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SUMMER OUTLOOK

July 15, 2019 in News & Events

SUMMER OUTLOOK

REVIEW OF THE PAST QUARTER: Just as global growth has started to stabilise, it is at risk of being derailed by multiple headwinds. Uncertainty is very much the narrative this quarter as political risks heightened, causing markets to become even more jittery. The hardball style of the self-proclaimed ‘Tariff Man’, US president Donald Trump, has seen the US-China resolution blow up, and while trade talks are scheduled to restart, whether a meaningful outcome will emerge remains unclear. Elsewhere, additional sanctions will be applied by the US to Iran in response to Iran shooting down a US drone. As a result, supply-shortage fears have pushed up the price of oil.

Meanwhile the US Federal Reserve (the Fed) has continued to take a hands-off approach, hesitant to not tinker with a fragile global system. However, compared to the prior quarter the market is convinced that the Fed will relax its stance and apply interest rate cuts this year. Over in the eurozone, the region continues to be hampered by political risk. Italy and the EU restarted their conflict over the nation’s refusal to curb public spending. The key difference this time is that populist support has swelled to such an extent that Italy is comfortable with not backing down from EU threats. In the UK, it has been an eventful quarter as Theresa May relinquished power after repeatedly failing to get parliament on board with her withdrawal bill. Boris Johnson is in pole position to be new prime minister.


THE ACTUARIAL VIEW: Markets look to have well and truly recovered from their December meltdown, it is not clear though whether this has been driven by improvements in the prospects for the underlying businesses, or simply that any alternatives have got worse. The news can be difficult to keep track of, with ongoing political and economic uncertainty. Yet some GDP figures have turned out better than expected, which has indubitably provided a boost. While forecasts were predicting a slowdown, what the actual results revealed was a slightly slower slowdown, so it was hardly all good news. The International Monetary Fund is forecasting global growth projections will be at their lowest level since the financial crisis. On balance it seems that negative news outweighs the positive.

From a modelling point of view this translates into assets being more expensive than they were previously, with no improvement in the underlying prospects. This means only modest changes to the asset allocation models themselves. There are some relative changes – for example, emerging markets were slightly less affected, meaning we can be slightly more positive on them. The biggest change is that cash now looks a better prospect over the short term than bonds. thanks to the risk/reward trade off.


WHAT TO LOOK FOR IN Q3:

  • UK: The Monetary Policy Committee (MPC) announcements and minutes, along with an inflation report, are to be released on 1 August.
  • US: There will be interest rate decisions from the Federal Open Market Committee (FOMC) on 30-31 July. Minutes will be published three weeks after each decision. The FOMC projection for inflation and economic growth is due 18 September. Non-farm payrolls, which indicate wage growth, are set to be released on 1 August.
  • Europe: Quarterly GDP estimated data is set to published on 31 July. A European Central Bank Monetary policy meeting has been arranged for 25 July.
  • Other data: China year-on-year GDP growth and industrial production is to be released 15 July.

Most Likely: With central banks holding interest rates constant amid recessionary fears, the potential for rate cuts has increased, which could be positive for UK equities. However, this will likely be outweighed by negative investor sentiment as UK businesses stop stockpiling and political uncertainty heightens following the extended Brexit deadline and hardliner Brexiteer Boris Johnson potentially in the PM role, which increases the threat of no deal. UK equities will thus likely lag their developed market peers and could well see a softer quarter, especially given the solid start to the year we have witnessed.

Worst Case: The UK leaving the EU with no deal (more likely under a Johnson PM-ship), followed by a surprise interest rate hike as inflation sets in, would likely see a broad sell-off in UK equities, given the long-term headwinds, increased recessionary risks and negative sentiment toward the UK economy this outcome would imply.

Best Case: With the probability of another referendum significantly lower with two pro-leave PM candidates, a soft deal would likely be the best outcome of the possible Brexit option-set – this is what markets have largely been expecting. Coupled with an interest rate cut, this would be particularly positive for UK equities.




Most Likely: The market expects the Fed to cut interest rates over the summer as economic data in the US weakens. We expect trade war tensions and political uncertainty to persist, potentially weakening investor sentiment. In Europe, economic growth is resilient; however, the political environment remains fragile, meaning further uncertainty for markets. Overall, we expect volatile periods of performance for global equity markets over the summer.

Worst Case: US president Trump continues to threaten other nations with sanctions and trade spats, resulting in downward pressure on markets. Political sentiment in Europe continues to worsen with the Brexit deadline looming and Italy’s budget controversies continuing, potentially weakening investor confidence.

Best Case: President of the European Central Bank Mario Draghi has spoken of the possibility of further easing, indicating to markets the European Central Bank will support markets if necessary. This extends to other regions, as in both the US and Japan monetary policy remains accommodative. Trump changes tact on his approach to trade and international relations, easing tensions.





Most Likely: Sentiment towards emerging markets is likely to remain positive as the Fed adopts a more dovish stance. The outcome on the US-China trade deal is yet to be reached so more trade-sensitive areas could be volatile in the meantime.

Worst Case: Any disappointment on the trade front or the market pricing in fewer than three rate cuts would be a negative catalyst. Sensitive areas like China and South Korea look particularly vulnerable where growth is already slowing before accounting for potential trade-conflict effects. Elsewhere, execution risk looms in Brazil around political reforms and results are required to justify high expectations.

Best Case: Sentiment would improve further if a US-China deal is reached. The market’s expectations of at least three interest rate cuts in the US should prove most beneficial to Brazil, Turkey and Argentina. India appears especially compelling under its prime minister, Narendra Modi, who secured a second term with a bigger majority, ensuring a continuation of his pro-market reforms, which could attract more investment into the country.

Most Likely: Following the signal sent by the Fed to financial markets, the BoE has also signaled its intention to maintain its interest rate policy for a while. Core inflation should remain within the 2 per cent to 2.5 per cent range, which means returns from cash remain negative. Headline inflation is unlikely to come down significantly over the coming quarter due to UK sterling’s weakness and lack of labour force.

Worst Case: The worst-case scenario for cash savers is that inflation continues to rise with cost-push pressures at the fore. Another likely headwind is UK sterling weakness as Brexit negotiations turn sour and imported inflation compounds woes, with the BoE refraining from further tightening for the already weakened consumer.

Best Case: Any progress in Brexit negotiations could well be taken by the BoE as a signal to continue tightening, especially if wage growth surprises to the upside. In such a scenario, returns to cash would improve, despite staying negative. Similarly to government bonds, cash could also act a safe-haven with financial markets being undermined by global trade tensions.






Most Likely: Which central bank will cut its interest rates first? Expectations for the Fed to cut interest rate levels are high, while the US economy is showing resilience. The returns on bond markets are likely to stay volatile as investors will wait for any indication of a recession. With the risk of increasing interest rates being limited, credit markets might outperform if companies keep on improving their balance sheets.

Worst Case: After several years of monetary stimulus, we might have reverted to a normal situation where any sign of wage growth and inflation is bad news for bond markets. Markets have quickly interpreted the Fed’s recent decisions as: the recession is down the road. Any sign that global economies are nowhere near recession could bring yields up, which will drag both government and corporate bond markets. The oil price and the relations with Iran could also be negative.

Best Case: Bond markets might have already priced in negative news – as such the upside is now limited. But political uncertainty will continue to act as a drag on bond yields, anchoring the investors’ expectations to lower levels from current ones. Companies might further delay their capital expenditure decisions and lower their debt level. The low level of debt supply relative to demand might boost bond prices.







Most Likely: In the UK, as for the past three years, Brexit talks are dominating sentiment and we should see returns in the sector closely linked to news coming out. Elsewhere, with interest rates still low compared to property yields, further progress should be made, and a weakening pound will help the overseas investments of UK investors.

Worst Case: A softening in the US economy and the Fed cutting interest rates would be negative signals for US property investors and could spill over to the rest of the world. In mainland Europe, Germany dominates the market and further rent-control news could undermine investors’ sentiment. The UK could follow the US path if the likelihood of a no deal materialises and signs of a recession show.

Best Case: A resolution (or even the perception of a resolution) to the chaotic Brexit negotiations with the EU would lift uncertainty off investors’ shoulders and, provided the outcome is a trade deal, would give reassurance about the future of the UK economy. On the other side of the pond, an interest rate cut could reinvigorate the market by making mortgages more affordable.

SPRING OUTLOOK

April 4, 2019 in News & Events

Spring Outlook

REVIEW OF THE PAST QUARTER:
Markets have rebounded from last quarter’s selloff as investor sentiment picked up. This has been driven by a perceived change of heart at the US Federal Reserve where it is expected they will stop hiking rates and become more cautious. In addition, thawing tensions between the US and China have helped boost hopes of a deal but key stumbling blocks, such as digital trade, remain and could yet see hostilities drag out.

Political uncertainty remains high in the UK, with there still being no clear plan on how to deliver Brexit, despite the two-year Article 50 deadline coming and going. Although the European Union have agreed to extend the deadline, there is a still a chance the country crashes out with no-deal, if it is unable to agree any alternative.

Meanwhile in commodities, both iron ore and oil prices have been surging, albeit for different reasons. A tragic dam collapse at an iron ore mine in Brazil led to concerns of a supply crisis, which in turn helped fuel iron ore prices to a peak of US$88/per tonne. Oil’s resurgence was down to deliberate supply cuts by Opec (the Organisation of the Petroleum Exporting Countries) starting to materialise. In more worrisome news, prices have also been influenced by the deteriorating conditions in Venezuela.

THE ACTUARIAL VIEW:
A global economic slowdown has been on the horizon for a while now; recently however there has been evidence that a hard landing is in the offing. Much of this risk has been caused by politicians, whether it be over Brexit in the UK or US president Donald Trump and the ongoing US-Chinese trade war across the Atlantic. Not all the gloom is AngloAmerican however, as Germany only narrowly avoiding a recession.


Globally, interest rates are down, making bonds look less attractive. In the UK the FTSE is forecast to pay out a 5 per cent yield this year, an astonishingly high amount with bond yields so low and illustrating the attractive valuation of the UK equity market. Doubtless Brexit uncertainty has been responsible for the low valuations. When combining the valuations with the preponderance of overseas revenue in the index, it is clear the UK market provides significant protection against all but the most severe scenarios. With this in mind there has been a significant increase in the UK allocations into the models at the expense of global equities. In short-term portfolios there has been a move into cash and away from bonds – this is due to the increased downside in bonds and better relative returns from higher risk assets.

WHAT TO LOOK FOR IN Q2:
UK: Monetary Policy Committee (MPC) announcements and minutes, along with an inflation report, are to be released on 2 May. Brexit timelines have been extended until 12 April at the minimum.

US: There will be interest rate decisions from the Federal Open Market Committee on 30 April-1 May. Minutes will be published three weeks after each decision. Year-on-year core inflation rate is published on April 10. Non-farm payrolls, which indicate wage growth, are set to be released on 5 April.

Europe: Quarterly GDP data is set to published on 30 April. A European Central Bank Monetary Policy meeting has been arranged for 10 April.

Other: India’s general election is set to start on 11 April in seven phases and end on 23 May, whereupon a new prime minister will be elected. South Africa’s general election is set for 8 May.

ASSET CLASS SCENARIOS:

Most Likely: With three deals rejected and the Democratic Unionist Party’s (DUP’s) lack of support for a fourth, the path forward is unclear. If the government can’t find some compromise that can attract support, they have until 12 April to decide on either a longer extension to Article 50, or no deal. Under pressure to avoid a no-deal scenario, a longer extension period is agreed. Avoiding a no deal will be reprieve enough to spark a relief rally for equities and UK sterling, though this may not be long lasting given the underlying uncertainty about the UK’s future that will still prevail.

Worst Case: During the extended Article 50 period May buckles under pressure from hard-line Brexiteers who are averse to a longer extension and gives in to no deal, which remains the worst outcome for UK equities and Sterling, both of which would see a broad sell-off with multiple longterm headwinds.

Best Case: Parliament approves a deal. The avoidance of a no-deal scenario, combined with clarity on what Britain’s future looks like, will be positive for both UK sterling and UK equities, outweighing the headwind to large caps from the stronger pound.

Most Likely: Following the signal sent by the US Federal Reserve to financial markets, the Bank of England has also signaled its intention to maintain its interest rate policy for a while. Core inflation should remain within the 2 per cent to 2.5 per cent range, which means returns from cash remain negative. Headline inflation is unlikely to come down significantly over the coming quarter due to cost pressures from a range-bound oil price.

Worst Case: The worst-case scenario for cash savers is that inflation continues to rise with cost-push pressures at the fore. Another likely headwind is UK sterling weakness as Brexit negotiations turn sour and imported inflation compounds woes, with the Bank of England refraining from further tightening for the already weakened consumer

Best Case: Any progress in Brexit negotiations could well be taken by the Bank of England as a signal to continue tightening, especially if wage growth surprises to the upside. In such a scenario, returns to cash would improve despite staying negative. Similarly to government bonds, cash could also act a safe haven, with recession kicking in for the US.

Most Likely: As the US Federal Reserve isn’t planning to hike rates through 2019 we expect investors to make the most of the last legs of the bull run, particularly as the trade tensions seem to have eased (for now) between the US and China. This back and forth from the US Federal Reserve, Brexit and trade spats will likely bring further volatility in the quarter to come.

Worst Case: The trade spat between China and the US reignites and adds downward pressure to markets. The populist parties take the lead in the European parliamentary elections and either nothing gets done as they can’t agree, or they push forward with their populist promises, which could hurt sentiment towards European equities. On top of this, as the tax cut benefit wears off and the likelihood of disappointment from earnings increases, the downside potential for US equities rises.

Best Case: Despite the ‘gilets jaunes’ protests in France, financial markets recovered from the turmoil of Q4 2018 in Q1 2019; however, the European Central Bank is unlikely to shift from its easy monetary policy, as inflation remains below target. Trade tensions keep to a minimum and the world keeps on turning – despite US president Trump’s best efforts to the contrary.

Most Likely: The highlight of central banks’ meetings last month was the indication of a more patient approach to any future adjustments to the interest rate levels in the world. The returns on bond markets are likely to stay volatile as investors will wait for any indication of a recession or latestage cycle. With the duration risk being limited, credit markets might outperform if companies keep on improving their balance sheets.

Worst Case: After several years of monetary stimulus, we might have reverted to a normal situation where any sign of wage growth and inflation is bad news for bond markets. Markets have quickly interpreted the US Federal Reserve’s recent decisions as an indication a recession is coming soon. Any sign that global economies are nowhere near recession could bring yields up, which will drag both government and corporate bond markets.

Best Case: Bond markets might have already priced in negative news – as such, the downside is now limited. But political uncertainty will continue to act as a drag on bond yields, anchoring investors’ expectations to lower levels from current ones. Companies might further delay their capital expenditure decisions and lower their debt level. The low level of debt supply relative to demand from institutions might drag yields lower

Most Likely: Sentiment towards emerging markets is likely to improve further and equities could end the quarter in positive territory as the US Federal Reserve has signalled a pause in rate rises. While US president Donald Trump delayed the 1 March tariff deadline, the consensus appears to suggest that a trade deal will go ahead; however, until it is reached there could be some volatility.

Worst Case: If a US-China trade deal is not reached, emerging markets and in particular the more sensitive regions to global trade are likely to reverse their strong upward advance. This quarter will see general elections in India, and the rupee has traded high on optimism that the government, led by Indian prime minister Narendra Modi, will be reelected. Any disappointment is likely to surprise on the downside.

Best Case: Sentiment is likely to continue to improve for emerging markets and a US-China trade deal would be the cherry on top. The pause in US rate rises should be most beneficial for those countries that have a high proportion of US dollar-denominated debt, such as Brazil, Turkey and Argentina.

Most Likely: European real estate investment trusts (REITs) remain attractive due to the European Central Bank maintaining ultra-low interest rates, ensuring a favourable environment for consumer and business spending. The UK continues to be the least attractive region, given the continued lack of clarity around Brexit. In the US, the Federal Reserve has continued to refrain from further rate hikes, ensuring the yield gap between bonds and US REITs remains attractive to investors.

Worst Case: In the UK, Brexit talks dominate investor sentiment with a number of direct property funds switching to bid pricing in a bid to deter outflows. An accidental no deal would be harmful for both UK growth and, subsequently, the property market. Similarly, a scenario of trade war escalation could potentially see selloff contagion spill over as investors exit riskier asset classes.

Best Case: A resolution to trade tensions between the US and China. Key central banks refraining from rate hikes this year would help global REITs, which had cheap valuations this year due to rising rates in 2018. An end to the Brexit uncertainty and an outcome that is favourable for UK companies will help drive prices in this region.

WINTER OUTLOOK

January 29, 2019 in News & Events

Winter Outlook

REVIEW OF THE PAST QUARTER:
It proved to be a case of too much good news being bad in October. Strong employment growth, little inflation and, mainly, US Federal Reserve chairman Jerome Powell’s “long way” from neutral interest rate comment sparked a treasury yields rally. In turn, bond market contagion spread to the rest of the global markets. Since then, Powell appears to have cooled on further hikes, bringing ‘safe-haven’ assets back to life. However, one of the key indicators of an upcoming recession – the spread between ten-years and two-year US treasury bonds – has been steadily tightening and is now close to the point of inversion.

Meanwhile, oil prices have been falling after previous fears of limited supply due to Iran’s sanctions were eased once the US extended waivers to key importers of Iranian oil. A surplus along with a slowdown in demand caused Opec members and Russia to curb supply in December. Qatar announced it would be leaving Opec next month. Poor GDP figures have dominated headlines this quarter. The wider eurozone posted unexpected sluggish growth for Q3. Individually, Italy, Germany and Japan’s economies all contracted for the same period. Rising protectionism caused by an ongoing trade war between China and the US, and increased market volatility, led to both the Organisation for Economic Co-operation and Development and the International Monetary Fund revising forecasted global growth for this year and the following.

THE ACTUARIAL VIEW:
With just a few months left before Brexit things are currently no clearer, meaning that political news completely overshadows any economic news. In the UK employment figures are still good and economic growth has slowed less than expected; nevertheless, the UK market has underperformed most other markets. The UK remains a fast moving situation and things could change quickly. Europe remains a mixed bag, with Italian political upheaval a drag. In the US tightening monetary policy, looser fiscal policy plus trade protectionism has meant the country has struck out on its own and has become disconnected from other markets. Emerging markets are all very different but in general face a headwind of a tightening US dollar, trade restrictions and weak Asian growth.

Despite volatility, markets have kept up with expectations, except for the UK, thanks to the Brexit effect. Foreign earnings are likely to provide some protection here, meaning the UK looks slightly better value now than previously. Property, however, is far more susceptible than equities – a hard Brexit is likely to lead to a slash in demand followed by a collapse in rent and values. All this translates into a move away from property into more UK equity and fixed income.

WHAT TO LOOK FOR IN Q1:
• UK: Monetary Policy Committee (MPC) announcements and minutes are scheduled for 7 February and 21 March. The UK is due to leave the EU on 29 March.

• US: There will be interest rate decisions from the Federal Open Market Committee on 29-30 January. Minutes will be published three weeks after each decision.

• Eurozone: Quarterly GDP data is set to publish on 31 January. The ECB Monetary Policy meeting is scheduled for 24 January.

• Other Data: Thailand’s general election is set to take place on 24 February. China’s Trade Balance is expected to be published between 7-15
January.

ASSET CLASS SCENARIOS:

Most Likely: Approaching the final stage of Brexit negotiations with little clarity will heighten uncertainty, increasing the probability of no deal. The pound weakens and negative sentiment hurts equities to a limited extent, given already low valuations. Parliament may buckle under pressure and approve the deal, providing the market with respite and seeing equities rally, driven by smaller companies benefiting from a stronger pound.

Worst Case: Parliament rejects the proposed deal and the EU rejects the backstop issue. A general election ushers in a Labour government. The short-term impact would be damaging, with the pound weakening and UK equities selling-off. The Bank of England may hike interest rates sooner than expected to curb inflation, which would be negative for gilts and provide an additional headwind for equities.

Best Case: Parliament approves the deal, resulting in higher growth expectations fuelling the economy over the longer-term. Over the next quarter results will be less positive for equities: a stronger pound would boost smaller companies but be negative for equities overall as over 70 per cent of firms’ revenues are generated outside the UK. The Bank of
England may hold off on interest rates hikes, providing some respite for equities and gilts.

Most Likely: Following the Bank of England’s decision to hike rates, the return from cash has slightly improved. Core inflation should remain within the 2 per cent-2.5 per cent range, which means returns from cash remain negative. Headline inflation is unlikely to come down significantly over the coming quarter due to cost pressures from a range-bound oil price.

Worst Case: The worst-case scenario for cash savers is that inflation continues to rise with cost-push pressures at the fore. Another likely headwind is UK sterling weakness as Brexit negotiations turn sour and imported inflation compounds woes, with the Bank of England refraining from further tightening for the already weakened consumer.

Best Case: Any progress in Brexit negotiations could well be taken by the Bank of England as a signal to continue tightening, especially if wage growth surprises and tends to the upside. In such a scenario, returns to cash would improve despite staying negative. Similar to government bonds, cash could also act a safe-haven with recession kicking in for the
US.

Most Likely:US markets will have increased sensitivity to the Federal Reserve’s rate decisions with an increase in month-on-month volatility; however, economic fundamentals remain robust. The European Central Bank plans to keep rates low for the foreseeable future, supporting growth. Despite these positives, the escalating trade tensions between the US and China continue to increase uncertainty in the market and will likely dampen global growth in the coming quarter.

Worst Case: The trade spat between China and the US keeps equities on the defensive and investors on the sidelines. US out performance is unlikely to persist through 2019 as the effect of the tax cuts wears off. The stand-off between Brussels and Rome escalates and Italy distances itself from the EU, creating further uncertainty across the region. Slower global growth could lead investors to the Japanese yen, which is traditionally negative for the Japanese equity market.

Best Case: The recent collapse in the oil price is supportive for Europe as an importer of the commodity, and consumers are still showing an appetite to spend, which should help to narrow the gap between the US and European markets. Trade tensions ease and President Trump adopts a new outlook, reducing uncertainty and supporting the global economy.

Most Likely: Bond markets will navigate troubled waters, as market participants try to guess the Federal Reserve’s next move. As Jerome Powell said, the Fed’s benchmark interest rate is near the neutral rate and investors might be tempted to move back into government bonds. UK fixed income markets are expected to stay immune from these headwinds as the Bank of England would prevent itself from interfering in the Brexit debate.

Worst Case: After several years of monetary stimulus, we might have reverted to a normal situation where any sign of wage growth and inflation is bad news for bond markets. If a Brexit deal is reached before the deadline, the Bank of England might trigger an unexpected rate hike. The cost of financing for companies should increase, pushing bond investors to reconsider their investments in debt issued by companies.

Best Case: Bond markets might have already priced in negative news – as such the downside is now limited. Political uncertainty will continue to act as a drag on bond yields, anchoring investors’ expectations to lower levels from current ones. Companies might further delay their capital expenditure decisions and lower their debt level. The low level of debt supply relative to demand from institutions might drag yields lower.

Most Likely: Emerging market equities are likely to be volatile, with sharp market moves reacting to tweets rather than actual macroeconomic data, continuing until the 1 March ‘hard deadline’ for a trade deal. If the risk-off sentiment continues, emerging markets are likely to generate negative returns. Trade tensions and tightening financial conditions are likely to be the key risks for the region.

Worst Case: Emerging markets would struggle if the US dollar strengthens or if the Federal Reserve surprises the market with more rate hikes. If a US-China trade deal is not reached, emerging markets could get hurt as supply chains get disrupted, particularly for more trade-reliant economies such as South Korea, Thailand and Vietnam.

Best Case: A reversal of the broad US dollar appreciation would be a much-needed tailwind for emerging markets. Earnings growth in emerging markets could take a lead over the US, where earnings are expected to slow as the effects of the US tax reform moderate.

Most Likely: Despite a recent rate rise in the US, the asset class is still attractive. The rise suggests an economy getting stronger, meaning rents can grow, supporting performance. In the UK, the performance of real estate investment trusts (REITs) is likely to be tightly correlated to the Brexit deal being negotiated with the EU and could go either way.

Worst Case: In the UK, a no-deal Brexit would leave corporates, hence tenants of commercial property, with high uncertainty. Capital values might fall, and we do expect an increase in income return. In the US, an acceleration in the growth of the economy would not necessarily be a good thing as the Federal Reserve would raise rates quicker and money would rotate from the real estate sector to bonds.

Best Case: Clear guidance on the Brexit deal from the government would help corporates prepare for a transition period and support property performance. Continental Europe would continue to benefit from cheap financing. This could help corporate activity and support capital growth. A weaker pound would also be supportive, both for Europe and the US,
where continuing healthy growth will push rents higher.