Thinking tactically: What really happens next?

Transcription

1 Thinking tactically: What really happens next? Guy Monson March 2015

2 Since 2008, Central bank asset purchases have successfully protected markets from an array of global risks... A SHARP INCREASE IN CENTRAL BANK BALANCE SHEETS Central bank assets as share of GDP, Jan 2008 = US Japan Euro UK Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Since 2009, Central banks have purchased $10.7 trillion of financial assets. Currently: ECB monthly purchase = 60bn BOJ monthly purchases = 6.6trillion yen ($58bn) Source: Macrobond 1

3 The winners have been bond and equity investors in a global Hunt for Yield. GLOBAL 10 YEAR BOND YIELDS GLOBAL EQUITY AND BOND MARKETS Economy Switzerland -1.13% Germany -0.24% Sweden -0.23% France -0.15% Negative 2 Year Bond Yields Source: Sarasin & Partners/MacroBond Source: Sarasin & Partners/MacroBond

4 Equity volatility has fallen despite rising geopolitical and cyber risks and sharp increases in oil volatility, EQUITY AND OIL VOLATILITY CYBER AND GEOPOLITICAL RISKS Source: Macrobond Source Bank of England Stability Report Nov

5 But can the gap between bond yields, interest rates and nominal growth remain this wide for much longer? US NOMINAL GDP, BOND YIELDS AND FED FUNDS RATE Source: Macrobond 4

6 In the UK the economy continues to improve despite the election, although UK assets have underperformed UK GROWTH PROSPECTS AND ELECTORAL OUTLOOK 1 year Equity Returns: Nikkei + 27%, Euro Stox + 14%, S&P %, FTSE % Source Bank of England/Economist Feb 2015/Elections etc, Trinity College Oxford. Returns 20 02/3 source Bloomberg 5

7 1.The European Crisis is starting to abate: The ECB has crossed the Rubicon with QE EUROPEAN INFLATION TO BE NEGATIVE FOR THE FORESEEABLE FUTURE Falling energy prices pull inflation into negative territory On 22 January 2015 the President of the European Central Bank, announced an 'expanded asset purchase programme': where 60 billion per month of euro-area bonds bought. The stimulus was planned to last until September 2016 at the earliest with a total QE of at least 1.1 trillion. Source: Macrobond 6

8 Greece: Private sector debt is now so limited that contagion risk from a managed default would be limited GREECE S DEBT BREAKDOWN GREEK DEBT COMPARED TO EUROZONE AVERAGE The average maturity of Europe's loans to Greece is 32 years (the last payment due in 2053). Greece pays about 1.5 percent on those loans - by comparison the UK Government s average debt duration is 10.9 Years & the average coupon 1.69% Source EuroStat, Bloomberg Source: EU Commission, EuroStat 7

9 European sentiment, led by Germany, is starting to climb Could this be like the UK in 2013 & animal sprits return? The German government closed fiscal year 2014 without posting any net borrowing for the first time since 1969 (ie with a balanced budget). The 2014 pay round brought employees an average year-onyear rise of 3.0%in their negotiated rates of pay. the highest for almost 20 years. It is remarkable how quickly and, in particular, how strongly economic growth in Germany picked up towards the end of last year Bundesbank Monthly Report February 2015/Bloomberg Source: Macrobond 8

10 2. The strong economies of the US & China have subsidised growth in the weak though a strong dollar/rmb US DOLLAR VS KEY CURRENCIES Source: Macrobond 9

11 3.The world has received a huge boost from lower oil prices and commodity prices WEAKER OIL AND METAL PRICES IMPROVE MARGINS LOWER PUMP PRICES BOOST CONSUMPTION Roughly $1.5 trillion p.a. transfer from oil producers to consumers Source: Macrobond Source: Macrobond 10

12 In Asia, the $220bn oil import bill will drop sharply, even as US shale oil/gas keeps flowing (even at these prices) ASIAN AND EM OIL IMPORT BILL BREAK EVEN FOR US SHALE PROJECT Source: Macrobond Source: HIS Energy 11

13 Global equities remain the strategic asset of choice INVESTMENT BACKDROP 1. While most Governments are still facing debt & deflation risks improving economic momentum means interest rate risk is re-emerging 2. Bond yields will trend higher as they start to price in a oil led simultaneous global recovery in world growth mid-year & rising European momentum 3. Lower oil prices are capping global inflation but the impact appears to be temporary. Political risk in Libya, Nigeria, Iraq and potentially Russia could limit further downside. 4. Equities still remain our asset of choice. Valuations risks appearing in the US - Global Equity income attractive. 5. Sterling risks are rising as BREXIT/Policy risks climbs in run up to UK election ( ). 12

14 What does this mean for financial markets? 13

15 Preparing for when Federal reserve starts raising interest rates PRIMARY DEALERS SURVEY ON US RATES If economic conditions continue to improve the committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Before then, the committee will change its forward guidance. Janet Yellen Senate Bank Committee Feb 2015 Source IMF, New York Fed Survey (% chance you attach to the timing of the first increase in Fed Funds) 14

16 And investors are gradually tuning in to a slow cycle of rising rates US & GERMAN 2 YEAR BOND YIELDS Source: Macrobond 15

17 The problem is that once policies tighten in the US, history tells us that there is usually a global response 5 EPISODES WHEN 10 YEAR US TREASURY RATES ROSE RAPIDLY Source IMF Direct Jan

18 And this holds risks for a world economy that still bears the debt scars of the Credit Crisis GLOBAL STOCK OF DEBT OUTSTANDING BY TYPE $ trillion, constant 2013 exchange rates DEBT BY SECTOR IN ADVANCED ECONOMIES (% OF GDP) Index: 100 =2000 Source Haver Analytics Source Haver Analytics 17

19 Key Risks 18

20 1. Watch for risks in High Yield Bonds CUMULATIVE FLOWS INTO HIGH YIELD BOND FUNDS CREDIT STERLING CREDIT SPREADS BBB A AA AAA AA and A have widened 14bp from low BBB widened 18bp No new GBP issuance in December Source: Bank of England Source: Macrobond 19

21 The appetite to warehouse corporate bonds in the event of a crisis is very modest globally US PRIMARY DEALERS CORPORATE BOND INVENTORIES Source: Bank of England/Federal Reserve Bank of New York./Dealer inventories represent US primary net dealer positions in US corporate bonds. 20

22 2. Caution in the global rush to buy what is now low yielding London residential property THE PROPORTION OF UK POSTCODES WITH POSITIVE HOUSE PRICE INFLATION(A) UK - NEW INSTRUCTIONS TO SELL AND BUYER ENQUIRIES(A) (a) Rising and falling inflation are determined by comparing current monthly inflation to the average rate of inflation in each postcode district during the past twelve months. (a) Data are for England and Wales, and show the percentage balance reporting an increase in new instructions to sell/new buyer enquiries over the past month less the percentage reporting reduced instructions/enquiries. Sources: Hometrack and Bank calculations. Source: Royal Institution of Chartered Surveyors (RICS). 21

23 How attractive is UK commercial real estate today if yields rise? YIELDS ON UK COMMERCIAL REAL ESTATE The proportion of commercial real estate transactions in London with yields below 5% (a) Source: The Property Archive and Bank calculations 22

24 3. US equity valuations rising & when to buy China State Owned Enterprises (SOE) US VALUATION RISKS ARE RISING DOES CHINA OFFER A VALUE ALTERNATIVE? Source: Macrobond Source: Macrobond 23

25 4. The global corporate tax - a fair tax rate will need to be assessed in company earnings RECORD LEVELS OF PROFITABILITY EXTRAORDINARY VARIATIONS IN TAX RATES Source: US Federal Bank of St Louis Source: Organisation for Economic Corporation and Development 24

26 And for the long term investor, could bank dividends be a safe haven from higher rates. BANKS HAVE BECOME MUCH HEALTHIER AND DIVIDEND GROWTH COULD BE IMPRESSIVE Note: Sarasin ESG team are aiming to improve transparency over distributable reserves (FT 16.2) 25

27 Global equities remain the strategic asset of choice PORTFOLIO POLICY Bonds Underweight: Shorter duration in UK and US, and caution global high yield Equities Overweight: Global equity earnings yields compelling vs other asset classes, but US valuations high if bonds yields rise. Don t chase US benchmark and consider portfolio insurance. EM Equity Oil consumers & Reformers attractive (China, India and Indonesia) Look for beneficiaries of slowly rising rates including Bank Equity, Insurance. Alternatives: Infrastructure & Global Property Risks: High yield credit London Real Estate US Valuations Global corporate tax agenda & earnings 26

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