House View Commitee - SEB Group · 2016-06-10 · outlook, stretched valuations, heightened geopolitical risk, and weakening tactical and strategic growth momentum are the primary

House View June 2016

Slide 2

Summary

- The level of risk utilization is maintained at 40%

- Discrepancy between implied EPS growth and our economic outlook, stretched valuations, heightened geopolitical risk, and weakening tactical and strategic growth momentum are the primary arguments for the cautious stance towards risk

- PMIs have fallen for two consecutive months

- Increasing the likelihood that we are still in the manufacturing recession which began in 2015

- The weak job report of May (including downward revisions to April) combined with the decline in PMI employment components increases the uncertainty about the strategic growth outlook

- Signs of slowing employment, however volatile, are important in this late stage of the business cycle

- Equity markets are priced for a more significant pickup in growth than what leading indicators are signaling

- The combined 2016 and 2017 implied EPS growth seems exceedingly optimistic given the uncertain growth outlook and still elevated margins in the US

- The downside risk of the upcoming BREXIT vote and the Spanish election outweighs the potential upside

- The base case is that Britain will remain in the EU but the likelihood has decreased in late May and early June

- The low level of risk utilization does not reflect a view of an imminent recession

- The markets will remain range bound for some quarters to come and we could as such move higher in risk utilization once again

40%

Slide 3

-20% 0% 20% 40% 60%

Cash

Commodities

Emerging Market Debt

High Yield Bonds

Investment Grade

Equities

Government Bonds

Hedge Funds

Allocation

Strategicallocation

Diff

Multi Asset Model Portfolio

Model Portfolio - The model portfolio is underweight equities, commodities, and Emerging Market debt compared to the strategic allocation

- The low allocation towards equities is the largest relative position in terms of weight and tracking error (compared to the strategic allocation)

- The relatively high allocation towards government bonds is a consequence of the risk reductions that have been implemented gradually ever since November 2015

- It is maintained at a high level given a lack of attractive alternatives in terms of risk adjusted returns and liquidity

- In case of an increase in risk utilization the allocation towards government bonds would likely finance it

- The model portfolio remains overweight credit

- It is unlikely that this position will be increased over the coming months/quarters unless pricing of the asset class turns considerably more favorable

- Caution is warranted in regard to increasing exposure towards relatively illiquid asset classes at this late stage of the business cycle

- Credit conditions are tightened within the US

- In isolation a large negative factor for credit spreads

- Despite tightening credit conditions and poor liquidity the overweight is maintained as credits remains the only major asset class to offer a decent yield to the portfolio

- The allocation towards commodities was lifted in April given a more balanced outlook for supply/demand of oil

Long only portfolio. Yearly VaR(95%) ex. mean between 4% and 16%. No restrictions on the individual asset classes. The weights are set manually by the House View committee; i.e. they are not based upon an optimization model.

Source: SEB

Slide 4

Multi Asset Class Risk and Return Estimates

Source: SEB

Global Equities EM Equities

Government Bonds

High Yield

Investment Grade

EMD LC

Hedge Funds

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

0% 5% 10% 15% 20%

E(R

)

Risk

Slide 5

-6% -4% -2% 0% 2% 4%

North America

Europe

Japan

Sweden

East Asia ex. Japan

EM Asia

EM Ex. Asia

Change

New

Old

Equity Model Portfolio (Pure)

Relative positioning - The model portfolio remains underweight Emerging Markets and overweight Developed Markets

- Asia remains the preferred region within Emerging Markets

- The earnings outlook for Asia is stronger than that of LatAm

- The geopolitical risk of LatAm remains highly elevated

- Macroeconomic momentum is stronger and more stable for Asia than that of LatAm

- EPS revisions are currently a more positive factor for EM Asia than for LatAm

- There is no explicit view between Europe and the US

- The outlook for earnings in Europe is looking stronger than for the US

- Lower current and future margin pressure

- Increased leverage to a stabilization in global and Emerging Market growth

- Less stretched valuations

- However the geopolitical risk for Europe remains highly elevated

- The BREXIT vote and the upcoming Spanish election mitigates the brighter earnings outlook

- The model portfolio remains neutral towards Japan

- Faltering growth and inflation combined with a strengthening Yen lifts the likelihood for increased stimulus over the coming months

- However it is not recommended to allocate towards Japan before the Yen starts to weaken once more

Source: SEB

Slide 6

Equity Risk and Return Estimates (12M Forward P/E)

Source: SEB and Bloomberg

China (11.4)Europe (14.0)

Sweden (15.3)

DM (17.1)Japan (16.5)EM (12.7)

US (17.9)

LatAm (15.1)

-1%

1%

3%

5%

7%

9%

11%

10% 12% 14% 16% 18% 20% 22% 24% 26% 28%

Ret

urn

Risk

Slide 7

Fixed Income Model Portfolio (Pure)

- Duration:

- We remain short duration

- FED will continue the process of normalizing US interest rates

- We believe that the market will have to reprice the FED rate hike cycle

- ECB and the Riksbank will keep conditions as easy as needed to promote inflation moving towards their targets

- We do not expect to see further rate cuts by the ECB

- Credits in general

- We stay neutral to credits in a pure fixed income context

- We regard the outlook for credits, in the near term, to be balanced

- The market is still supported by expansionary monetary policy but the business cycle is becoming mature

- Strategically we are still concerned about the outlook for credits which we regard being stuck between two relatively negative scenarios

- In case growth remains stable we expect to see further rate hikes by the FED which in our view will be credit negative

- If we are wrong about FED tightening this will most likely be due to a significant deterioration in the growth outlook, which again will be credit negative

Recommended duration allocation

Source: SEB

Macro and the markets June 2016

Slide 9

Developments in the Markets

- As an illustration of the high cross asset interdependence in the markets all asset classes delivered positive returns following the House View meeting of May

- Commodities delivered the highest return of all major asset classes

- Driven by significant gains in Energy and Agriculture

- On an aggregated level the markets remain driven by the FED and expectations towards the FED rate hike cycle

- However the EM space has started to diverge from the trend of 2015 and early 2016 by posting gains up through late May despite a rising implied probability of a summer rate hike

- With the small caveat that the negative correlation between the probability of an imminent rate hike and EM asset performance reemerged during the early part of June where a weak job report and a dovish Yellen reduced the likelihood of a June/July rate hike and thereby lifted EM asset prices

- Rising 12M Forward EPS estimates have mitigated (in terms of multiples) some of the price increases that we have seen in global equity markets

- However global equities continue to trade at levels that have only been surpassed in the early parts of 2015 and during the IT-bubble

- EPS revisions remain negative for global equities on aggregate

- The positive revisions to the Energy sector being mitigated by negative revisions in close to all other sector

- 12M Forward EPS estimates are only going up as 2017 numbers are becoming more dominant

Positive EPS revisions for the Energy sector mitigates downward revisions of other sectors

Equities are once more trading at very high multiples

Source: Bloomberg and SEB

Source: Bloomberg

01-1402-1

403-14

04-1405-1

4

06-1407-

1408-1

409-1

410

-1411

-1412

-1401-1

502-1

503-15

04-1505-1

506-1

507-

1508-1

509-1

510

-1511

-1512

-15

01-1602-1

603-16

04-1605-1

6

06-1606-1

6-4

-3

-2

-1

0

1

2

Con

trib

utio

n to

1M

EP

S re

visi

ons,

%-p

oint

s

Energy

All other sectors combined

Slide 10

Economy Developed Markets

- The outlook for global growth remains blurred

- Leading and tactical indicators continues to point towards weak growth

- The US housing market has started to improve

- The US labour market is showing conflicting signs with falling employment growth not being mirrored by rising Initial Jobless Claims

- Manufacturing growth momentum, as measured by the Markits PMIs, fell back in May

- Increasing the likelihood that some factor(s) beyond inventories and energy sector CAPEX is/are hampering manufacturing growth

- Inventories and falling energy sector CAPEX (due to falling oil prices) were by many analysts used to explain the manufacturing decline which took hold in 2015

- The weakness of the manufacturing sector seemed to spread to the previously more stable service sector in May

- The main macro print since the last House View meeting was the job report for May

- The job report was in close to all aspects a disappointment

- The growth in employment was the weakest in years

- Confirmed by falling employment components of the PMIs

- The rising wage growth in isolation puts pressure on the FED to hike rates

- The weakness of the job report has yet to be confirmed by the more timely and leading Initial Jobless Claims

The weak job report of May was confirmed by the PMIs

Global manufacturing momentum continues to falter

Source: Macrobond

Source: Macrobond

Slide 11

Economy Asia and Emerging Markets

- Despite a rising probability of a summer rate hike during late May EM assets continue to perform

- Reversing the trend of 2015 and the early part of 2016

- The increased resilience towards tightening US monetary policy is driven by a stabilization in the growth outlook for EM in general and EM Asia in particular

- A stabilization in the sense that the likelihood for a significant EM recession has fallen

- Tactical growth momentum remains weak (as for DM)

- We note that we have seen improving current account deficits for Brazil and Turkey over the last couple of quarters

- The two countries which over the past couple of years have been the most exposed to a tightening of the US monetary policy

- As for DM we saw a continued slowdown in manufacturing momentum for Emerging Markets in May

- The decline was most pronounced for China where we saw a decline in the traditional growth components

- The Li Ke Quiang index as such fell back to 4% after a brief period of gains in March and April

- Without getting the same focus as during January we saw a fall in the Yuan against the USD in May

- On the margin we saw a small improvement in trade of the EM Asia space in May (excluding China)

- Giving support to the strategic growth outlook for the region

Current account deficits are improving for Brazil and Turkey

Yuan weakened against the USD in May but gained little focus Source: Macrobond

Source: Macrobond

In Focus June 2016

Slide 13

In Focus #1: Brexit proposed strategy

A stay is most likely, for now

– The stay voters are mostly young, well educated etc., they have smallest participation in elections, will be mobilized.

– The consequences of a leave is too hard to estimate.

– Risk of loosing investments and jobs is a reality.

– The expected reactions from Europe of a no is hard to estimate a risk.

Markets today our strategy

– Markets are priced according to the likelihood expressed in betting a stay.

– The only risk premia in the markets is the pound, positive trend after the outcome.

– Equity markets have no obvious risk preemie, a stay is a non event.

– Yields are priced according to the FED.

A leave is negative for all

– A no outcome adds an uncertainty preemie, everywhere.

– The USD will strengthen and Euro and GBP weaken.

– US SPX does not need a stronger USD, will dent earnings.

– Uncertainty will immediately affect investments and probably affect growth negatively.

– Political consequences in Europe risk tilting to the anti growth nationalistic side.

– Immediate risk off.

The Pound

Equities are priced for a stay

A no is a rural

elderly vote

Political consequences

of a no

Markets follow the

odds

Exit negotiations

Asset Class Views June 2016

Slide 15

Shor

t rat

es

Long

rate

s

Cre

dit c

ondi

tions

Mac

ro

EPS

mom

entu

...

-0.02

-0.01

0

0.01

0.02

0.03

0.04

0.05

Cha

nge

in s

igna

l

Developed Market Equities 12M Outlook

- We expect that Developed Market equities will be the best performing asset class over the coming 12 months

- Although we expect that the aggregated return will be lower than the historical average

- Gains in global equities will be driven by EPS growth

- As the potential for further multiple expansion is exhausted

- Over the coming 12 months we expect to see earnings growth for MSCI World in the vicinity of 4-7%

- Primarily driven by rising earnings in Europe

- Earnings growth will be supported by the following factors

- Leverage remains low for large cap equities

- With low financing cost we expect leverage to increase

- Thereby lowering the requirement of top line growth

- Buy-backs will continue to support EPS growth as it has done ever since the financial crisis

- The recovery in oil prices will improve earnings for the energy sector compared to the last couple of year

- We expect that the positive factors for earnings will outweigh the negatives (which are still present)

- US margins will continue to decline due to rising labor costs

- We note that implied EPS growth estimates still exceeds our targets

- We are as such expecting to see negative revisions to 2017 EPS estimates (both for Europe and the US)

We expect to see EPS growth in the US but 2017 estimates still have to come down

Source: Bloomberg

Our proprietary quant model for equities remains positive. Supported primarily by EPS revisions (which have stabilized)

Source: SEB

2012

2013

2014

2015

2016

2017

2018

Jan13 Jan14 Jan15 Jan16-2

0

2

4

6

8

10

12

14

16

Esti

mat

ed E

PS

Gro

wth

Slide 16

2012

2013

2014

2015

2016

20172018

Jan13 Jan14 Jan15 Jan16-15

-10

-5

0

5

10

15

20

25

30

Esti

mat

ed E

PS

Gro

wth

Emerging Market Equities 12M Outlook

- We expect that Emerging Market equities will deliver a positive return over the coming 12 months

- A return similar to Developed Market equities albeit with higher volatility

- In contrast to Developed Market equities we see scope for multiple expansion

- As the uncertain outlook around EM growth and outflows over the latter years have depressed (relative) valuations

- Multiple expansion will however first be a factor to recon with once the macroeconomic outlook has stabilized further

- Similar to the Developed Market equities we expect to see relatively strong EPS growth for the EM space

- As sentiment towards EM equities remains muted we do not believe that this EPS growth is fully priced in

- We have previously stated that EPS estimates for the EM universe would have to be revised lower

- However as growth seems to be consolidating we have lowered our conviction in this view

- Despite our positive strategic stance we stress that the tactical risks for the asset class are elevated

- We believe that EM equities and EM FX will come under pressure once the markets start to price in more rate hikes by the FED

- Which will lead to USD strength

- We are furthermore concerned about the geopolitical risks of the universe

We see scope for multiple expansion in EM

Source: Macrobond

The negative trend in EM Asia EPS estimates has been broken

Source: Bloomberg

Slide 17

High Yield Bonds 12M Outlook

- We expect that global High Yield bonds will outperform Investment Grade and Government bonds over the coming 12 months

- Structural factors which historically have been supportive for the asset class are still in place

- The growth outlook remains stable

- Albeit not exuberant

- The global hunt for yield is still alive

- As such we still expect investors to move from higher rated bonds and into High Yield

- On a sector like for like basis

- Credit conditions are improving in Europe

- For Europe the funding costs are declining rapidly

- We expect that ECBs expanded QE program will have a positive spillover effect on the European High Yield market

- We recommend having an overweight to global High Yield in a multi asset portfolio

- The stabilization in commodity prices have on the margin reduced some of the pressure on the asset class

- High Yield remains the asset class which has been most priced for a recession/negative scenario

- Even with the latest spread tightening we view High Yield as attractive compared to equities

- Given the high valuations of equities

- Our primary cause for concern of the asset class is the tightening of credit conditions in the US

Credit conditions are getting tightened in the US

Our fair value model predicts further spread tightening

Source: Macrobond

Source: Macrobond

Slide 18

Investment Grade Bonds 12M Outlook

- We expect to see further spread tightening for global Investment Grade bonds

- The recession risk for the US economy has resided

- The market remains in the process of pricing in the upcoming ECB purchases

- In isolation several factors are supporting Investment Grade spreads

- QE by the ECB should help to reduce spreads even further

- Making the asset class interesting in a pure fixed income perspective

- We are presently seeing inflows to the asset class

- The economic environment remains stable

- With improving credit conditions for Europe

- Given that absolute spread levels remains low it is still not an asset class on which we expect to earn significant positive returns

- And we are seeing better value in High Yield

- But following the ECB meeting we do expect to see a significant tightening of spreads

- In Europe due to a lower yield on Investment Grade

- In the US due to higher government bond yields

Albeit the absolute return potential remains moderate we expect spreads to tighten on the back of ECB

Source: Macrobond

Slide 19

Core Government Bonds 12M Outlook

- We expect to see global yields move higher over the coming 12 months

- Primarily for the US

- We expect that US inflation both core and headline will rise over the coming months

- The deflationary pressure from commodity prices will start to leave the headline index

- Wages will continue to rise

- The unemployment rate is firmly below most NAIRU estimates

- Soft data indicators continue to point towards higher wages

- Albeit they have moderated as of late

- The participation rate has started to rise, but we do not expect that this in itself will be enough to mitigate the shortages in the US labour market

- We note that wages for people already in occupation is rising faster than the aggregated number

- We stress that rising inflation will be an issue for the US and not for Europe

- The latter still has a significant output gap

- The recent strength in the EUR will on the tactical horizon lead to lower headline inflation

Wage inflation is on the rise for people in jobs

Source: Macrobond

Soft data indicators point towards more wage inflation

Slide 20

Commodities 12M Outlook

- The allocation towards commodities was increased in late April following a more positive view on the asset class

- This as we seem to have exited the market environment in which the USD was the primary driver behind commodity prices in general and oil prices in particular

- As such we have seen a normalization of the USD sensitivity of oil prices

- A sensitivity which was severely stretched in the early part of 2016

- The reduced sensitivity to the USD has increased the dependence on fundamentals and flows

- The latter has started to turn supportive over the past couple of months

- We stress that sentiment towards commodities remains muted and we expect to se further inflows into the asset class over the coming months

- The former has for a long time looked more favorable

- With US oil production continuing to decline as a function of a decreased number of active oil rigs

- EIA expects global demand to overtake production in the early part of 2017

- In a broader context we expect that the tentative signs of improving industrial production and construction in China will continue to support the broad commodity space

The negative correlation between the USD and oil prices has started to reside gradually. Flows continue to drive prices.

Source: SEB

2009 2010 2011 2012 2013 2014 2015 2016-4

-3

-2

-1

0

1

2

3

4

Nor

mal

ized

Bet

a co

effi

cien

t

USD

Rig Count

Net-Speculative position

Risk environment June 2016

Slide 22

Online survey 45%

Phone 40%

Betting Odds 33%

Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul15

20

25

30

35

40

45

Leav

e th

e EU

Online survey 45%

Phone 40%

Betting Odds 33%

-0.22%

1992 1995 1997 2000 2002 2005 2007 2010 2012 2015 2017

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

6M

cha

nge

in t

emp

empl

oym

ent

Risk Environment

- The most prominent short term risk is that of a BREXIT

- The likelihood of which has increased over the later part of May and the early part of June

- We view the implied betting odds as being the best predictor and as such we remain of the view that the most likely outcome is for Britain to remain in the EU

- We expect that the short term market impact of a BREXIT will be short lived

- As such we expect to see falling equity markets being quickly viewed as a buying opportunity

- Especially since we expect to see supportive central banks (Both the ECB and BOE)

- For 2016 as a whole the main risk is that the economy will fall into a recession; being that either a light or hard version

- The likelihood of such a scenario remains elevated given the low current growth rates, the challenges for manufacturing, and the tightening of credit conditions in the US

- In terms of current macro we put more emphasis on the job report, however volatile, than what we would do if we were earlier in the business cycle

- Especially growth in temporary employment

- It remains uncertain what the impact of a slowdown in growth, from current levels, would entail for the financial markets as we expect to see further central bank action in such a scenario

- In case of a material slowdown we expect to see a rate cut in the US being followed by additional stimulus

The likelihood of a BREXIT has increased in the early part of June

Source: Bloomberg

Temporary employment in the US has started to decline. Usually a strong recession indicator

Source: Bloomberg

Slide 23

Disclaimer

This report has been compiled by SEB Group to provide background information only and is directed towards institutional investors.

The material is not intended for distribution in the United States of America or to persons resident in the United States of America, so called US persons, and any such distribution may be unlawful.

Although the content is based on sources judged to be reliable, SEB will not be liable for any omissions or inaccuracies, or for any loss whatsoever which arises from reliance on it. If investment research is referred to, you should if possible read the full report and the disclosures contained within it, or read the disclosures relating to specific companies.

Information relating to taxes may become outdated and may not fit your individual circumstances.

Investment products produce a return linked to risk. Their value may fall as well as rise, and historic returns are no guarantee for future returns; in some cases, losses can exceed the initial amount invested. You alone are responsible for your investment decisions and you should always obtain detailed information before taking them. If necessary, you should seek advice tailored to your individual circumstances from your SEB advisor.

This material is not directed towards persons whose participation would require additional prospectuses, registrations or other measures than what follows under Swedish law. It is the duty of each and every one to observe such restrictions. The material may not be distributed in or to a country where the above mentioned measures are required or would contradict the regulations in that country. Therefore, the material is not directed towards natural or legal persons domiciled in the United States of America or any other country where publication or provision of the material is unlawful or in conflict with local applicable laws.