AQUILA MONITOR December 2015 Independent, disciplined, transparent. And a touch more personal. Unabhängig, umfassend, unternehmerisch. Und eine Spur persönlicher. Contents: Executive Summary Macroeconomic Assessment Asset Classes Reference Portfolio
Executive Summary We are cautious in our growth outlook and forecast that the world economy will only grow by 3% in 2016 As we approach the year-end we have brought our equity allocation back down to neutral. The US economy is growing at a modest pace around 2% pa. The US yield curve is now rather flat. The Eurozone is also growing but only around 1.5% pa. At the shorter end, yield curves are shifting lower in both EUR and CHF. We expect US interest rates will be raised in December. The US dollar remains in an uptrend. The ECB is set to become even more expansionary. Gold is in a bear market. Indian equities, Nifty 50 index since 2012 India Indian financial markets have had high hopes for the reform plans of Mr. Modi s government. Initiatives have included a cut in corporate tax rates, measures to ease the path for inward investment from overseas as well as an aggressive infrastructure program. But the election ending at the start of November in the state of Bihar one of the most heavily populated states in India was an important test of the popularity of the government. Despite polling the most votes, Mr. Modi s BJP is generally considered to have lost the election. Indian GDP is growing at around 7% to 8% pa. Inflation has come down and the current account balance has improved. The Indian stock market accounts for just 0.8% of the MSCI World index. The market is thus relatively small. Also, direct investment in Indian stocks is expensive and cumbersome for overseas investors. The Indian stock market s estimated P/E ratio, based on earnings estimates for next year, is just under 17. This is relatively high, when compared with the US S&P 500 (just over 16) and the Eurostoxx 50 (around 14). Given this and the fact that the market s dividend yield at around 1.4% - is not particularly attractive, we are not investing in India. AQUILA MONITOR December 2015 2
Macroeconomic assessment: Business cycle/monetary policy PMI Heatmap: Emerging market economies are weak and in red 2015 Jan. Feb. Mrz. Apr. Mai Jun. Jul. Aug. Sep. Okt. Weltweit 53 54.1 55.2 54.8 54 53.6 54.1 54.6 53.3 53.7 Eurozone 51 51 52.2 52 52.2 52.5 52.4 52.3 52 52.3 Frankreich 49.3 52.2 51.5 50.6 52 53.3 51.5 50.2 51.9 52.6 Deutschland 53.5 53.8 55.4 54.1 52.6 53.7 53.7 55 54.1 54.2 Italien 51.2 51 52.4 53.9 53.7 54 53.5 55 53.4 53.9 Spanien 56.9 56 56.9 59.1 58.3 55.8 58.3 58.8 54.6 55 Schweiz 48.2 47.3 47.9 47.9 49.4 50 48.7 52.2 49.5 50.7 GB 49.1 56 55.7 53.7 52.5 52.5 53.1 49.6 52.2 54.2 USA 53.5 52.9 51.5 51.5 52.8 53.5 52.7 51.1 50.2 50.1 Japan 52.2 51.6 50.3 49.9 50.9 50.1 51.2 51.7 51 52.4 Eurozone USA Japan Brasilien 49.2 51.3 47 44.2 42.9 41 40.8 44.8 42.7 42.7 Russland 45.6 44.7 46.8 50.8 51.6 49.5 50.9 49.3 50.9 49 Indien 53.3 53.5 53.2 52.5 51.2 49.2 52 52.6 51.5 52.6 China 49.8 49.9 50.1 50.1 50.2 50.2 50 49.7 49.8 49.8 Südkorea 49.4 49.7 51 51.9 48.2 45.2 48.5 46.6 50.5 48.8 Taiwan 51.9 50 53 53.9 51.3 45.5 46.9 45.3 46.9 45.7 Source: Aquila ECB s balance sheet interventions since 2009, (Euro bn) 1st Buy program, covered bonds 3rd Buy program, covered bonds Buy program ABS bonds 1st Buy program government bonds 2nd Buy program, covered bonds Official Quantitative Easing Business Cycle: Positive signs but from a low level The US economy continues to give mixed signals. The third quarter GDP growth was 2.1% and for 2015 as a whole as well as for 2016 we expect a growth rate around 2%. There has been some good news on the political front. An increase in the debt ceiling has been agreed along with a Budget for 2016 which should boost the economy by around 0.3% next year. There now is a fair chance that Washington politics may not trouble the markets until at least the Spring of 2017. The Eurozone economy is on a rather modest growth path. But a November reading of 54.4 for the Eurozone PMI suggests that a slight acceleration is in prospect. We expect 1.5% growth for both 2015 and 2016. Overall, the world economy will probably have expanded by around 3% this year. The latest estimates of the IMF and the World Bank are, respectively, 3.1% and 2.9%. The IMF is forecasting 3.6% growth for the world economy in 2016 and the OECD a more modest 3.3%. With our 3% estimate, we are more conservative. The truth is that we find it hard to see what might cause an acceleration from the current growth rate. Monetary policy: Is the market being too dovish with its US rate outlook? AQUILA MONITOR December 2015 3 The Fed s FOMC forecasts Fed funds at 0.375%, 1.375% and 2.625% for, respectively, end-2015, end-2016 and end-2017. Market forecasts, as indicated by the Fed fund futures, are well below this trajectory. Particularly in 2016 and 2017 there is a wide gap between the expectations of the key people deciding US monetary policy and those of investors. Following the latest ECB press conference one assumes that Eurozone monetary policy will be shifted in the direction of more yet expansion this December. An extension of the ECB s QE program in terms of both the volume of bonds purchased and the duration of the program seems to have been decided. The statement that the ECB is prepared to use all available options could imply a move to make deposit rates more strongly negative or to scale negative rates according to the size of deposits. China s latest monetary policy easing move involved reductions in the key deposit rate from 1.75% to 1.5%, in the key lending rate from 4.6% to 4.35%, and in the commercial bank reserve ratio from 18% to 17.5%. This year China s monetary policy stance has become significantly more stimulative.
Asset Classes Equities/Bonds The major equity markets, performance year to date MSCI World Nikkei Eurostoxx S&P 500 SMI DAX MSCI Em. Mkts. US government bond yield curve, % Equities: trending higher Equity markets have continued to climb despite the recent terrible events in Paris and the escalation of the war in Syria. Fears that developments in China could lead to a sharp slowdown in the global economy appear to have dissipated. As a result, markets have able to look forward to the impending easing moves of the ECB, most likely to be announced this December. Investor sentiment measures show a definite improvement and there is talk of a Christmas rally. Positive factors for the equity market are valuations, which are in line with long-term averages, as well as dividend yields which look very attractive in the current low interest rate environment. With the major central banks continuing their policies of financial repression, equities look the most attractive of the major asset classes. But we don t see strong positive factors to boost equities further in coming months. Indeed, it looks to us as though equity market risk is rising. For this reason we have reduced our previous tactical overweight allocation to equities back to neutral. Bonds: US yields have hardly moved Despite the very strong likelihood of a US rate rise this December, and thus the start of an uptrend in the US interest rate cycle, the longer end of the US yield curve has hardly moved in recent weeks. Rather, the obvious rise in international tensions (Paris, Syria) has fueled a demand for the safety of US Treasuries, tending to push yields down. We assume that the Fed will be rather careful in moving US interest rates higher and that the longer end of the US yield curve may not be under much upward pressure as a result. In core European markets there are no signs of any rise in rates. Partly because of this, and also because of the ECB s substantial QE bond-buying program, large parts of Europe s bond markets are now posting negative yields. Finding attractive bond investments in this environment is a hard job. Schweiz USA UK Deutschland AQUILA MONITOR December 2015 4
Asset classes Currencies and other assets EUR/USD since 2006 FX: USD is moving up The number of analysts beating the drum for a stronger dollar has been rising. One argument being advanced is the prospective divergence of trends in monetary policy between the Fed on the one hand and the ECB and the Bank of Japan on the other. It looks as though the market is now positioned much the same way as the analysts something which should sound a note of caution. Also, it does not look as though the Fed will raise interest rates sharply next year. All that lobbying by big corporations in Washington may already have paid off in encouraging the Fed to take a cautious approach. In the end, one can only observe that the major currencies continue to compete to some extent so that they are weaker than the others. Competitive devaluation is seen as one way of boosting economic growth from uncomfortably low levels. Gold, US dollars per ounce since 2005 Other assets: A bear market in gold? Since mid-2012 gold looks to have been in a fairly well-defined downward trend. Prices are now setting new lows on a fairly regular basis and chartists point to the danger that gold will fall back down to $800 an ounce. But prices in the market for physical gold are being kept in check by the derivative markets, on which much larger volumes are traded. Most of the major investment banks now see further declines for gold and are offering products and strategies to reflect this view. In a way the gold price is the mirror image of the value of the US dollar, which is currently being boosted by expectations of higher US interest rates. Gold has probably not lost its status as a barometer of crisis something which suggests that developments in Syria and the related terrorist attacks in Paris are not being viewed by the markets as a serious crisis. It would probably take a massive erosion of the market s confidence in the power of central banks to rekindle a strong, sustained investor interest in gold. This possibility is why it is still sensible to keep a small position in gold in our portfolios on risk diversification grounds. AQUILA MONITOR December 2015 5
Aquila Reference Portfolio CHF Tactical Allocation Strategic Allocation Bandwidth prior month current Liquidity 6 10 10 5-15 Bonds 40 40 40 35-45 Governments 3 3 Corporates Investment Grade 24 19 40 High Yield 4 4 Emerging Markets 3 3 Various 6 11 Equities 44 40 40 35-50 Switzerland 11 11 10 Europe 13 12 10 North America 13 10 10 Japan 2 2 5 Emerging Markets 5 5 5 Other Investments 10 10 10 5-15 Gold 3 3 5 Real Estate 0 0 Private Equity 0 2 Hedge Funds & Alternatives 7 5 5 Total 100 100 100 AQUILA MONITOR December 2015 6
Disclaimer Produced by Investment Center Aquila & Co. AG The information and opinions contained in this document are based on sources that we consider to be reliable. Nevertheless, we cannot vouch either for the reliability or for the correctness or completeness of these sources. This information and these opinions constitute neither a request nor an offer or recommendation to buy or sell investment instruments or to conduct any other transactions. We strongly recommend that prospective investors consult their independent financial advisor before making decisions based on this document in order to ensure that their personal investment objectives, financial situation, individual needs and risk profile and any additional information provided in comprehensive advice are properly considered. AQUILA MONITOR December 2015 7