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  • Market review

    Market review

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    The first quarter of 2018 was characterised by significant bouts of volatility, resulting in predominantly negative returns across Growth assets

    The first quarter of 2018 was characterised by significant bouts of volatility, resulting in predominantly negative returns across Growth assets. After rallying strongly for most of January, equity markets reversed sharply at the end of the month, leading to a material short-term drawdown across most markets, followed by choppy returns for the rest of the quarter. UK equities posted high single-digit negative returns, accentuated by sterling strength. Japanese and European equities followed closely behind, while US equities fared relatively better. High yield markets posted modestly negative returns with spreads widening and the US outperforming Europe. Emerging market hard currency debt ended the quarter lower, while local currency debt posted positive returns. Property securities endured a difficult period, while commodities posted mixed returns with the move higher in Brent oil to over US$70 per barrel noteworthy.

    Within Defensive assets, the period was marked by a broad-based sell off in government bonds over January and February largely driven by higher inflation concerns, albeit with some consolidation in March. After a protracted period of benign volatility, implied volatility spiked significantly higher in equity markets with other asset classes witnessing a less pronounced increase. The Japanese yen rallied significantly, the US dollar had another weak quarter, while the euro posted mixed performance. US LIBOR1 rates rose significantly, reaching levels not seen since 2009.

    Within Uncorrelated assets, gold posted modestly positive returns. Infrastructure assets had a difficult quarter with concerns around political risk, higher bond yields and the collapse of a prominent construction company weighing on sentiment, resulting in broad-based weakness.

    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 31.03.18.

    Key themes for the coming 6-12 months


    • Transition in financial markets – positive economic conditions and corporate earnings offset by tighter liquidity and late-cycle concerns
    • Improved cyclical environment for EM – benefiting from positive domestic macroeconomic adjustments and softer US dollar environment
    • China supply-side reform – progress being made in improving quality of economic growth and corporate profitability

    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 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, April 2017.

  • A letter from your PM



    The ‘Great Restructuring’

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

    Philip Saunders

    Much of the recent Western narrative about China has focused on its intractable debt problem – 240% of GDP at the last count – and its reversion to an autocracy. We believe that both of these concerns miss what is really unfolding, which is of great significance from an investment perspective. In fact, it has prompted us to take advantage of recent equity market weakness to build exposure in Chinese H shares, but more on that in a moment.

    Since 2006, it has become increasingly apparent that China’s post 1978 growth model had become increasingly unsustainable. It depended on substantial state investment in infrastructure and heavy industry, coupled with property investment and manufacturing for export. The pace of urbanisation was extraordinary and China became the ‘workshop of the world’. However, high growth rates became ever more dependent on debt and capital productivity declined. Under Jiang Zemin (1993-2003) and Hu Jintao (2003-2013) there was plenty of talk about reform but little actual progress. Threats of economic weakness were met with more economic stimulus and more debt, the most spectacular example of this coming in response to the global financial crisis in 2009.

    Under President Xi, reform momentum has been restored and this has notably been the case in his second term. In fact, his first term saw him focus on securing the levers of power via the campaign against corruption, which culminated in the abolition of term limits for the presidency. This will allow him to see through the reform process. Evidently, he understands the debt and environmental challenges that China faces well and has reorganised the Chinese Communist Party (CCP) and government in addition to appointing an impressive cadre of technocrats. This includes Liu He, as his leading economic advisor and Yi Wang, as governor of the Bank of China, to implement far reaching reforms to reshape China and its economy.

    If successful, these initiatives will increasingly redirect the economy on to a new path. This will be characterised by consumer-sector-led growth, a hybrid banking and capital markets financial system, reform of the state owned enterprise (SOE) sector and greater integration with the world economy and financial system. In effect this is a ‘Great Restructuring’ and represents a profound shift in focus from volume to value and from quantity to quality. The objective is to allow the ‘new economy’, and more targeted demand management, to sustain growth, while undertaking significant supply side reforms in the SOE sector to dramatically reduce debt dependence and poor capital productivity.

    We believe that such a course of change and renewal makes Chinese assets much more investable. In the past, the way to convert the impressive Chinese macro story into returns has been to focus not on Chinese assets, but those of suppliers to China, such as resource stocks, resource producing economies or exporters of capital and consumer goods. Sure, ‘digital leaders’, such as Tencent and Alibaba, have delivered impressive returns, but they have been the exceptions to the general rule. But this is changing and, to judge by Chinese equity valuations, that change is not reflected in prices. Chinese capital markets are opening up rapidly and the quality of many Chinese companies is improving. The country has significant net foreign assets, a high level of domestic savings and a stable currency. Its financial assets are in the process of becoming significant and investable components in global indices. Over the longer term, a selective focus on quality Chinese companies, rather than general beta allocations seems to be the sensible way forward, but in the shorter term, H shares listed in Hong Kong, which have a heavy bias to SOEs and financial sector companies in particular, are ripe for a rerating as investors start to better understand the course that China is currently on.

    Philip Saunders
    Co-head of Multi Asset Growth

  • Equities

    Equities

    ---o+++
    Equities
    North America  
    Europe ex UK  
    UK  
    Japan  
    Asia ex Japan  
    Emerging markets  
    Emerging market equities are supported by the relatively robust late cycle environment, characterised by US dollar weakness and upward pressure on commodity prices

    North America

    -- - o + ++
    North America  

    The recent volatility and sell-off from the technology sector has resulted in a period of consolidation for US equities following a protracted rally. Valuations continue to appear relatively stretched, but remain justified by strong earnings revisions. 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 cash-generating abilities.

    Europe ex UK

    -- - o + ++
    Europe ex UK  

    Fundamentals remain relatively supportive, with strong sales growth and a generally more supportive macroeconomic backdrop for the euro-zone, although this has moderated lately. 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 Italy do 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 as the underperformance in the first quarter demonstrated. 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 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. 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  

    For Asian equities broadly, fundamentals are still weak relative to other emerging markets and structural issues continue to act as a constraint, as reflected by our score.

    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, leading us to take a more constructive view about 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, characterised by US dollar weakness and upward pressure on commodity prices. Valuations are also undemanding versus history and attractive relative to developed markets.

    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 31.03.18.

  • 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 moving higher together, accelerating inflation) or the expansionary fiscal programme could, however, still put upward pressure on yields, as was the case in the first quarter although we would anticipate this to be short lived.

    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.

    However, the recent moderation in economic data and related shift in ECB rhetoric to remain more accommodative does mean the risks appear more balanced. We favour areas of the periphery, such as Spain, where yields reflect a risk premium which appears unwarranted relative to other areas such as Italy.

    UK

    -- - o + ++
    UK  

    The Bank of England looks set to hikes rates again in May, and this is very much priced in by markets. The main reason for hikes appears to be the higher inflation environment although with sterling rallying recently, this looks unlikely to persist.

    The economy also remains under pressure with economic growth slowing as real disposable income is squeezed. Our interest rate profile is below that of the market’s forecast making UK gilts attractive.

    Japan

    -- - o + ++
    Japan  

    The Japanese government bond market remains largely dominated by the Bank of Japan, 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  

    Our view on emerging market hard currency bonds has moderated recently, primarily due to the rising Libor rate environment, and the related likely rotation from leveraged ‘yield tourists’ as the relative appeal of less risky assets increases. Risks also still remain from the increased protectionist agenda from the US.

    Like other emerging market assets, the fundamentals remain relatively positive on balance, but the aforementioned headwinds make us cautious on balance.

    Emerging Markets Local Currency

    -- - o + ++
    Emerging Markets Local Currency  

    Broadly speaking, we are constructive on the outlook for emerging market local currency bonds. 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 Behaviour with central bank investment grade bond purchases. However, on balance, this is more than offset by expensive valuations with corporate spreads looking tight, while flows appear less supportive than last quarter.

    In absolute terms, caution is warranted shorter term given any upward yield pressure from government bonds, although our longer-term view is for yields to remain anchored.

    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 supportive from the perspective of central bank buying of investment grade providing an indirect support, but less so in terms of investors flows.

    Valuations are again the main constraint with spreads against government bonds particularly tight. The asset class remains a beneficiary of the late cycle environment but as history has proven, 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 31.12.18.

  • 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

    US Dollar

    -- - o + ++
    US dollar  

    While the US dollar is helped by robust economic growth and tightening monetary policy, the currency remains relatively expensive with downside pressure from a growing twin deficit.

    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  

    The euro has started 2018 trading within a range which is in line with our expectations. ECB normalisation and attractive valuations still support the currency, while much of the good news from positive economic data appears priced in.

    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 relatively cheap, investor positioning is 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 to tactically position ourselves when the currency approaches the end of a 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.

    Attractive valuations still support the currency, while much of the good news from positive economic data appears priced in. 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.

    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 while the support from a weaker US dollar and China should also prove helpful.

      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 31.12.18.

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