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  • Market review

    Market review

    Download PDF Indicator

    The final quarter of 2017 saw positive returns from Growth assets yet again with equities, in particular, performing strongly

    The final quarter of 2017 saw positive returns from Growth assets yet again with equities, in particular, performing strongly, continuing the trend from the first three quarters of the year. Japanese equities, supported by buoyant economic data, led the way with emerging market equities following close behind. US equities returned mid-single digits to finish the year having achieved positive returns in every month of the year for the first time ever, while UK equities also posted positive returns. European equities, however, lagged the other markets with the prospect of political instability in Spain and Italy weighing on returns. High yield bonds churned out a small positive return, while both local and hard currency emerging market debt finished off a strong year by posting modest returns. Property securities globally generated decent returns, led by the UK, while commodities continued their recent resurgence driven by the price of Brent oil passing US$60 a barrel.

    For Defensive assets, the main movements of note related to the flattening of the yield curve across most major government bond markets, as market participants started to re-adjust their expectations of inflation and future monetary policy. Implied volatility across multiple asset classes continued to remain at subdued levels, in keeping with most of 2017. The US dollar and the Japanese yen had middle-of-the-pack performance among other G10 currencies, with the euro and sterling generally strengthening relative to other developed market currencies, while emerging market currencies broadly outperformed.

    Within Uncorrelated assets, a rally towards the end of December resulted in reasonable returns for gold over the period, while within infrastructure, concerns around the potential impact of a changing political backdrop globally led to a wide dispersion of returns with those companies most exposed to this risk underperforming.

    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 31.12.17.

    Key themes for coming 6-12 months

    • Global growth self-reinforcing - The global economy appears to have achieved ‘escape velocity’ from post GFC stagnation.
    • Chinese growth to moderate - We expect this to be orderly, with rebalancing in favour of the domestic and service sector continuing.
    • Less accommodative monetary policy - While the US is already reducing its balance sheet, Europe and Japan have just begun to do so and we expect this to accelerate.

     

     


    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

    The information may discuss 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 views presented herein reflect Investec Asset Management’s (‘Investec’) judgment as at the date shown and are subject to change without notice.There is no guarantee that views and opinions expressed will be correct, and Investec’s intentions to buy or sell particular securities in the future may change. The investment views, analysis and market opinions expressed may not reflect those of Investec as a whole, and different views may be expressed based on different investment objectives. Investec has prepared this communication based on internally developed data, public and third party sources. Although we believe the information obtained from public and third party sources to be reliable, we have not independently verified it, and we cannot guarantee its accuracy or completeness. Investec’s internal data may not be audited

  • A letter from your PM



    Turning Japanese?

    I really think so.

    - A letter from Philip Saunders

    Philip Saunders

    For some time, Japan has been dismissed as irrelevant by Western investors. The standard view was that Japan was a special case, plagued by terrible demographics, eyewateringly high levels of government debt and endemically slow growth. In the face of these challenges, the attempt by Prime Minister Shinzo Abe to revive Japan via policies that had come to be dubbed ‘Abenomics’, was widely dismissed. Japan’s relative decline appeared even starker when compared to the rise of its more dynamic neighbour, China. In terms of assets, the Japanese yen was regarded as perennially weak and interesting only as a funding currency1. Japanese bond yields were low and hopelessly distorted by monetary policy. The majority of Japanese companies were content with a return on equity (RoE) way below international norms. Furthermore, the weight of the Japanese market in global equity indices had declined to the point of immateriality.

    In most senses these are stale views and a more current and objective view of Japan is quite revealing. Rather than being a special case, Japan has already had to confront many of the problems that other developed and emerging economies are doomed to face over time. These are primarily a function of ageing populations with their accompanying decelerating growth rates, entrenched disinflationary forces and rising demands on government expenditure. Whereas Japanese government debt levels are uncomfortably high, interest rates and hence debt service costs are low. In stark contrast to most other developed nations, Japan’s corporate and household sectors have been deleveraging for the past 25 years. Given the improved state of the corporate, financial and household balance sheets, Japan’s financial health has improved while its debt is internally funded. Indeed, it remains a strong creditor nation in terms of net foreign assets. In recent years, deflation has moderated to the extent that prices are now rising, albeit modestly, and growth has been running comfortably above trend. Japan runs material trade and current account surpluses and is a beneficiary of lower oil prices.

    Given such a constructive macro backdrop, it is somewhat surprising that the yen is the cheapest of the major currencies. Our estimates would indicate that the currency is in the order of 15% below fair value, making it one of the most attractive ‘Defensive’ assets currently available to investors. Historically, when ‘Growth’ assets have sold off materially, the yen has rallied strongly. The fact that it is languishing has much to do with the Bank of Japan’s (BoJ) aggressive policy of capping interest rates at very low levels, but assumptions that this will not change could be unwise. After all, at 2.7%, Japan’s unemployment rate is now at a 24-year low, indicating limits to economic capacity. In fact, things are changing already in the form of a sharp decline in BoJ purchases of Japanese government bonds required to maintain rates at 0%.

    The Japanese equity market has continued to deliver globally competitive returns at the index level as well as offering some of the best alpha potential internationally. The Topix Index’s advance of 19.7% in local currency terms actually lagged earnings growth which at over 20% was higher than other developed markets. The primary driver of this earnings growth has been the robust global economy given Japan’s position as the most operationally geared major global market. If earnings meet our expectations, it is likely that Japan will exceed the peak RoE achieved in the last cycle due to the greater focus by companies on profitability, balance sheet efficiency and corporate governance. This increased emphasis on shareholder returns has formed part of the core thesis for our allocation to this market since 2013.

    Philip Saunders
    Co-head of Multi Asset Growth

    1In a carry trade, an investor will typically take a short position in a funding currency, which often has a low interest rate, with an offsetting long position in a currency offering higher interest rates. The investor therefore benefits from the difference in rates.

  • Equities

    Equities

    ---o+++
    Equities
    North America  
    Europe ex UK  
    UK  
    Japan  
    Asia ex Japan  
    Emerging markets  
    US equity valuations continue to move higher and appear relatively stretched. However, strong earnings revisions help justify these levels

    North America

    -- - o + ++
    North America  

    US equity valuations continue to move higher and appear relatively stretched. However, strong earnings revisions help justify these levels. Broadly, US equities continue to offer high quality. While the US Federal Reserve (Fed) is now in the process of actually shrinking its balance sheet, the pace of this, together with interest rate rises, should be gradual.

    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 are continuing to improve, with strong sales growth and a generally more supportive macroeconomic backdrop for the euro zone. Valuations do not yet appear a constraint to further upside.

    Longer term, any normalisation from the European Central Bank (ECB) through tapering is a potential headwind, while political risks from countries such as Spain and Italy do still remain, although they are somewhat more contained.

    UK

    -- - o + ++
    UK  

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

    The direction of the market has largely been governed by moves in sterling. Uncertainty remains around Brexit negotiations, and evidence has emerged of more significant concerns for the real economy as inflation continues to rise.

    Japan

    -- - o + ++
    Japan  

    Japanese equities remain one of our core themes. Valuations continue to appear attractive and fundamentally there are strong stock buyback trends providing attractive opportunities at the company level. We are focused on companies with improving profitability driven by ‘self-help’ initiatives including capital efficiency.

    Longer term, yen strength is a concern although it would take a meaningful move higher from current levels for this to become a significant hindrance.

    Asia ex Japan

    -- - o + ++
    Asia ex Japan  

    Fundamentals are still weak relative to other emerging markets and structural issues continue to act as a constraint.

    In China, we have pared back our conviction somewhat, although we continue to look for companies that stand to benefit from the country’s reforms, economic rebalancing and supportive valuation.

    Emerging markets

    -- - o + ++
    Emerging markets  

    Valuations have normalised somewhat across emerging market equities after a protracted period of looking relatively attractive. Fundamental momentum has also weakened, although there are no real signs of any significant strain.

    We note that price momentum is falling across regions, particularly areas like Latin America, emerging Europe, the Middle East and Africa.

      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 31.12.17.

  • Bonds

    Bonds

    ---o+++
    Government Bonds
    North America  
    Europe ex UK  
    UK  
    Japan  
    EM Hard Currency  
    EM Local Currency  
    IG Corporate Bonds  
    HY Corporate Bonds
    With the euro-zone economy improving and the ECB likely to taper, yields are unlikely to fall much lower and bonds appear relatively expensive

    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 continues to recover steadily and the Fed is slowly normalising monetary policy, much of this is already priced into US Treasuries, particularly further out along the curve.

    An unexpected bout of second round inflationary pressure (prices and wages moving higher together, accelerating inflation) or large unfunded tax cuts could however still see upward pressure in yields.

    Europe ex UK

    -- - o + ++
    Europe ex UK  

    With the euro-zone economy improving and the ECB likely to taper, yields are unlikely to fall much lower and appear relatively expensive.

    We would note that while the ECB’s withdrawal of stimulus appears likely to accelerate, it will also likely remain gradual. We believe markets are overestimating the uptick in inflation and we expect this to fall back in coming months with core measures still challenged.

    UK

    -- - o + ++
    UK    

    After a period of looking relatively cheap, shorter-dated UK Gilts now appear fairly valued following the Bank of England’s first interest rate increase in 10 years.

    We still remain cautious about longer-dated Gilts which appear vulnerable to looser fiscal policy against the backdrop of a weak economy.

    Japan

    -- - o + ++
    Japan  

    The Japanese government bond market remains largely dominated by the BoJ, with measures such as direct yield targeting limiting the scope for yields to move either way in the short term.

    However, we expect to see scope for the Bank to shift its yield target higher or to reduce bond purchases as the Japanese economy strengthens.

    Emerging Markets Hard Currency

    -- - o + ++
    Emerging Markets Hard Currency    

    Opportunities exist for more growth-oriented, short-duration names and demand from institutional investors remains high. However, valuations are somewhat stretched and are less attractive relative to both local currency bonds and their own history.

    The Fed’s rate hiking cycle presents some challenges for hard currency debt, particularly as inflationary pressures pick up.

    Emerging Markets Local Currency

    -- - o + ++
    Emerging Markets Local Currency  

    Broadly speaking, we are constructive on the outlook for emerging market local currency bonds, particularly in currency hedged terms. In several key markets, we see a positive cyclical and structural inflation story which should prove supportive.

    Investor flows have also been very strong of late, and the broader market does not appear too heavily owned, broadening the scope for this to continue.

    Investment Grade

    -- - o + ++
    IG Corporate Bonds    

    Fundamentals are positive, with favourable leverage and corporate earnings trends, as is Market Price Behaviour2 with central bank investment grade bond purchases and healthy investor flows. However, on balance, this is more than offset by expensive valuations with corporate spreads looking tight.

    Caution is warranted as upward yield pressure on government bonds could subsequently put pressure on the asset class, particularly as the Fed continues to hike interest rates.

    High Yield

    -- - o + ++
    HY Corporate Bonds  

    Like with the investment grade markets, the fundamentals are sound, with strong leverage and corporate earnings dynamics, while Market Price Behaviour is still very supportive with central bank buying of investment grade providing an indirect support and net issuance being negative.

    However, valuations are again a constraint with spreads against government bonds particularly tight. The positive growth environment and tailwinds do help support the asset class shorter term.

      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 31.12.17. 2Takes into account factors such as reaction of prices to news, changing investor expectations and the level of asset ownership.

  • 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

    US Dollar

    -- - o + ++
    US dollar  

    While the US dollar is helped by robust economic growth and tightening monetary policy, the currency remains relatively expensive, although less so than at stages of 2017.

    Although the currency could see a short-term bounce, we believe the tailwind of higher rates is in the price and other opportunities elsewhere appear more attractive.

    Euro

    -- - o + ++
    Euro  

    We are neutral on the euro, with the positive and negative cases evenly balanced. Faster economic growth and attractive valuations still support the currency, although current investor positioning is for further appreciation.

    More broadly, medium-term risks lie to the downside due to structural concerns about weak inflation and wages, where any upside pressure has typically been fairly limited and transitory.

    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 is very cheap, particularly against the US dollar.

    The currency also remains attractive as a Defensive asset and, as such, is a useful hedge for our portfolios, particularly as we reach the later stages of the business cycle.

    Sterling

    -- - o + ++
    Sterling  

    While sterling remains cheap, investor positioning is now long against a backdrop of a fragile economy which is still grappling with the potential fallout from Brexit negotiations.

    Given the current price action, our preference is tactically to position ourselves when the currency approaches the cheaper levels of its trading range.

    Asia ex Japan

    -- - o + ++
    Asia ex Japan  

    Asian currencies still look particularly vulnerable to further downside. We view these currencies as expensive while investor positioning is long.

    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.

    Emerging Markets

    -- - o + ++
    Emerging Markets  

    Like other emerging market assets, several currencies have enjoyed a strong run of late meaning valuation is not as attractive on a broad-based level.

    In an asset class with significant regional variations, we remain positive on select, attractively valued currencies. More broadly, a synchronised global recovery in economic growth points to reduced downside risk.

      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 31.12.17.