Investment Evening, Prague, 14th December 2015

Nick BeecroftFounder and CEO, HP Economics

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A Winning Portfolio for 2016?

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2016-a Goldilocks Year?• Global growth accelerates a little in 2016 to 3.6%, after 3.2% in 2015• Inflation in developed markets (DM) recovers back to 2% targets more

quickly than expected.• So the US and UK have to raise rates more quickly than expected• Europe stabilizes, but ECB possibly eases some more.• Japan implements structural reform and BOJ eases.• China growth eases further to 6.3%-lowest since 1987• So PBOC eases further• Emerging markets (EM) regain their footing, with

– Modest growth– Low Inflation– A relatively ‘slow’ and patient Fed

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Rate Divergence is Coming

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Black Swans

• Greater than usual risk of outlying scenarios-’Black Swans’• EITHER, bad-– low growth, low inflation, China disappoints, geo-

political risks, so– the Fed has to stop raising rates, or even cut them again

• OR,• BAD-– inflation much higher than expected, China does fine,

peace reigns, so– The FED has to raise rates much faster and higher than

expectedwww.hpeconomics.com

Portfolio Implications of Central Scenario

• Government bonds to suffer more than expected• But corporate bonds have a ‘yield cushion’

already• Equity returns quite low• Commodities continue to under-perform• Foreign Exchange

Makes for a challenging year!

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Government Bonds

• Conventional yields rise more than expected• US 10-yr 3.25%, from current 2.25%• Inflation protected bonds in US and UK outperform

conventional• Buy 10-yr Treasury Inflation Protected

Securities/sell 10-yr notes

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Corporate Bonds

• Now have a nice ‘yield cushion’• Especially if you’re playing the spread to government bonds• Fundamentals are OK– Global growth– Inflation– Monetary policy

• But avoid the oil sector• Accumulate some mining sector

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Equities

• US looks expensive, energy under threat• Asia ex-Japan uninspiring

– Growth is challenged– China is slowing– FED hiking, so currency risk

• Europe looks good– Crisis abated– Monetary policy

• Japan looks best– Cheap valuations– Room for earnings growth– Favourable macro

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Equities

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The Equity Cycle in Japan

• Despair-2008-extreme earnings collapse• Hope-March 2009 onwards-good earnings growth• Growth-Jan 11 onwards-continued earnings growth• Optimism-characterised by P/E growth, but in Japan– 12month forward P/E= 15.6– Median over last 30 years=19

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Commodities

• Not appealing• Supply/demand imbalances almost everywhere-energy and

metals• Especially in oil– Opec was a disaster– So need non-Opec supply contraction– Low China/EM growth is a problem

• US/EU storage capacity could be exceeded– 20% chance that the Northern Hemisphere winter is mild

enough

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Foreign Exchange-Currency Wars?

• US$ to strengthen. Too obvious?• FED not too concerned-economy has coped• Small chance of an FOMC statement message• In contrast, currency depreciation is an ambition for EU/Japan• So, monetary divergence• China-if US$ appreciates too much, ‘peg’ will be under threat

– If USD/CNY is 6.40– And USD/JPY = 120, CNY/JPY = 18.75– But if USD/JPY = 140, CNY/JPY = 21.875

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EM Foreign Exchange

• The waters should be calm with– Modest growth– Low Inflation– A relatively ‘slow’ and patient Fed

• So carry trades can work• BUT, there are risks, as ever

– Oil price crash– FED risk– China devaluation

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Portfolio Composition

• What about Black Swans?• I feel the second is much more likely– inflation much higher than expected, China does

fine, peace reigns, so– The FED has to raise rates much faster and higher

than expected

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Portfolio Composition

Percentage• Cash 10• Conventional government bonds 0• US Treasury Inflation Protected Securities 10• Corporate bonds 10• Equities

– Japan 30– EU 20– India 10

• Commodities -gold 10• Foreign exchange

– Short EUR/USD– Long USD/JPY– Long INR/ZAR

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