Oil-Price Drop Boosts Growth, Especially in Europe

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1 3 Volume 7, Issue 3 Allianz Global Investors Insights March 2015 Global View Oil-Price Drop Boosts Growth, Especially in Europe The oil price has roughly halved since last summer. Which markets will benefit from this development, and which ones will suffer? At first sight, the answer seems to be trivial: Countries that are net importers of oil notably the US, Europe and Japan will benefit, as a declining oil price is akin to a cut in indirect taxes and an increase in real disposable income, while net exporters will suffer due to slower oil revenues. The oil-price decline is, so to speak, a reallocation of wealth from oil exporters to importers. This is not to say that it is a zero-sum game for the global economy: As the combined size of net oil-exporting economies is small relative to the ones of net importers, the world economy is expected to benefit. However, the real answer is a bit more complicated. It is not only the oil-price decline per se that matters, but also the reason behind the decline: Did the oil price come down primarily because of a positive supply shock which would be good for global growth or is it merely reflecting weak global demand in the first place? If it is the latter, a weaker oil price would still lift the growth outlook, but only relative to a lowered base-case scenario. We believe that both supply and demand factors are relevant at this juncture. Oil production outside OPEC, which accounts for around 60 per cent of the world s oil production, has been constantly rising and is up around three million barrels per day compared with Stefan Hofrichter Chief Economist 2010 levels very much reflecting the increase in shale-oil production in the US over the same time period. On the other side, we have also noticed a significant decline in various other commodity prices, notably copper, which is still perceived to be and rightly so a litmus test for global growth. This broad-based decline in commodity (Cont. on page 2) 02 Perspective on Asia Pacific Asian High-Yield Bond Outlook 03 Viewpoint Innovation and Regulatory Changes Bode Well for Biotech 05 Grassroots SM Research Digitalization Is Shifting Investor Behavior and Preferences

2 Global View prices also continues to mirror the decline in China s growth rates, which have roughly halved in nominal terms since the beginning of this decade and are now approximately 8 per cent. Nevertheless, based on our own research and that of third parties, including the International Monetary Fund, we have come to the conclusion that supply factors dominate and probably explain about two-thirds of the oil-price decline, while demand factors only account for around one-third. Under this assumption, global GDP growth could still be around one-third of one percentage point higher two years from now even if the oil price gradually reverts to the levels of last year and could conceivably be up by more than this if the oil price stays at current levels. Of course, the actual impact on growth also depends on private-sector spending patterns: Will higher disposable income ultimately end up in higher private-sector spending, or show up in higher savings rates? The evidence so far points to higher spending in the US, Europe and Japan. For Europe, this tailwind comes exactly at the time when its economy is receiving additional support from a weaker currency, following the announcement of quantitative easing by the European Central Bank in late January. Hence, European growth, in particular, could surprise on the positive side this year. That would clearly provide support for risk assets in the region. Perspective on Asia Pacific Asian High-Yield Bond Outlook Asian high-yield credits underperformed the broader Asian credit market in 2014, with most of the underperformance coming in the final quarter. However, the sector still returned a respectable 6.1 per cent in US dollar terms for Asian high-yield credits sold off as investors became concerned over idiosyncratic risk in the Chinese property sector, as well as concerned over the impact of low oil and commodity prices on the oil & gas and coal mining sectors particularly in China and Indonesia. As a result, spreads widened to levels not seen in two years. Yet since the end of January, Asian highyield credits have rebounded steadily thanks to investor sentiment boosted by the European Central Bank s quantitative easing program; by the oil-price reversal after a prolonged sell-off; and by a number of central-bank rate cuts in Asia. This has allowed volatility to subside, and allowed a renewed risk appetite to return to the Asian credit market. Looking ahead, we expect volatility to remain a feature of Asian credit markets in However, with volatility comes opportunity, and we believe there are now some interesting opportunities in selective Indonesian and Indian highyield corporate names. Chinese issuers are also showing good value, with credit spreads in some sectors now trading at levels wider than what their credit ratings would entail. Overall, Asian highyield credits still offer an attractive yield pick-up (see accompanying chart) in today s environment of low global interest rates. While we have seen an increase in leverage and some weakening of debt-servicing capabilities of Asian high-yield issuers in general, we believe the sector should remain supported by still-reasonable levels of liquidity which we define as cash levels at more than Yield Comparisons of Asian vs. US Issues 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Indonesia (Avg: BB-) China (Avg: BB-) India (Avg: BB) David Tan CIO Fixed Income Asia Pacific 30 per cent of total debt, on average. As we stay cognizant of the more volatile environment, bottom-up, fundamental security selection and active management will remain key features of our investment approach. US High Yield (BB) US High Yield (B) Source: J.P. Morgan as at 27 February Yield is based on yield to worst (YTW). Yields for Asian countries are based on J.P. Morgan CEMBI Broad High Yield Country Indices. US yields are based on J.P. Morgan US High Yield Indices. 2

3 Viewpoint Innovation and Regulatory Changes Bode Well for Biotech Leadership Trends Global equity markets have gradually recovered since the depths of the global financial crisis, and many broad market indexes have reached new all-time highs. A major player in this development has been the biotechnology sector, as the accompanying table shows. Biotechnology stocks posted a 34 per cent gain in 2014, which comes on the heels of a striking, multi-year string of outperformance that began in Granted, this period of excellence has not been without some heartrending corrections, as biotech stocks lost nearly 20 per cent in the first half of last year, before regaining their ascent in late April. Based on this information, one might wonder if biotech stocks have entered bubble territory. Given the relatively recent burst of the dot-com bubble, it is easy to understand how one may draw certain parallels. Biotech s Starring Role From our perspective, however, while we expect to see continued volatility in the biotech sector, we do not believe we are in a bubble. There have been many factors driving the impressive performance in biotech. In particular, one critical and fundamental strength that differentiates biotech from other industries has been its impressive earnings. Looking forward, there are significant positive developments that bode well for the industry s profitability and earnings outlook, which in turn should also provide valuation support. Specifically, these developments include new product approvals, innovation and regulatory changes. Innovation and Regulation The biopharmaceutical industry is experiencing a convergence of two key long-term drivers: innovation and regulatory changes. With respect to innovation, the Human Genome Project was initiated in 1990 and completed in 2003 at a cost of more than USD 3 billion. The objective was to Market Index 2014 Return 2013 Return NASDAQ 14.8% 40.2% S&P % 32.4% Nikkei 225 (Japan) 9.0% 59.4% Russell % 38.8% DAX (Germany) 2.7% 25.5% CAC 40 (France) 2.4% 22.4% FTSE 100 (UK) 1.0% 19.1% US Health Care Sector 25.3% 41.5% NASDAQ Biotechnology 34.4% 66.0% John Schroer Sector Head of Health Care determine the sequence of chemical base pairs that make up human DNA, and to identify and map all of the genes of the human genome. We would argue that the overall benefits to society from this massive, collaborative project are only now beginning to be realized, and that they will continue. With the ability to sequence the human genome and with the assistance of better, faster and cheaper computing power biotechnology firms are unlocking more of the mysteries about underlying causes of diseases. This continuing innovation holds the potential to revolutionize the way patients are diagnosed and treated. For example, drug trials are often based around genotypes (underlying genetic properties) rather than phenotypes (observed traits). Large trials across broad populations are being replaced with trials focused on genetic diagnostics or biomarkers. Although the treated populations may be smaller, the greater efficacy allows for higher pricing. Working in conjunction with this series of advances in medical technologies are a host of new regulatory changes. Traditionally, development programs for most new products have been, unfortunately, long and expensive. However, recent legislation guiding the US Food and Drug Administration has Source: Bloomberg as at 31 December Total return figures are in local currency. (Cont. on page 4) 3

4 Viewpoint provided faster approval pathways for products designated as breakthrough therapies. As shown in the accompanying graphic, this dramatically shortens development timelines for innovative products and speeds the availability of innovative therapies for patients. Despite the spectacular returns we have seen thus far with price-to-earnings and price-to-sales ratios that are, on average, above historical norms we do not see a bubble, but rather an industry that is benefitting from a range of factors: an innovative collection of companies that are applying new tools with increasing agility, harvested from information discovery and sums invested over prior decades; It is important to note that biotechnology stocks tend to be more volatile than those in other areas of health care, such as larger pharmaceutical companies, hospitals, managed care and medical devices. In addition, biotech will be subject to pullbacks and rapid shifts in market sentiment, and if the broad market undergoes a correction, biotech stocks may well fall by a materially greater amount. Therapeutics Are Driven by Innovation and Regulation Innovation Genomics However, there are long-term secular developments at play that will profoundly change the way patients seek treatment for debilitating conditions. As therapeutics and biotechnology companies compete to meet the demand for new treatments, they will likely continue to reward investors that have long-term time horizons. Regulatory Changes Precription Drug User Fee Act V a regulatory framework that is shortening timelines and reducing the total overall cost of drug development for innovative products; Better Patient Selection Breakthrough Therapy Designation strong expected revenue and earnings growth; and a growing patient population in developed as well as developing economies. Targeted Therapeutics Shortened Development Time Lower Cost Increased Return on Investment Source: Allianz Global Investors. 4

5 Grassroots SM Research Digitalization Is Shifting Investor Behavior and Preferences Grassroots SM Research recently assessed consumer behavior in relation to increasing digitalization in the asset management industry in Germany and the UK. Among the more than 600 respondents surveyed, wealth accumulation in Germany and retirement planning in the UK were the top considerations for saving and investing. Study results also revealed that about three fourths of the respondents in Germany and slightly more in the UK check their online trading accounts at least once per week, or even daily. In addition, both German and UK investors indicated that their securities accounts websites are among their most important tools for investment research. Online investors in Germany are mixed as to whether they should spend more time working on their portfolios, while slightly more than two-thirds of UK investors surveyed believe they need to devote more time on their portfolios. And whereas considerations and motivations for saving and investing such as real estate, expensive purchases, wealth accumulation, retirement planning, etc. can vary between the regions surveyed, most respondents in the UK and almost all in Germany prefer tailor-made investment solutions. Johanes Jacobi European Grassroots SM Research Analyst Customized investment products increase customer loyalty, said Allianz Global Investors Portfolio Manager Thomas Orthen, who requested this research and works out of the firm s Frankfurt office. This effect is reinforced when customers are engaged in their investment products via easily accessible digital touchpoints. About Allianz Global Investors Understand. Act. This two-word philosophy is at the core of what we do. To stand out as the investment partner our clients trust, we listen closely to understand their needs, then act decisively to deliver solutions. 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