Imagining the Unimaginable

Transcription

1 4 Volume 7, Issue 4 Allianz Global Investors Insights April 2015 Global View Imagining the Unimaginable On 10 March, near the beginning of the European Central Bank s (ECB) bondbuying programme, Executive Board member Benoit Coeure made a noteworthy comment: More than half of Germany s outstanding debt had a negative yield to maturity. To some market-watchers, this statement would have been unimaginable a mere six months ago, and surely marked an epochal event that would be long-remembered. But to unwind the facts at hand from our reactions, let us take ourselves back to a time before 2007 both in expectation and mindset to test the limits of the markets collective imagination: The idea that the global financial system might collapse an event that very nearly occurred in the days after the collapse of Lehman Brothers, were it not for the swift decision by US authorities to allow the remaining broker-dealers access to US Federal Reserve (Fed) liquidity was simply inconceivable. The quantitative easing policies espoused by the Fed in the immediate aftermath of the great financial crisis were the stuff of textbook legend but, again, were unthinkable in the real world. The thought that the whole of the Organisation for Economic Co-operation and Development might lapse into a protracted period of disinflation and falling inflation expectations, despite monetary policy approaching the zero bound, was outside the imagination of all observers. With these milestones in mind, let us revisit Mr. Coeure s speech: Anyone who predicted two years ago that European Monetary Union (EMU) peripheral spreads would tighten beyond pre-emu crisis Andreas Utermann Global Chief Investment Officer levels and that European yield curves would trade within Japanese government bonds would have been dismissed as a fantasist or worse. Yet not only have these events occurred; they have happened more frequently than one could have previously imagined. (Cont. on page 2) 02 Heard at AllianzGI Taking the Market s Pulse on EM Debt 03 Viewpoint Productivity: An Understated Wellspring of Growth 04 Soundbites from Research Low Oil Prices Spur Energy Industry to Action 04 Perspective on Europe How Low Can Interest Rates Go in the Euro Zone?

2 Allianz Global Investors Insights Global View Do we then conclude from the current state that the world has become so unpredictable that we should give up on forecasting future events, and instead seek to pre-position ourselves for whatever comes? Quite to the contrary. We continue to face a range of previously unthinkable events that demand creative solutions, including the persistently high levels of overall debt that burdens most economies; the massive, 300- plus per cent level of gross domestic product (GDP) to debt in Japan; and the enormous imbalances within the global financial system, to name but a few. Moreover, the answers to these challenges will most likely lie outside the scope of conventional policy measures. History will be but a poor guide, and obvious black swans will likely not be as risky as they seem. Succeeding in this very challenging environment, where the most unimaginable events may unfold at unthinkable speeds, will require extraordinary and sustained agility a skill Allianz Global Investors is particularly focused at developing among its professionals. We believe that in the midst of these obstacles, opportunities abound, and we strive to have the courage, initiative and skill to help our clients take advantage of them during exceptional times in capital markets. Heard at AllianzGI Taking the Market s Pulse on EM Debt Every year, dealers and independent think tanks host emerging-market (EM) conferences covering sovereign debt, corporate credit and local currencies. Arguably, the most important conference judging by the EM corporate issuers and investors in attendance is held every February. With 300 global investors attending the most recent event in February 2015, our team was able to take the pulse of the market on a number of issues, both fundamental and technical. In general, we found that many people we spoke to agreed on a range of important issues: EM corporate debt has the potential to provide mid-single-digit US dollar (USD) returns in Flows have recently turned positive for the EM asset class, as the primary market has ground to a halt, while substantial coupon and principal repayments are being made by issuers. Unconstrained global managers generally prefer EM corporate debt at this stage. The primary market should slow in Latin America issuance is expected to decline due to lower capital expenditure needs resulting from lower commodity prices, and to idiosyncratic risks in Brazil. Issuance in Central and Eastern Europe is declining on the back of the Russia/Ukraine standoff, while Asia is likely to maintain its 2014 pace. Valuations in Russia and Brazil are extremely attractive but come with significant near-term idiosyncratic risks primarily geopolitical risks for Russia and political risks for Brazil. Argentina and Venezuela appear to be the two biggest sovereign risks in Latin America. Argentina s main risk is political, which may be mitigated after the October 2015 elections. Venezuela, hit by the oil price correction, is seen as vulnerable, but the Venezuelan government will muddle through 2015 to buy time. Russia s spreads are not expected to improve this year; investors expect credit default swaps to widen from February levels by the end of the year. Investors generally believe Ukraine may default on its debt before the end of Views on Brazil were mixed; many people we spoke to believe Brazil will be downgraded to junk before While China s growth is trending down, its economy is still not perceived as vulnerable to a hard-landing scenario, Greg Saichin CIO Global Emerging Markets Fixed Income despite pockets of instability. Our takeaways from this event ratify our sanguine views on the market, despite the ongoing volatility. From a general investment perspective, we believe not much has truly changed over the last three years. We live in an era of financial repression, now also supported by the new quantitative easing policy by the ECB. As a result, there are few compelling stories out there, and EM debt is one of them. It is an asset class that is valued attractively at a time when EM governments are enacting policies to reinforce solvency. 2

3 Viewpoint Productivity: An Understated Wellspring of Growth Allianz Global Investors Insights Throughout the post-great Recession period, many developed-market economies experienced real economic growth at rates well below their long-term trend line. Persistently disappointing cyclical expansion suggests that, perhaps, developed-market economies have entered a prolonged period of secular stagnation. During such periods, output and incomes barely increase, underutilization of resources persists and living standards sag. Sluggish gains in labour productivity (real output per paid hour of work) typically play an important role in secular stagnation. In the US, for example, labour productivity increased at a 1.2 per cent annual rate from the 2009 cyclical trough through By comparison, productivity growth averaged 2.5 per cent a year from and 1.7 per cent annually between 1975 and During the second half of the 20th century, especially, tepid productivity increases pushed up unit labour costs (the ratio of compensation per worker over productivity per worker) and exacerbated inflation. Real business profits declined, structural unemployment increased and the international competitiveness of domestic companies weakened. Yet the current weakness in labour productivity may have significantly less ominous implications for real economic growth and investment opportunities, particularly in the US and UK. Sharp increases in employment have dramatically increased the number of paid hours of work as businesses became more confident in the long-term economic outlook. Payroll expansion also has reflected a long-term decline in the cost of labour relative to the cost of capital, particularly among developed-market economies. Profit margins remain at, or near, record-high levels and inflation rates remain historically low. Elevated real profits enable businesses to buy back shares, increase dividend payouts, make profit-accretive acquisitions, invest in plants and equipment, and sustain large cash holdings. None of these outcomes resemble secular stagnation. Standard analyses view productivity from the supply side of the economy. As such, productivity is measured as a function of the quantity and quality of labour and capital, as well as the efficiency with which these inputs are combined to create output. However, in this context, headline productivity figures significantly understate improvements in economic well-being. Output-per-hour data fail to pick up changes in the composition and mix of output that lead to meaningful improvements in outcomes, rather than outputs. Consider each of the following examples: Advances in medical technology shorten and make more comfortable the recovery periods from surgery, returning workers to their jobs sooner and making them more productive. Satellite imaging reduces the number of drill rigs required to discover and extract oil. Solid-state electronics increase the life expectancy and durability of household electronics, lowering demand for replacement and repairs. Advanced inventory-tracking systems rationalize distribution channels and eliminate intermediaries that were previously needed to bring goods and services to market. The Internet and social media expand the reach and repetition of messages globally at minimal cost. The ability of customers to complete financial transactions, as well as book travel and entertainment, takes off the market many activities counted previously in GDP. Steve Malin, Ph.D. Investment Strategist More precise tools, scanning, mechanical drawings and sensors reduce material consumption and waste. Customization of production enables businesses to reduce planned levels of inventories. All of these advances reduce measured output the numerator of the productivity fraction while simultaneously improving outcomes. Continuing advances in technology promise to help businesses contain costs, boost profitability and improve standards of living around the world, even if official productivity data do not reflect these gains. The investment implications look promising. For instance, workplaces will be redesigned, creating new opportunities for architects, engineers and construction companies. Improvements in robotics promise to boost output in sectors such as national defense, agriculture and automobile production. Entire industries will take on a new look, as online education, medicine and finance become commonplace, and as entertainment distribution broadens to all types of mobile devices. To be sure, the diversion of otherwise productive investment toward cybersecurity, environmental protection, anti-crime and anti-terrorism measures and compliance with laws and regulations will put additional downward pressure on productivity gains. In the end, however, productivity will continue to be understated by official statistics and secular stagnation will remain a torch song only for pessimists. 3

4 Allianz Global Investors Insights Soundbites from Research Low Oil Prices Spur Energy Industry to Action Oil prices have shown unprecedented volatility in recent months. In particular, the Brent oil price peaked at USD 116 per barrel in June 2014, but by January 2015 had collapsed by more than 60 per cent, to USD 45 per barrel, despite a global economy that is still in growth mode. The initial months of this sell-off were driven by higher than expected supply growth from the US a trend highlighted in previous editions of this newsletter higher supply outside the US, demand concerns in emerging markets and a stronger US dollar. Then during its 27 November, 2014, meeting, the Organisation of Petroleum Exporting Countries (OPEC) did an abrupt about-face, changing its tactics to focus more on market share than price support. The market had grown accustomed to OPEC support over the past several years, and without it, the bottom fell out of oil prices, as negative sentiment and bearish technical charts took over. While we believe most of the damage to oil prices has been done, important considerations remain, including the additional supply risks arising from the uncertain future of Iran s oil exports and the continued, relentless surge of the US dollar. However, despite the recent bearish trend, the global energy industry is reacting with tremendous urgency to reduce supply. We have never seen the industry reduce capital expenditure intentions and drilling activity this fast. We expect a significant supply response to occur in the US by mid-2015, and believe US oil growth will flatten and go into decline by year end. International production will also be difficult beginning in Meanwhile, the collapse in oil prices is already stimulating an improvement in demand. Paul Strand Sector Head, US Resources As a result, we believe that current oil prices are too low, and expect prices to work higher over time as the market comes back into balance. We view the energy sector as an attractive investment at current levels for investors with a month time horizon. Perspective on Europe How Low Can Interest Rates Go in the Euro Zone? The ECB started buying up government bonds at the beginning of March 2015, with immediate and impressive results: a quick drop in yields, a tumbling euro, a flattening of yield curves and rising break-even inflation rates. Unsurprisingly, the arrival in the market of a new structural buyer for substantial sums is skewing supply and demand, thereby wiping out term premiums and risk premiums. But how far can yields fall? Addressing this question requires a novel approach. In fundamental terms, the current levels in euro-zone bond markets are unjustifiable. Technical flows are now, and will remain, the determining factors that explain the dynamics of price-setting. This loss of bearings goes along with an extreme level of risk for investors, as fixedincome portfolios have never been so vulnerable to the risk of a rise in interest rates. This rather particular environment looks set to persist for a long time and may become a new reality. Investors should nevertheless take heed: We are pre-empting returns, and this bow, which is being pulled back as far as it can go, may yet fire the arrows of tomorrow s crises and losses. Franck Dixmier CIO Fixed Income Europe 4

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