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  • Market review

    Market review

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    The third quarter of 2018 saw a continuation in the performance divergence between developed market and emerging market assets.

    The third quarter of 2018 saw a continuation in the performance divergence between developed market and emerging market assets. US equities advanced during another strong quarter, reaching all-time highs, and driven in particular by the healthcare, industrials and telecoms sectors. Japanese equities followed closely behind, with a weakening yen and strong earnings momentum providing a favourable tailwind, particularly towards quarter end. Meanwhile, in continental Europe, equities experienced a positive, albeit volatile quarter. The strong performance in the US, Japan and Europe helped global equities generate a mid-single-digit return for the period. In contrast, UK equities de-coupled from their inverse relationship with sterling to produce a slight negative return, despite sterling’s weakness over the quarter. Also weighing, Asian and emerging market (EM) equities continued to be negatively impacted by poor sentiment and continuing fears around protectionism.

    Elsewhere within Growth assets, high-yield bonds benefited from a narrowing of spreads in a reasonably benign period for the market. Listed property returns were broadly flat, although the UK market underperformed. Commodity markets fell overall, with the continued rise in the price of Brent crude not enough to offset falls in the price of precious and base metals. The continuation of emerging market currency weakness led to another negative period for emerging market local currency debt.

    Within Defensive assets, the quarter saw a sell-off in government bonds in most regions and across most parts of the curve, leading to negative returns for long-duration positions. The US dollar and the euro both held broadly steady on a trade-weighted basis over the period, while the Japanese yen depreciated, driven in part by the widening interest rate differential between the US and Japan. Volatility was relatively muted over the quarter.

    Within Uncorrelated assets, gold prices continued to fall over the quarter as the prospect of rising interest rates in the US reduced its appeal (being a non-yielding asset), while Infrastructure was boosted by improved sentiment following corporate activity in the sector.

    At a glance - our asset class views

    ---o+++
    Equities
    North America  
    Europe ex UK  
    UK  
    Japan  
    Asia ex Japan  
    Emerging markets  
    ---o+++
    Government Bonds
    North America  
    Europe ex UK  
    UK  
    Japan  
    EM Hard Currency  
    EM Local Currency  
    IG Corporate Bonds  
    HY Corporate Bonds  
    ---o+++
    Currencies
    US dollar  
    Euro  
    Sterling  
    Japanese Yen  
    Asia ex Japan  
    Emerging Markets  

      View for the coming 6 to 12 months* Previous quarter's view

    *Views of Investec Asset Management’s Multi-Asset team and reflect preferences within respective asset class. As at 30.09.18.

    Key themes for the coming 6-12 months


    • Late cycle overheating prompting policy response
    • Liquidity withdrawal impacting economies and asset markets
    • US and Chinese “stand-off” over trade creates continuing uncertainty

    For professional investors and financial advisors only. Not for distribution to the public or within a country where distribution would be contrary to applicable law or regulations.

    Important Information

    This material is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contains statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual results may differ materially from those stated herein. All rights reserved. Issued by Investec Asset Management, issued October 2018.

  • A letter from your PM



    Don’t cry for me Argentina – from QE to QT

    - A letter from Philip Saunders,
    Co-Head of Multi-Asset Growth

    Philip Saunders

    The first signs of the ending of the first quantitative easing (QE) era started to break surface in the second quarter of this year and have intensified in the third. It has taken five years for the process to get to this point. Ben Bernanke, as chairman of the US Federal Reserve Board (Fed), had announced the onset of QE tapering as long ago as June 2013, which sparked the ‘taper tantrum’. However, globally, conditions remained loose, and most markets subsequently moved higher. The Fed has been careful to lift interest rates gradually and has been assisted in this by a persistently benign inflation rate. It has also provided forward guidance well in advance. There were clearly some straws in the wind that suggested that we were close to a turning point in the liquidity cycle. The one that stands out most was the issuance by the government of Argentina of a 100-year US dollar bond in June 2017 – it was 3½ times oversubscribed.

    In fact, the first major economy to tighten liquidity conditions materially was not the United States but China. Having loosened conditions aggressively in 2015 to bolster growth, it started to tighten policy once more in 2017 and took draconian steps to rein in its shadow-banking sector.

    The first ‘pip to squeak’ was offshore USD high-yield bonds issued by Chinese property companies, another popular area for investors ‘reaching for yield’ in 2017. Absolute yield levels had effectively doubled by June 2018. Argentina came next, then Turkey – both were initially dismissed as idiosyncratic problems that were not reflective of a broader change in conditions. Thereafter, the weakness broadened to include most of the EM universe.

    As yet, higher risk American assets have largely remained immune. In fact, the US high-yield bond market has been remarkably well behaved, with the riskier CCC end of the credit spectrum doing notably well in the first half of the year. The US equity market has rallied to new highs despite the sharp backing up in US Treasury bond yields. In fact, for all the Fed’s tightening, credit conditions have remained benign in the US. This precisely reflects the flood of international liquidity away from the periphery and into dollar or domestic US assets. President Trump’s late-cycle 2017 tax cuts and Jobs Act have helped domestically but have also impacted both growth and interest rate differentials between the United States and the rest of the world.

    Although we are in the midst of what will probably prove to be a transitory relief rally, it is our contention that the liquidity regime is changing – from QE to QT (quantitative tightening) – and that this change, in turn, will put continuing pressure on the ‘weak links’ and result in weaker global growth rates. This would be a toxic combination for Growth assets. The investment implication is that the repricing of many assets is underway but incomplete. Consequently, one should be particularly cautious of those asset classes which benefited most from the QE carry trade.

    Philip Saunders
    Co-head of Multi Asset Growth

  • Equities

    Equities

    ---o+++
    Equities
    North America  
    Europe ex UK  
    UK  
    Japan  
    Asia ex Japan  
    Emerging markets  
    The US economy remains the key driver of global economic growth. Consumer and business sentiment remain elevated, and strong earnings growth continues to underpin US equities.

    North America

    -- - o + ++
    North America  

    The US economy remains the key driver of global economic growth. Consumer and business sentiment remain elevated, and strong earnings growth continues to underpin US equities. Quantitative tightening from the Fed poses a challenge to most Growth assets, not least US equities, suggesting a more volatile outlook.

    We retain our preference for high-returning companies with earnings visibility that appear cheap given their cashgenerating abilities.

    Europe ex UK

    -- - o + ++
    Europe ex UK  

    Fundamentals continue to moderate on a macroeconomic level but remain robust on balance, with earnings still supportive. Valuations do not appear a constraint to further upside.

    Longer term, any normalisation from the European Central Bank (ECB) through tapering is a potential headwind, while the tensions from escalating trade wars will continue to weigh on sentiment in bouts.

    UK

    -- - o + ++
    UK  

    We retain our neutral stance on UK equities. Fundamentals and valuations alike are mixed, with the former looking more favourable in sectors like homebuilders, while the media and retail sectors appear relatively cheap. That said, neither appear compelling.

    Interestingly, while sterling has typically driven the overall direction of performance in recent times, this inverse correlation was absent during the third quarter.

    Japan

    -- - o + ++
    Japan  

    Japanese equities remain a long-held core theme of ours. Valuations continue to appear attractive and fundamentally there are strong stock buyback trends providing attractive opportunities at the company level. Our focus remains on companies with improving profitability driven by ‘self-help’ initiatives, such as improving their capital efficiency.

    Longer term, tightening by the Bank of Japan or any protracted
    period of yen strength are concerns, although it would take a
    meaningful move from current levels for either to become a
    significant hindrance.

    Asia ex Japan

    -- - o + ++
    Asia ex Japan  

    For Asian equities broadly, fundamentals remain weak relative to other emerging markets and structural issues continue to act as a constraint, as reflected by our score. Valuation is clearly now more compelling, but lingering tensions over trade continue to weigh on sentiment.

    In China, policy planning has been consolidated and centralised to focus explicitly on supply-side reform. China appears to be serious about the current reform programme, which should support the structural prospects for the Chinese economy and its equity market.

    Emerging markets

    -- - o + ++
    Emerging markets  

    Emerging market equities are supported by the relatively robust late cycle environment, against a backdrop of supportive global growth. Valuations are also undemanding versus history and attractive relative to developed markets, particularly after another weak quarter.

    The asset class has seen an increase in long institutional positioning over the past 18 months, although positioning is not stretched given the extent to which the asset class has been shunned for the past five years.

      View for the coming 6 to 12 months* Previous quarter's view

    *Views of Investec Asset Management’s Multi-Asset team and reflect preferences within respective asset class. As at 30.06.18.

  • Bonds

    Bonds

    ---o+++
    Government Bonds
    North America  
    Europe ex UK  
    UK  
    Japan  
    EM Hard Currency  
    EM Local Currency  
    IG Corporate Bonds  
    HY Corporate Bonds  
    We view US Treasuries as one of the cheaper areas of the developed market government bond space.

    North America

    -- - o + ++
    North America  

    We view US Treasuries as one of the cheaper areas of the developed market government bond space. While the US economy continues to perform strongly, and the Fed is slowly normalising monetary policy, much of this is already priced into US Treasuries, particularly further out along the yield curve.

    An unexpected bout of second-round inflationary pressure (prices and wages accelerating higher) or the expansionary fiscal programme could, however, still see upward pressure on yields in the short run.

    Europe ex UK

    -- - o + ++
    Europe ex UK  

    The improvement in the euro-zone economy and the ECB’s normalisation of monetary policy, against a backdrop of expensive valuations, make a sustained rally in core euro-zone bond yields appear unlikely.

    In peripheral countries, we note the political situation remains fragile in select countries such as Italy, and we remain negative on the outlook for the bonds there. These bond markets having previously been beneficiaries of the ECB’s QE programme, now look vulnerable ahead of anticipated QE unwinding.

    UK

    -- - o + ++
    UK  

    The Bank of England (BoE) appears committed to normalising policy and the recent bounce in inflation supports this. Economic data is fairly mixed with areas like retail sales still supportive, while signs of Brexit impacting the real economy are beginning to emerge.

    With UK gilts flagging as expensive on our monitors, we believe bonds are likely to sell off as the BoE looks to hike interest rates.

    Japan

    -- - o + ++
    Japan  

    The Japanese government bond market remains largely dominated by the Bank of Japan (BoJ), although it is interesting to note that more recently the focus has been on the cost of extraordinary monetary stimulus rather than the benefits to the economy this brings.

    As such, we see little value in Japanese bonds, where in our view a less accomodative BoJ is not yet being fully discounted in prices.

    Emerging Markets Hard Currency

    -- - o + ++
    Emerging Markets Hard Currency  

    As with emerging market hard currency debt, the local currency asset class remains under pressure from negative sentiment. The same is true of EM currencies, making it difficult to take a positive view on the asset class as a whole.

    That said, we are still finding select opportunities where fundamentals remain robust and valuations appear compelling, not least from a real-yield perspective.

    Emerging Markets Local Currency

    -- - o + ++
    Emerging Markets Local Currency  

    Our view on emerging market local currency bonds has moderated somewhat over the past quarter. While the inflationary environment remains supportive, valuations appear less attractive relative to areas of developed markets and indeed hard currency bonds.

    That said, we still see opportunities in select areas such as Indonesia where fundamentals remain robust and valuation appears compelling.

    Investment Grade

    -- - o + ++
    IG Corporate Bonds  

    While fundamentals are still positive, with favourable leverage and corporate earnings trends, expensive valuations continue to weigh on the prospects for the asset class as a whole with corporate spreads looking particularly tight.

    Market price behaviour is also generally looking less supportive with the ECB looking to halt corporate bond purchases in December of this year, and with investor inflows generally subsiding.

    High Yield

    -- - o + ++
    HY Corporate Bonds  

    As with investment grade bonds, the fundamentals for high-yield corporate debt appear sound: both leverage and corporate earnings dynamics appear strong, while market price behaviour support is diminishing, as an indirect consequence of the ECB’s proposed tapering of investment-grade bond purchases.

    Valuations are the main constraint with spreads against government bonds particularly tight. The asset class remains a beneficiary of the late cycle environment but as history suggests, high-yield corporate credit is often one of the first casualties of any recession.

      View for the coming 6 to 12 months* Previous quarter's view

    *Views of Investec Asset Management’s Multi-Asset team and reflect preferences within respective asset class. As at 30.09.18.

  • Currencies

    Currencies

    ---o+++
    Currencies
    US dollar  
    Euro  
    Sterling  
    Japanese Yen  
    Asia ex Japan  
    Emerging Markets  
    We believe the Japanese yen is the most attractive major currency in our universe. Japan’s economy is growing strongly, with inflation showing signs of picking up while the yen appears very cheap, particularly against the US dollar.

    US Dollar

    -- - o + ++
    US dollar  

    While the US dollar is helped by robust economic growth and tightening monetary policy, the currency continues to look relatively expensive in our view, with downside pressure from a growing twin deficit.

    We believe the tailwind of higher rates is in the price and other opportunities elsewhere appear more attractive, particularly given the dollar’s strength year to date.

    Euro

    -- - o + ++
    Euro  

    We are broadly constructive on the euro given attractive valuations and short investor positioning. The currency has struggled to generate any upward momentum in the face of weaker economic data.

    While the economy has generally been weaker, there is scope for positive surprises in the data. The ECB is also set to end QE soon which should provide another anchor of support for the currency.

    Japanese Yen

    -- - o + ++
    Japanese Yen  

    We believe the Japanese yen is the most attractive major currency in our universe. Japan’s economy is growing strongly, with inflation showing signs of picking up while the yen appears very cheap, particularly against the US dollar.

    The currency remains attractive as a Defensive asset, in our view. We therefore view it as a useful hedge for our portfolios, particularly as we reach the later stages of the business cycle.

    Sterling

    -- - o + ++
    Sterling  

    Uncertainty has grown around the UK’s political situation and this has weighed on sterling, despite the BoE continuing to hike rates.

    With a Brexit deal now in sight, we believe sterling is modestly undervalued while investor positioning is generally short. As we approach Brexit in March 2019 and the BoE continues with its rate hiking cycle, we believe the currency will remain well supported.

    Asia ex Japan

    -- - o + ++
    Asia ex Japan  

    Asian currencies still look particularly vulnerable to further downside. Many Asian economies also still appear at the peak of their financial cycles. This dynamic will likely undermine their economies and we expect the currency markets to bear the brunt of any adjustment process that will be necessary.

    Several of these currencies, such as the Korean won, are also likely to come under pressure from protectionism as President Trump steps up his agenda.

    Emerging Markets

    -- - o + ++
    Emerging Markets  

    In an asset class with significant regional variation, we are positive on what we view as the more attractively valued currencies. Fundamentally, we favour countries with a strong terms-of-trade underpinning, which are not overly reliant on US dollar financing.

    While a synchronised global recovery in economic growth points to reduced downside risk, further tightening by the US Federal Reserve through its balance sheet unwind and rate hikes will put pressure on many currencies within the universe, not just those with higher amounts of US dollar debt.

      View for the coming 6 to 12 months* Previous quarter's view

    *Views of Investec Asset Management’s Multi-Asset team and reflect preferences within respective asset class. As at 30.06.18.

    1London Inter-Bank Offered Rate, the average interest rate used to charge for borrowing across financial institutions.