other information for any Putnam fund or product, ca your financia representative or ca Putnam at Pease read the prospectus carefuy before investing. In the United States, mutua funds are distributed by Putnam Retai Management. putnam.com CM /15