February 2016

MARKETS: Japan’s surprise rate cut

In January, Japan surprised the world with a rate cut; volatility saw more money seek safe havens; and one firm spoke of opportunities in Spain and Ireland. EUROPE: EQUITIES – NIALL GALLAGHER, INVESTMENT DIRECTOR, GAM.  Gallagher highlights opportunities in Spain and Ireland, and sectors including consumer, healthcare and industrials. Many of the macroeconomic imbalances that have put a strain on Europe over the last few years have finally been unwound. Deleveraging has permitted the emergence of a positive credit impulse which is driving a strong rebound in domestic demand in the peripheral economies.  We are seeing the best investment opportunities in the two stars that burned so brightly in the 2000s – Spain and Ireland – where the level of domestic demand has corrected to such a degree that we see a multi-year bounce in internal demand as inevitable. This trend, combined with the operational gearing consequences for companies that are ‘survivors’, has multiple years to run, in our view. Although there are large sections of the market where we think return on equity won’t return to prior levels, there are significant areas across consumer and industrial sectors that will experience a strong earnings rebound.  There are also sectors where we are seeing signs of structural improvements to profitability, such as telecoms. Select telecom stocks are about to enter a virtuous cycle of rising revenues, falling costs and lower capital expenditure. This will drive a significant expansion in free cash flow allowing both for rising cash dividends and a value transfer from net debt to equity inside of enterprise value.  The transition of consumer spending from the physical to the online world is a positive trend, and exceptional businesses with leading e-commerce capabilities are obvious beneficiaries. So are service providers in payments and logistics that facilitate online transactions. The growth in middle-class emerging market consumption, in turn, will benefit the luxury, consumer and healthcare sectors. In the latter, we prefer companies that should benefit from emerging market consumers degrading their diet, as Western consumers have done over the past 30 years, ‘catching’ many of the ‘diseases of civilisation’, such as diabetes, kidney failure and cancer from excess sugar consumption. EUROPE: BONDS  TANGUY LE SAOUT, HEAD OF EUROPEAN FIXED INCOME, PIONEER INVESTMENTS Oil is in a bull market. Not the headline you might expect to see after the last couple of months, but technically it could be correct if the recent bounce in the oil price continues. The standard definition of a bull (bear) market is a 20% rise (fall) in the price of an asset. The oil price has appreciated by almost 18% from its intraday lows of last week to Monday morning [February 1]. What is also interesting is the effect this has had on markets – it has been the main driver of a classic ‘risk-on, risk-off’ sentiment. So as the oil price has risen in the past couple of days, we’ve seen equities recover, core bond yields rise, peripheral bond spreads tighten, the US dollar has appreciated against the euro and the Japanese yen and credit spreads globally have tightened. In turn, that backs up the view of the European investment-grade fixed income team that much of the price action in the first three weeks of the year is a response to the movements in the oil price, and not a reflection of changing economic fundamentals. EUROPE: UK EQUITIES  RICHARD BUXTON, HEAD OF UK EQUITIES, OLD MUTUAL GLOBAL INVESTORS With growth at such a premium, the valuation gap between growth stocks on the one hand and value on the other remains excessively stretched, with no noticeable catalyst in sight as to how this could be reversed. Value stocks, recovery stocks, commodity stocks, mega-cap stocks – if it doesn’t have positive earnings momentum, investors just do not want to know.  And yet we are reaching a point where I believe investor enthusiasm for expensive growth stocks is reaching a dangerous level, whereas the current aversion to large-cap value is a distinct opportunity. While investors increasingly question the sustainability of dividend payments in some resource stocks, given the current level of the oil price, there is value to be found in big oil, notably BP and Shell. You can if you wish ignore the protestations of management that the dividends will be held, assume payouts are halved and yet still find yields attractive relative to bonds or other equities. We are also seeing good value and dividend growth within the banking sector as the legacy issues of the past several years, notably PPI claims, dwindle and capital buffers are restored. Those banks with domestically geared loan books such as Barclays and Lloyds should weather the current storm better than those with exposure to emerging economies. JAPAN – SCOTT JAMIESON, HEAD OF MULTI-ASSET INVESTING, KAMES CAPITAL In January, the Bank of Japan unexpectedly implemented negative interest rates. Japanese equities rallied and the yen weakened. The Bank of Japan (BoJ) has just taken their policy interest rate negative (to -0.1%). In doing so they join the Eurozone, Switzerland and Sweden. The reasoning is straightforward: economic growth is flatlining (household spending fell by more than 4% in December), inflation is falling and, driven by the market’s current desire for safe havens, the yen has been very strong.  JAPAN  JOOST VAN LEENDERS, CHIEF ECONOMIST OF MULTI-ASSET SOLUTIONS, BNP PARIBAS INVESTMENT PARTNERS It is clear that the BoJ surprised the markets with this step.  Until very recently, BoJ governor Kuroda had ruled out the possibility of negative rates.  It may be that Kuroda wanted to foster his reputation for policy surprises, but we believe that this decision smacks of desperation.  The majority in the BoJ policy committee was slim, only five to four. This move has no direct implications for our asset allocation.  We have been long the Japanese yen lately
as a hedge against adverse macroeconomic developments, although after this strategy proved successful in the recent market turmoil, we took profits
on the position in early January.   In our recent move towards an overweight in developed market equities, our preference is for Japanese and US equities.  The possibility of more easing in Japan was one supportive factor (but not the only one); increased M&A activity is another. JAPAN  WOUTER STURKENBOOM, SENIOR INVESTMENT STRATEGIST, RUSSELL INVESTMENTS  This is a meaningful step towards further stimulus by the BoJ. It is not as full-throttle as additional quantitative easing (QE), but it is a significant positive nonetheless. Japanese equities have been poor performers so far in 2016, with a negative lead from Wall Street exacerbated by yen strength, so this move injects some oxygen into the market. Our central case for Japan remains that economic growth will continue. Stimulation from the BoJ is a positive, and growth concerns – emerging markets, China, US profits – are second-order problems.  It was hoped that the Japanese economy would be stronger than current levels at this stage, however it is encouraging that the central bank is happy to act strongly through negative interest rates. JAPAN – TONY ROBERTS, JAPANESE EQUITIES FUND MANAGER, INVESCO PERPETUAL This is a further attempt to encourage lending as the negative rate acts as a charge on reserves left at the central bank. This policy aims to stimulate the domestic economy and to ultimately assist in the BoJ’s goal of achieving sustainable inflation.  While the core measure of inflation (ex-food and energy) has seen consistently positive readings for some time, it has failed to meet the 2% target and the fact that the BoJ has deemed it necessary to implement further measures highlights the difficulty of their task.  It will only become clear over time how much of an impact this new policy will have on the Japanese economy and at this stage we see no reason to change our view that Japan is likely to see only modestly positive GDP growth in 2016. In terms of the outlook for the Japanese equity market, we maintain our cautious view, based on uncertainty in the global economy, the potential for slower profit growth in Japan and the likelihood, in our view, that the earnings boost from the weaker currency could fade.  JAPAN – SEAN YOKOTA, HEAD OF ASIA STRATEGY, SEB The central bank eased because it saw downside risk growing from global financial market volatility, lower oil prices and China/emerging market growth risks. These risks can spread by hurting Japanese corporate and household confidence and lower inflation expectations. However, the BoJ is adopting a multiple-tier system where the interest rate on financial institution’s current account are not all set at -0.1%. It will be divided into positive interest rate (for basic balance of reserves), zero interest rate and negative interest rate for ‘excess reserves’. On a weighted basis, the current account will likely have a rate closer to 0% instead of -0.1%. The BoJ moved to the tiered system because it is worried that negative rates on all of banks’ current account will eat into their earnings and tighten lending standards.    Along with the BoJ, we will be closely watching the yen and equity market (especially bank stocks) to gauge the buy-in from markets.  JAPAN – KOK WEI YEE, PORTFOLIO MANAGER, FIDELITY JAPAN ACTIVE GROWTH FUND The BoJ is well aware that significant market turbulence can negatively affect the real economy, and the easing measure is more of a pre-emptive and symbolic move. The ECB appears ready to do more and the US Fed is being flexible in adjusting monetary policy, all of which is very bullish for asset markets. Global policymakers will stay supportive of economic growth and remain vigilant against negative growth effects from asset market volatility. CHINA – JAN DEHN, HEAD OF RESEARCH, ASHMORE GROUP  Investment banks’ U-turn on China
Having talked up the probability of a large devaluation in China, many investment banks are now taking the opposite view. U-turns of this type are of course typical of investment banks whose views tend to change with the price action (because they make money on crossing bonds rather than investing per se). In this particular case, the U-turn reflects a number of factors. Firstly, banks are also making revisions to their outlook for US growth and therefore Fed hikes. Secondly, there is growing recognition that a large devaluation makes little sense when China is able to (a) grow solidly, (b) sustain a $60 billion (€55 billion) per month trade surplus and (c) grow its share of global trade despite having one of the most appreciated real effective exchange rates in the world. Thirdly, vice-president Li Keqiang stated categorically last week that China has no intention of devaluing the renminbi. Finally, China is holding the course on overall macroeconomic policy by only easing very gently (both monetary and fiscal) and instead using liquidity instruments to deal with temporary market panics. This is sensible policy. GLOBAL – PERCIVAL STANION, HEAD OF PICTET ASSET MANAGEMENT MULTI-ASSET TEAM Markets have overreacted to disappointing economic data from the US and China. Investors are also reading too much into the steep fall in the oil price. The decline in crude has more to do with oversupply than falling demand. The gauges we monitor – liquidity, valuations and investor positioning – each suggest an equity market bounce is more likely than a protracted sell-off. It is also worth noting that each time the US economy has hit an ‘air pocket’ but avoided recession, stocks gained by an average of 30% in the subsequent 12 months. With emerging market stocks now trading at a 35% discount to their developed counterparts (on a price-earnings basis), and with the US dollar likely to appreciate at a slower pace, we believe it makes sense to begin rebuilding positions in EM asset classes. We would turn more bearish if growth in China and the US undershoots our expectations. However, even in this scenario – which we consider unlikely – we think the risk of a catastrophic collapse in prices is limited. We consider that valuations are much lower than those that prevailed in the lead-up to the severe market declines of 1987, 2000 and 2008. SAFE HAVENS  DANIEL MORRIS, SENIOR INVESTMENT STRATEGIST, BNP PARIBAS INVESTMENT PARTNERS We believe that investors need to take advantage of the volatility as opposed to seeking safety in overvalued haven assets. A perpetually bearish stance is no more advisable than a perpetually bullish one. When corrections occur such as the one we have seen in January, we believe that assets should be reallocated to those with high betas such as information technology and energy in equities or high yield debt. SAFE HAVENS – NITESH SHAH, DIRECTOR, COMMODITY STRATEGIST, ETF SECURITIES Physical gold receives its highest inflows since August 2015 as investors hedge against market malaise. Gold has traditionally been the first port of call in times of market stress. While most people cannot understand why cyclical assets fell so hard so fast, many realised that gold performs well in times of panic and went long the yellow metal while waiting for an entry point back into other cyclicals. Gold rose 0.7% last week [to January 29, in US dollars]: 3.4% year-to-date. Inflows into physical gold ETPs rose to $85.3 million. ©2016 funds europe

Executive Interviews

INTERVIEW: Put your money where your mouth is

Jun 10, 2016

At Kempen Capital Management, they believe portfolio managers should invest in their own funds. David Stevenson talks to Lars Dijkstra, CIO of the €42 billion manager.

EXECUTIVE INTERVIEW: ‘Volatility is the name of the game’

May 13, 2016

Axa Investment Managers chief executive officer, Andrea Rossi, talks to David Stevenson about bringing all his firm’s subsidiaries under one name and the opportunities that a difficult market...


ROUNDTABLE: Beyond the hype

Oct 13, 2016

The use of smart beta investing continues to grow. Our panel, made up of both providers and users, discusses what the strategy actually means, how it should be used and the kind of pitfalls that may arise when using this innovative investment technique.

MIFID II ROUNDTABLE: Following the direction of travel

Sep 07, 2016

Fund management firms Aberdeen and HSBC Global meet with specialist providers to speak about how the industry is evolving towards MiFID II.