House View Commitee - SEB Group › ... › 2017-01_house_view.pdf · - Fed hiked, as expected, in...

SEB House View January 2017

Summary

- The macroeconomic environment will remain a positive factor for risk assets over the coming quarter

- We expect leading indicators to hover around current levels while at the same time we expect to see strength in hard data

- As the latter has not yet fully converged up to the levels indicated by the former

- We do not expect to see surprise indicators rising further from current levels; however we do not expect them to fall back into negative territory either

- I.e. we expect macro to be positive for risk assets but less so than compared to the past 3 months

- We expect the Q4 2016 earnings season to surprise sufficiently on the upside to drive equities higher

- Q4 2016 EPS estimates have not been revised higher in line with the stronger production/consumption numbers and the steepening yield curves (positive for bank earnings)

- Given the currently strong tactical macro environment we expect 2017 EPS estimates to be maintained

- Indicating local currency EPS growth of 7% for MSCI World

- Financial markets will focus on macro and earnings over the coming months rather than central banks

- A more hawkish FED will as such not be a negative for financial markets until Q3/Q4 2017

- Political risk in Europe (German and French elections) will not be discounted in the equity markets while macro remains strong and the earnings season is ongoing

Old (50%) New (55%)

The speedometer controls to what extent the portfolios should utilize their risk budgets. It is connected to the model portfolio (page 3) which at all times utilizes its risk budget in-line with the speedometer. In a very general sense it can be interpreted as equities on/off (with 50% being neutral).

10% 10% 30% 50% 70%

Cash

Commodities

Emerging Market Debt

High Yield Bonds

Investment Grade

Equities

Government Bonds

Allocation

Strategicallocation

Diff

Multi Asset Model Portfolio

Model Portfolio - The model portfolio is overweight equities by 6%-points

- Financed by an underweight to both commodities and government bonds

- We have reduced the allocation towards High Yield

- Following the significant rally that we have seen over 2016

- The reduction in credit is the first step towards a combined barbell strategy for the total portfolio

- Seeking greater exposure to the lowest and highest risk classes

- We stress that we still expect High Yield to outperform all other fixed income asset classes for 2017

- But see the upside potential and risk/reward of a barbell strategy as more attractive

- In a portfolio bared from having equities we still recommend an overweight to High Yield

- The low allocation towards Emerging Market Debt is a reflection of both our expectation towards a stronger USD and the potential disconnect between strong DM growth and EM due to the US focused stimulus programs which have reflated financial assets since the US presidential election

- Although the running yield on the asset class looks appealing we expect it to underperform for example US High Yield in a rising US rates environment

- Especially so since we expect the market and the FED to revise (higher) their policy rate forecasts during the summer of 2017

Long only portfolio. Yearly VaR(95%) ex. mean between 7% and 21%. 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

Global Equities

EM Equities

Government Bonds

High Yield

Investment Grade

EMD LC

Hedge Funds

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Multi Asset Class Risk and Return Estimates, 12M

Source: SEB

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North America

Europe

Japan

Sweden

East Asia ex. Japan

EM Asia

EM Ex. Asia

Allocation

MSCI AC

Diff

Equity Model Portfolio (Pure)

Relative positioning - The model portfolio is overweight European, Swedish, and Japanese equities

- Financed by an underweight to the US and EM

- On a relative basis Europe looks compelling compared to US equities

- A weak EUR will be a boon for European exporters

- We expect the EUR to weaken further against the USD over the coming quarters

- Given the substantial slack that remain in European labour markets and our expectation to a continued low EUR policy rate European equities face less margin pressure than US equities

- We even expect European margins to increase (converge upwards towards US margins) over the coming quarters

- We expect 2017 EPS revisions to be a more positive factor for Europe than for the US

- A continuation of the trend that started in late November

- We increase the underweight to EM equities

- The new US presidency combined with rising rates increases the uncertainty of the asset class

- On a tactical horizon we are concerned about the high level of negative EPS revisions for the region (despite the falling EM FX)

Source: SEB

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

Source: SEB and Bloomberg

China (13.3)Europe (14.2)

Sweden (16.0)

DM (17.4)Japan (16.5)

EM (13.4)

US (18.4)

LatAm (16.1)

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Fixed Income Model Portfolio (Pure)

- Relative Duration:

- We are slightly short duration against benchmarks in relative mandates

- We are short Sweden and Germany but neutral/long US rates

- Fed hiked, as expected, in December and indicated three hikes during 2017 compared to previously two hikes

- ECB will continue to buy bonds during 2017 but at a slower pace than during this year

- Trumps fiscal policy, higher inflation and central banks adding less stimulus all supports rates to continue to climb higher

- Curve View

- We are positioned for steeper yield curves in Sweden and Europe given that rate hikes from both the ECB and the Riksbank are far off

- Higher global rates will thus likely steepen the curve

- We are neutral the US curve. For long rates to climb markedly higher we think that a more aggressive Fed hiking cycle needs to be priced which should hurt the short end more

- Country spreads

- We are long US rates both vs Bunds and Swedish 10Yr. We regard US rates to be much more fairly valued. If the risk sentiment turns US rates should fall much more than Bunds

The market is not in alignment with the FEDs projection

2017-01-10

FED Median

Jul16 Oct16 Jan17 Apr17 Jul17 Oct17 Jan18 Apr18 Jul18 Oct18 Jan190.2

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Macro and the markets January 2017

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Developments in the Markets

- December was yet again another strong month for risk assets

- With US equities posting all time highs in the days before Christmas

- The strong equity markets, combined with unrevised EPS estimates, lifted multiples further

- US equities are now trading at forward PE levels last seen in the period from 1998 to 2002

- Despite hawkish rhetoric from the FED in regards to expected 2017 rate hikes and the strong equity markets yields fell back slightly in both Europe and the US

- However the move was miniscule in comparison with the increases we have seen since October

- Strong equity and commodity markets (especially oil) drove credit spreads tighter during December

- Broad US High Yield is as such trading at a spread of 380 bps; a level last seen in September 2014 around the beginning of the oil rout

- The USD continued to strengthen against all major peers

- Bringing the trade weighted USD back to the highest levels since 2002

- Despite hereof we saw stabilization in EM FX against the USD

- However this follows the large setback due to the US election

- The Yuan continued to weaken and closed in on 7.00

- Without causing the stir it did early 2016

The rally post the Trump election is the second largest since the start of 2013; max length of 60 days

The rally has brought valuations to the highest levels since 2002

Source: SEB

Source: SEB

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18.8

Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb-20

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Economy Developed Markets

- DM macro continued to surprise on the upside during December

- With gains in PMIs moderating the positive surprises was primarily driven by hard data and consumer confidence indicators

- The strength in macro over the past 3 months has lifted most surprise indicators to historical peak levels

- Thereby limiting the potential for further positive surprises

- Note that while surprises might taper off we still expect to see strong macro over the coming months

- Both the US and European consumer have become more positive over the past couple of months

- Both Conference Board and Michigan are at levels last seen in the 2000s

- The strength in confidence indicators have over the past couple of months also translated itself into hard data

- With both core US and German retail sales growing in the vicinity of 3.5%

- For Europe these are the highest growth rates since 2011

- Credit growth in both Europe and the US remains healthy

- Supported by loosening credit conditions for the consumer in both regions

- The December job report confirmed the strength of the US labour market

- The US unemployment rate fell further and is now firmly below most NAIRU estimates

- Confirmed by rising wages

Consumer confidence have risen to cycle highs

Soft data has been the primary driver behind the positive surprises since November

Source: SEB

Source: Macrobond

Economy Asia and Emerging Markets

- On an aggregated level the macro economic momentum for Emerging Markets gained further strength in December

- However this strength hides a growing divergence between EM Asia and LatAm

- With the former outperforming the latter in terms of tactical macro

- The strength of the old growth engine in China is starting to translate itself into a broader based strength

- Consumer confidence have risen to levels last seen in 2014

- Retail sales have accelerated to growth in the vicinity of 11% year on year

- In isolation the broadening range of indicators that are improving for China in itself should improve the stability of the current uptick in growth

- The tentative signs of a revival in EM trade over October/November was confirmed in December

- The pickup herein is driven both by rising Chinese and US imports

- Despite stronger commodity prices and the global pickup in growth LatAm continues to be challenged

- PMIs have started to reside once more for Brazil; following the recovery over the summer of 2016

- The reason for the disconnect between EM Asia and LatAm seems to be sentiment driven and can potentially be ascribed to the Trump presidency

- As there is no obvious reason as to why Brazil should not benefit from the more positive global outlook

Consumer confidence for China has gained strength

Source: Macrobond

Source: Macrobond

PMIs for EM Asia is going up faster than those of LatAm

In Focus January 2017

In Focus #1: European underperformance

- European equities has underperformed US equities significantly over the past decade

- Even during the last 3 years where Europe has not been influenced by the Eurozone crisis of 2011-2013

- The explanation behind this underperformance comes from two factors

- Margins in Europe have declined while they have remained high for the US

- Leaving profit margins in Europe considerably below their US counterparts

- Topline growth in Europe has been close to flat over the past 10 years

- Despite a significant rise for the US

- Going forward we expect both of these factors to reverse

- Profit margins in the US is set to compress due to increasing wages and rising financing cost

- European equities does not face the same pressure due to both more slack in the labour markets and expectations towards a more accommodative monetary policy

- Topline growth in Europe looks set to strengthen on the back of a weak EUR and a more robust global economic outlook

- In aggregate we expect European earnings to outperform those of the US going forward

- This we expect will lead to significant outperformance in terms of local currency performance

European equities have underperformed ever since 2006

108.62

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European earnings have trailed those of the US EBITDA margins have diverged between the US and Europe

Contribution to performance for MSCI EU Contribution to performance for MSCI US

Source: SEB and Bloomberg Source: SEB and Bloomberg


0 5 10 15 20 25 30 35

Financials

Materials

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12M Forward sector PEs Europe is trading cheap to the US due to IT weight and Energy multiple

There is no valuation premium between Europe and the US if sector weights are adjusted for

The expansion in US multiples is not caused by a change in sector weights

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US topline growth is double that of Europe sector adjusted US topline growth comes primarily from Health Care and IT

EU topline growth comes primarily from Health Care and consumer stables

62.98%

22.69%

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Nearly all sectors have delivered higher topline growth in the US than in Europe




EU EPS looks set to growth by 7%. Primary driver being Energy and Materials (Top-down)

US EPS looks set to growth by 5%. Primary driver being Energy and IT (Top-down)



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Bottom-up estimates for Europe Bottom-up estimates for the US

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Source: SEB and MSCI

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In Focus #2: Markets and Politics

- If there is anything that 2016 has taught us, it is that if fundamentals are supportive, political events will either act as a catalyst or be a mere blip on the performance chart

- Key takeaway is that all else being equal: Fundamentals and macro has been the dominating factor

- Brexit and the election of President Trump were both predicted to be negative market events, but ended up having little effect

- The FTSE100 ended 2016 on an all time high, as the markets quickly recovered on the back of a weakened pound

- Before the election, PMIs were subdued yet positive, and only accelerated following the vote

- Equally, the election of President Trump, to the surprise of many, spurred a sharp increase in the S&P500 and acted as a catalyst for a wider market rotation from defensives to cyclicals and growth to value

- One can argue that this happened on the basis of a favorable mixture of political policy outlook and strong fundamentals

- US macro and sentiment had already been positive at an accelerating rate for some time, and the addition of

light the fire

- These two miniature case studies seem to indicate that in spite of political turmoil, markets are extraordinarily resilient to large shifts in politics if the underlying fundamentals are sufficiently supportive to begin with

Market bounced back at an aggressive pace after Brexit

Impressive growth in the S&P 500 and consumer sentiment

Asset Class Views January 2017

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 20172

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MSCI US

MSCI EU

Developed Market Equities 12M Outlook

- Developed Market equities will be the best performing major asset class over the coming 12 months

- The primary driver behind the positive returns will be topline growth

- The valuation of MSCI World is at a level where we do not expect to see further multiple expansion

- Note that we expect multiple expansion in Europe and Japan but a slight contraction in the US

- Leaving the total for MSCI World unchanged

- The return of equities will largely mirror the gains in earnings

- The primary driver of EPS will be topline growth

- Supported by the stabilization and improvement in the outlook for 2017

- The energy sector will go from being a drag on aggregate earnings to a positive contributor

- It is expected to be the largest contributor for 2017 EPS growth

- Rising and steepening yield curves will support EPS growth for financials

- Topline growth is assumed to dominate the weak overall margin pressure which we are foreseeing for 2017

- Rising financing costs and wages will in our view drive margins for US companies down from the present all time high levels

- However at the same time we expect to see margin expansion in Europe

We expect to see convergence between European and US profit margins


Energy is set to be the largest contributor to US earnings in 2017


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Emerging Market Equities 12M Outlook

- Emerging Market equities is expected to deliver a return in the vicinity of Developed Market equities

- Albeit with higher volatility and with a more negatively skewed return profile

- A range of traditional arguments for high returns of the asset class is in place:

- EM is trading at a historically large discount to DM on most valuation metrics

- Weakening EM FX (we foresee further weakness in 2017) will be a boon for EM exporters and support local currency EPS growth

- A strong(er) US economy should support a revival in global trade

- A revival which have been elusive for the past 8 years

- The stabilization in commodity markets implies that the large EM energy sector will no longer be a drag on the aggregated EM universe

- Despite the range of positive factors several things are in our view skewing the return profile to the downside

- Geopolitical risk is high and we have yet to see political reforms in some of the major EM countries

- Brazil, Turkey, and Russia

- The argument that a strong US economy will lift global trade is in our view weaker than normal given that we expect the

focused

- The Chinese stimulus of 2016 will diminish during 2017 in an attempt to prevent the formation of bubbles

We expect bottom-up estimated EPS growth for EM to rise; measured in local currency

Source: Bloomberg and SEB

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017-40

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The difference in forward multiples between EM and DM is standing at all time highs

Source: Bloomberg and SEB

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 and the likelihood for a recession in 2017 have fallen post the Trump election

- The latter is our primary argument as to why we expect High Yield bonds to outperform

- Expectations to gradually rising core government bond yields will continue to drive investors into less rate sensitive asset classes; such as High Yield

- Credit conditions are being loosened in both Europe and the US

- Note that this is a reversal of the trend which we saw for 2016 as a whole

- Stabilization of oil prices eases the pressure on energy issuers

- We expect further spread compression in this space for 2017

- The return of topline growth in both Europe and the US will in our view improve free cash flows

- The primary risk for the High Yield space is rising financing costs

- This as leverage within the High Yield space has risen over the last couple of years

- However we do not expect this to be a major risk factor for the coming 6-12 months

We expect US High Yield spreads to go through the lows of 2014

Source: MacroBond

The premium on energy issuers in the High Yield space have all but been eradicated

Source: MacroBond

Emerging Market Debt 12M Outlook

- We expect Emerging Market debt to deliver a return in excess of DM government bonds and Investment Grade for 2017 as a whole

- However we expect the return to be a story of two halves

- For the coming two quarters we expect to see weakness of EM debt coming from both the rate and the FX component

- EM FX will weaken compared to the USD as the market continues to price in the stronger US growth outlook and the potential for a more aggressive US rate hike cycle

- EM rates will in this initial stage follow US rates higher

- As the US space becomes increasingly attractive we expect to see outflows for EM which also will have an upward pressure on EM rates

- We do not expect to see EM debt outperformance until the repricing of the US rate hike cycle is complete

- In terms of EM inflation we expect it to converge upwards towards the rising DM inflation over 2017

- EM FX weakness will lead to rising import prices

- Stronger commodity prices will no longer be a drag on inflation

- Rising EM inflation reduces the potential for EM monetary stimulus and we expect to see signs and discussions about tightening once we get closer to the summer

- This being especially so if growth of the EM space stabilizes further

- Geopolitical uncertainty and a lack of reforms in the EM space skews the return profile to the downside

We see an increased likelihood of ending up in a regime in which US yields rise rapidly together with EMD (#2)

-1.5 -1 -0.5 0 0.5 1 1.5-2

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Core Government Bonds 12M Outlook

- We expect core government bonds to deliver a negative return over the coming 12 months

- Driven on an aggregated level by rising US rates

- We expect to see both a flattening and a move higher for the US

- In contrast to the US market we expect short rates in Europe to remain firmly anchored

- Leaving a steeping of EUR curves as the only possible outcome so forth rates and inflation expectations continues higher

- The divergence between Europe and the US is largely a reflection of the different stages in the business cycles

- While slack in the US economy has all but evaporated European unemployment rates are still sitting firmly above most NAIRU estimates

- We are as such long way from experiencing any meaningful core upward inflationary pressures in Europe

- However it should be noted that the weak EUR will lift headline inflation

- But we expect the ECB too look past this and the potential upward pressure on inflation from rising commodity prices

- Supply/demand dynamics all else equal also favors Europe over the US

- Fiscal stimulus in the US will increase supply while demand in Europe will remain high given the ECBs QE program

Breakeven inflation remains substantially higher for the US than for Europe

Source: Macrobond

Commodities 12M Outlook

- We expect that commodities will deliver a positive return over the coming 12 months

- But with a return lower than that of equities

- In terms of oil we expect prices to be limited on the upside around current levels

- The move higher initiated by the OPEC decision to cut production have ensured that more US shale producers are operating at a profit

- Which has translated itself into higher production in the US

- And a rising number of active oil rigs

- We expect that this will gain focus over 2017 and as such limit the upside

- Note that this is also reflected in the forward markets by a very flat curve going out to 2018

Net-speculative positions stands at very elevated levels

Source: Macrobond

We have seen a significant rise in the number of active oil rigs following the rise in prices

Source: Macrobond

Risk environment January 2017

Risk Environment

- The primary risk scenario is in our view a significant rise in global inflation; especially US

- In such a scenario we expect the FED to communicate a more aggressive rate hike cycle than the one currently projected and priced

- In such a scenario we expect the US yield curve to flatten while at the same time move upwards and equities to correct

- The latter given the very stretched valuation levels that global equities are trading on

- With forward multiples trading close to 20 for the US valuations are one of our main strategic risks

- We also expect to see significant USD strength and broad EM underperformance

- We doubt that US growth in the range of 2.5% to 3.5% will be enough to withstand a significant hawkish shift by the FED

- In other words: Even if the running US GDP growth of 2.5% (Atlanta FED) is maintained then a hawkish FED will drive equities lower

- We see the likelihood of the scenario to be increasing over 2017 with the gradual implementation of various stimulus measures from the US

- Noting that these measures are launched at a time when the US unemployment rate is already sitting firmly below most NAIRU estimates

- And even in the absence of any new measures the US economy is already showing signs of overheating g; even with the meagre growth rates of later years

The disconnect between wages and the FED Funds curve is as large as ever; could force the FED to be more aggressive

Source: Macrobond

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