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  • Market Review

     

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    Market review

     

    Investor sentiment was largely driven by speculation around the outcome of the Brexit referendum, as the UK general public voted on its membership of the European Union.

    Investor sentiment was largely driven by speculation around the outcome of the Brexit referendum, as the UK general public voted on its membership of the European Union. On balance, market consensus was increasingly for a ‘remain’ vote, and the decision to leave on 23 June consequently wrong-footed markets. Sterling rallied strongly in the week running up to the vote, before selling off materially in the immediate aftermath of the result. Growth assets rallied over the quarter as the prospect of further easing helped buoy risk assets. In local currency terms, UK large cap equities were the top performer, while Japan and Europe lagged, both posting negative returns. Emerging market equities remained steady and generated modest positive returns. Credit markets were boosted by the rise in the oil price and the European Central Bank’s (ECB) implementation of its corporate bond purchase programme. Emerging market debt again posted positive performance, in line with other Growth assets.

    Developed market government bond yields once again fell, with ten-year German Bund yields ending in negative territory, joining ten-year Japanese Government Bonds. The US dollar posted modest positive returns. The Japanese yen was the top performing G10 currency, driven by the currency’s safe haven status. Similarly, gold continued to consolidate its returns from earlier in the year.

    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 30.06.16.

    Key themes for coming 6-12 months

    • A preference for income over capital appreciation – more opportunities in assets that reward through income rather than through growth potential
    • Continued low rates and monetary easing – the US Federal Reserve (Fed) has demonstrated over the past quarter that its rate hiking path has flattened out
    • As politics rises up the list of investor concerns, recent events have shown the need for portfolio resilience – constructing portfolios that can outperform the market in challenging environments and that are robust when markets reverse
  • A letter from your PM



    An inflection point for emerging markets?

    - A letter from Philip Saunders

    Historically, commodity prices and emerging market assets have been closely correlated. This was true in the secular commodity bull market of the 2000s and has continued to be the case in the subsequent commodity market bust beginning in 2011. While the latter was unfolding amid the broader bull market, emerging market assets had always appeared to be more geared to the downside during sharp market corrections. Indeed, they have generally proven to be serial underperformers.

    However, in the early part of 2016 this trend appeared to reverse. Markets plunged amid fears that the People’s Bank of China might devalue the renminbi again and in the wake of the US Federal Reserve’s modest rise in the Federal Funds Rate. Despite these ructions, key commodities, emerging market currencies, equities and fixed-income securities weathered this particular storm far better than was the case in previous set-backs. More often than not, market price behaviour is more eloquent about true investor positioning than surveys and fund-flow reports. Consequently, market price behaviour, an assessment of investor sentiment and flows, forms one of the key elements of our core investment decision-making framework, Compelling Forces™, along with ‘fundamentals’ and ‘valuation’.

    Correlation characteristics appeared to be changing in a stressed market environment, suggesting that the prices of metals and emerging market assets could be beginning a process of relative stabilisation or had actually reached their cyclical low points. Oil prices, however, suffered a further plunge at the beginning of this year, demonstrating an unusually high correlation with growth assets and in particular equity markets. However, oil has a unique dynamic due to the influence of the cartel known as Organisation of the Petroleum Exporting Countries (Opec). Opec had kept prices abnormally high by constraining supply, which ultimately attracted investment in new technology and new entrants, effectively ending the cartel. With Opec no longer managing supply, the market price played this role and the oil market played catch-up with other global commodity markets.

    The key change to fundamentals has been capacity cuts and supply constraint. Many market participants, as they often are, were simply ‘behind the curve’ because negative market momentum had taken over. But as the spectacular performance of gold mining stocks in the first quarter of the year illustrated so well, when the sellers have sold, it only takes a modest amount of buying to have a dramatic impact on the price. To the end of June, gold mining stocks, as measured by the Euromoney Gold Miner Index, were up an eye-watering 100%.

    We took relative commodity-price and emerging market currency resilience in the face of equity and credit market weakness as a signal to start the process of rebuilding exposure to commodity-related and emerging market assets in general. We have resisted the siren call of simplistic relative valuation metrics for a number of years. It is worth remembering the advice of one experienced emerging market observer: “never buy the equities until the respective currencies have put in their lows”.

    Resource stocks specifically, but emerging market assets more generally, tend to be highly cyclical and in our view, should be treated as opportunistic rather than a core exposure in a multi-asset context. In this era of constrained growth and returns, we can’t afford to ignore emerging markets and related exposures, which represent a large and growing opportunity set and more normal risk premia. But as investors, we should accept their inherent cyclicality and act accordingly.

    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 backdrop for emerging market equities has become more positive.

    North America

    -- - o + ++
    North America  

    We continue to favour US equities given their high quality characteristics in a market where resilience remains crucial.

    Our specialist equity research group has been in the process of constructing a basket of high quality stocks – US names represent a significant proportion of these.

    Europe ex UK

    -- - o + ++
    Europe ex UK  

    Material differences exist across Europe on both a regional and sector basis. On balance, we have a neutral view with valuations appearing somewhat more attractive, while the asset class has continued to see outflows.

    We remain bullish on pharmaceutical companies, which we believe represent cheap defensive stocks with the scope for growth. German real estate and Nordic banks are other areas we deem attractive, particularly the latter given attractive yields and return on equity.

    UK

    -- - o + ++
    UK  

    Our neutral stance on UK equities reflects a balance between positives and negatives for the asset class. The UK’s vote to leave the European Union has undoubtedly led to uncertainty going forward. In local currency terms, large cap UK equities have also actually rallied quite significantly since the vote which is a headwind from a valuation perspective.

    However, one of the catalysts behind this rally has been sterling weakness, and this appears likely to continue to provide support with the FTSE 100 dominated by companies with significant overseas assets and earnings.

    Japan

    -- - o + ++
    Japan  

    Japanese equities remain one of our core themes. The market continues to look cheap in valuation terms, with a price-to-book ratio of 1.05, for example. Fundamentally, there are strong buyback trends which are helping underpin the market.

    Despite the positives, we are cognisant of the strengthening yen. Also, market price behaviour is not particularly supportive, although it is by no means a material headwind.

    Asia ex Japan

    -- - o + ++
    Asia ex Japan  

    Asian equity markets do not score particularly well on our scorecards.

    The fundamentals are somewhat mixed, reflecting regional variations. We are cautious about Hong Kong and India, where a deteriorating employment outlook and central bank instability represent near term headwinds, respectively. More positively, China appears to have stabilised economically, albeit from government investment rather than private, while Indonesia has seen positive legislation changes.

    Emerging markets

    -- - o + ++
    Emerging markets  

    The backdrop for emerging market equities has become more positive. There are pockets of higher quality, valuation still looks attractive despite the rally in the first half of the year, and investor positioning still has scope to switch from being oversold. We prefer Europe, the Middle East, Africa and LatAm to Asia which is a narrower play on value.

    Emerging market economies do still continue to adjust to a structurally slower growth path, but the recent stabilisation in commodities and the currencies of these economies helps underpin the equity markets.

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

  • Bonds

    Bonds

    -- - o + ++
    Government Bonds
    North America  
    Europe ex UK  
    UK  
    Japan  
    Emerging Markets Hard Currency  
    Emerging markets Local Currency  
    Investment Grade corporate bonds  
    High Yield corporate bonds  
    The Brexit vote makes the fundamental backdrop for UK gilts particularly attractive, with the Bank of England now expected to cut interest rates

    North America

    -- - o + ++
    North America  

    US Treasuries appear expensive relative to our own projected interest rate profile and our valuation models. The asset is also heavily owned, which makes it susceptible to sell-offs and indeed limits the scope for further inflows.

    However, as a ‘high yielder’ globally, the fundamental backdrop continues to be supportive, particularly with the Fed holding back on interest rate hikes.

    Europe ex UK

    -- - o + ++
    Europe  

    Non-peripheral European government bonds are dominated by two primary counter forces which justify a neutral score.

    With yields reaching all-time lows in some countries, the bonds are very expensive. However, with the ECB buying significant amounts from a bond market that is faced with limited supply, it is difficult to see much downside in prices.

    UK

    -- - o + ++
    UK  

    The Brexit vote makes the fundamental backdrop for UK gilts particularly attractive, with the Bank of England (BoE) now expected to cut interest rates and also potentially introduce other stimulus measures.

    Relative to our predicted post-Brexit leave scenario, gilts do still appear cheap although our valuation models suggest otherwise. The asset appears overbought in the short term given the recent rally; this acts as a near-term headwind.

     

    Japan

    -- - o + ++
    Japan  

    We expect the Bank of Japan (BoJ) to cut interest rates further given the limits of what they can achieve with their quantitative easing (QE) programme. This should help underpin the bond market, but the risks appear too significant to underestimate.

    Indeed, if the BoJ was to step away from QE, prices could fall very sharply. As such, we are cautious on the prospects for further cuts in interest rates which have already rallied quite significantly.

    Emerging Markets Hard Currency

    -- - o + ++
    Emerging Markets Hard Currency  

    The emerging market complex has benefited from a degree of stabilisation in commodity prices and a more dovish Fed. Hard currency debt also benefits from relatively limited supply.

    Against a backdrop of still-attractive valuations, we have a more constructive view on the asset class overall, particularly with global institutions viewing it as an alternative to developed market high yield.

    Emerging Markets Local Currency

    -- - o + ++
    Emerging markets Local Currency  

    Like hard currency debt, sentiment around local currency debt has improved considerably which is again attributable to stable commodity prices and a more dovish Fed. However, the fundamental backdrop remains weak and has not shown any signs of material improvement.

    We believe the outlook is finely balanced and as ever with these markets, selectivity remains crucial. We have a preference for the higher quality end of the spectrum in countries like Mexico.

    Investment Grade

    -- - o + ++
    Investment Grade corporate bonds  

    Investment grade corporate bond markets are underpinned by central bank support. This is particularly clear in Europe where the ECB has started buying investment grade bonds.

    With the Fed pushing back interest rate increases, the search for yield continues and this should help support investment grade markets from a technical perspective.

    High Yield

    -- - o + ++
    High Yield corporate bonds  

    Like investment grade markets, the high yield market also stands to benefit from central bank support. The high yield space has also benefited from the stabilisation in the oil price which was not just adversely impacting energy names, but the sector as a whole.

    Valuations are not materially compelling given the rally over the past few months, although the asset class still looks attractive longer term. Further volatility appears likely, which can provide attractive entry points.

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

  • Currencies

    Currencies

    -- - o + ++
    Currencies
    US dollar  
    Euro  
    Sterling  
    Japanese Yen  
    Asia ex Japan  
    Emerging Markets  
    While the yen has rallied strongly recently, it is a currency that we still favour on balance and it does still appear relatively cheap

    US Dollar

    -- - o + ++
    US dollar  

    Fundamentally, the case for the US dollar appears attractive, with a relatively high carry, a Fed which is still expected to raise interest rates and an economy which, on balance, is slowly recovering.

    However, valuations appear neither cheap nor expensive, while investor positioning suggests the currency is likely to trade within a range.

    Euro

    -- - o + ++
    Euro  

    There are several factors to suggest potential downside for the euro. The ECB’s willingness to engineer a cheaper euro is perhaps the most significant of these, but there are also questions over the medium-term future of the European Union following Brexit, while carry is significantly negative.

    From a valuation perspective, the currency does appear fairly valued, which reduces our bearish conviction.

    Japanese Yen

    -- - o + ++
    Japanese Yen  

    While the yen has rallied strongly recently, it is a currency that we still favour on balance and it does still appear relatively cheap.

    Fundamentally, Japan’s economy is reasonably robust and if the BoJ was to step back from its QE programme, the yen has scope to rally significantly. As demonstrated in the aftermath of the Brexit decision, it also very much retains its safe haven status and can also rally strongly in bouts of risk aversion.

    Sterling

    -- - o + ++
    Sterling  

    Sterling weakness has been under the spotlight since the UK’s decision to leave the European Union. The fundamental backdrop is significantly negative, with the UK economy likely to experience a sharp economic slowdown in the short run, a large current account deficit and a BoE which is looking to cut interest rates.

    The significant sterling sell-off in the immediate aftermath of Brexit does mean valuation is not a significant headwind, although it does appear neutral at best. While the currency appears somewhat oversold, the scope for further weakness should not be ruled out.

    Asia ex Japan

    -- - o + ++
    Asia ex Japan  

    Currencies across Asia look particularly vulnerable to further downside. China has continued to devalue its currency, global economic growth is lacklustre, and many Asian economies are at the peak of their respective financial cycles.

    We expect these headwinds to be offset with easier monetary policy and as such, weakening currencies.

    Emerging Markets

    -- - o + ++
    Emerging Markets  

    Despite the recent rally, emerging market currencies still appear relatively cheap given the prolonged sell-off in the years preceding.

    Selectivity is again crucial and we are focusing on those positions where we see both strong fundamentals and attractive valuations. It is important to note that many of these economies are still adjusting to a structurally slower growth path and hence caution is warranted. The stabilisation of commodity prices can continue to be a strong tailwind.

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

Important information

This document is not for general public distribution. If you are a private investor and receive it as part of a general circulation, please contact us at +44 (0)20 7597 1900. The information discusses general market activity or industry trends and is not intended to be relied upon as a forecast, research or investment advice. The economic and market forecasts presented herein reflect our judgment as at the date shown and are subject to change without notice. These forecasts will be affected by changes in interest rates, general market conditions and other political, social and economic developments. There can be no assurance that these forecasts will be achieved. Past performance should not be taken as a guide to the future, losses may be made. Data is not audited. Investment involves risks: Investors are not certain to make profits. Where index performance is shown, this is for illustrative purposes only. You cannot invest directly in an index. Investec Asset Management does not provide legal and tax advice. The information contained in this document is believed to be reliable but may be inaccurate or incomplete. Any opinions stated are honestly held but are not guaranteed and should not be relied upon. This communication is provided for general information only and is not an invitation to make an investment nor does it constitute an offer for sale. This is not a recommendation to buy, sell or hold a particular security. No representation is being made that any investment will or is likely to achieve profits or losses similar to those achieved in the past, or that significant losses will be avoided. The securities or investment products mentioned in this document may not have been registered in any jurisdiction. In the US, this communication should only be read by institutional investors, professional financial advisers and, at their exclusive discretion, their eligible clients, but must not be distributed to US persons apart from the aforementioned recipients. In Australia, this document is provided for general information only to wholesale clients (as defined in the Corporations Act 2001). In Hong Kong, this document is intended solely for the use of the person to whom it has been delivered and is not to be reproduced or distributed to any other persons; this document shall be delivered to institutional and professional investors only. It is issued by Investec Asset Management Hong Kong Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong. The Company’s website has not been reviewed by the SFC and may contain information with respect to non-SFC authorized funds which are not available to the public of Hong Kong. In Singapore, this document is for professional investors, professional financial advisors and institutional investors only. In Indonesia, Thailand, The Philippines, Brunei, Malaysia and Vietnam this document is provided in a private and confidential manner to institutional investors only. In South Africa, Investec Asset Management is an authorised financial services provider. Investec Asset Management Botswana, Unit 5, Plot 64511, Fairgrounds, Gaborone, Botswana, is regulated by the Non-Bank Financial Institutions Regulatory Authority. In Namibia, Investec Asset Management Namibia (Pty) Ltd is regulated by the Namibia Financial Institutions Supervisory Authority. This is the copyright of Investec and its content may not be reused without Investec’s prior permission. Outside the US, telephone calls may be recorded for training and quality assurance purposes. Issued by Investec Asset Management, February 2016.