Buying time to keep growth on track

9 minute read

Mario Draghi normally goes to great lengths to avoid surprising markets. But after the ECB’s March meeting, he shifted course. He adjusted forward guidance by saying key interest rates would remain at their present levels for longer than previously assumed — probably until next year. The ECB also lowered its expectations for growth and inflation in 2019 and announced a fresh round of funding for banks, called TLTRO III.

That the ECB was so dovish so early was unusual. The market would have expected such a combination of messages and measures in May instead of March. By moving preemptively, the ECB has brought comfort to European sovereign markets at a time of downbeat economic data. The ECB is also buying time for companies and countries to get their house in order and make the necessary structural changes in order to cushion the risk of a global downturn.

On a tactical three-month horizon, we have added an overweight to Equities and increased the underweight in Alternatives. We maintain our overweight to Fixed Income.


Within Fixed Income:

  • Within fixed income we are underweighting all major government bonds, with the exception of US government bonds, where we have a neutral position.
  • Our underweight in EU government bonds is especially large.
  • On an excess return basis, EU investment-grade and high-yield debt are attractive.
  • We have made a significant allocation to emerging-market debt. This is supported by the shift to a more dovish stance on monetary policy globally and by emerging-market valuations, which remain attractive on a relative basis to other fixed-income categories.

Within Equities:

  • Our overall view on equities remains favorable.
  • We expect positive performance on a tactical horizon, which is why we have decided to overweight equities over alternatives.
  • Within equities, we have a large allocation to Chinese equities, which seem to be supported by investor sentiment and by the strong performance recently of the region.

Within Alternatives:

  • On a relative basis, our views on commodities and distressed credit are quite similar; therefore, we are neutral on both within the Alternatives bucket.

Figure 1: Our asset class overweights/underweights in our model portfolio as of April 1, 2019 on a 3-month horizon. Each percentage reflects the relative weighting of the different asset classes within our model portfolio.

Fixed income – Government bonds

US: Positive. Fundamentals have improved as the Fed has delivered on market expectations with its dovish stance. The Fed recently indicated a willingness to pause with rate hikes, with no hikes expected this year and just one hike in 2020. The runoff of the Fed's balance sheet will begin in May. The market was pleasantly surprised by these announcements. We believe the federal funds rate is already very near or above the neutral rate. Market expectations for 2019 remain below those implied by the Fed's dot plots and imply a rate cut.

Valuations are close to neutral but yields remain somewhat rich relative to other currency-hedged developed sovereigns. Investor sentiment is elevated for 10-year Treasuries and bullish for 30-year Treasuries. Interestingly, equity risk appetite is also elevated, while credit and global risk is roughly neutral. This suggests some potential optimism from the "Powell Put". Overall, sentiment is neutral this month.

Technicals have improved from last month. 10-year yields have broken the ultra-long-term downtrend going back to the early 1980s. Daily, weekly, and monthly momentum studies suggest lower rates. Support/resistance reflects a break to lower rates from the 2019 trading range, with 2.52% representing the next level of resistance, followed by 2.40/2.45%.

Europe: Neutral. Fundamentals are close to neutral. European economic data remains underwhelming and economic forecasts for the entire year for the Europe have been adjusted down. The ECB believes that the risk of recession in the eurozone is low and that structurally, growth will be muted.

Valuations are negative as German yields are too low based on any measure of "fair value" estimated by nominal or real growth. The steepness of the curve remains high. Therefore, carry-and-roll remains high too, especially at the 7-10 years segment. Sentiment is negative due to the uncertainty caused by Brexit, the upcoming EU elections in May and the change in the ECB board this year. Technicals are close to zero. The trend for technicals is clear: higher prices.

UK: Positive. Fundamentals are difficult to pin down due to Brexit. Lower growth has been forecast for 2019 and we do not believe that the first full hike will happen until March 2021. Valuations are negative as gilts are currently expensive. Sentiment is neutral. It is heavily influenced by Brexit, which changes by the hour depending on parliamentary events. Technicals are close to neutral. The technical uptrend in gilt yields appears to have been broken.

Japan: Positive. Japan remains strongly exposed to the drifting in global growth, which has deteriorated since Q42018. Japan is also especially vulnerable to the trade tensions between China and the rest of the world. With the US Fed having adopted a much more dovish stance, the BoJ has maintained a very conservative tone. This helps the market in discounting future policy action without the need for the BoJ to be more specific. As a consequence, the yen has continued to lose value against the dollar since December, which provides general support to the economy. We don't think the Bank of Japan will change its expansionary policy any time soon.

Valuations are very unattractive. The Japanese 10-year rate remains close to zero due to buying by the BoJ. However, the steepness of the Japanese curve still shows the attractiveness of roll-down strategies in the 10-12-year area. Sentiment is positive. Technicals are neutral.

Fixed income – Investment-grade

US investment-grade: Positive. Fundamentals are neutral this month as US economic growth has decelerated – it's not too hot, but not too cold either. Growth from China and Europe has been disappointing too, which clouds the macro picture for the US. Earnings are positive, but a lot less so than in previous quarters — Q2 2018 was probably the peak. Leverage, though it has declined, remains too high. (For BBB, leverage has even risen.)

Valuations are modestly negative as spreads are 1 standard deviation rich versus the long-term average — and even richer when adjusted for leverage and duration. Investors are still camping out at the front end of the curve. The 5- and 10-year curves are at the steepest levels we have seen in two years.

Sentiment has gone from positive to neutral this month. There's great equilibrium in sentiment: According to JP Morgan's recent investor survey, 31% of investors are bullish on the asset class, 31% bearish and 37% neutral. Lower growth in China, political risk and the trade war with China are the biggest concerns for sentiment.

Technicals, which are positive, are really driving this market. The primary calendar is running 7% behind last year's pace. New deals are well received, and come with minimal concessions. The FOMC's willingness to cease the balance-sheet runoff later this year is a positive development for asset prices.

European investment-grade: Positive. The fundamental backdrop is neutral. PMIs in Europe have clearly come under more pressure (though there is divergence between countries). PMIs are barely positive. Countries are scraping the bottom of the bowl for growth. Valuations are now neutral as dovish comments by the ECB have sent sovereign yields to ultra-low levels. Sentiment is subdued. Technicals are positive and a key pillar for this market right now. Everyone is hunting for yield again, and issuance levels are high.

Fixed income – High yield

US high yield: Positive. Fundamentals are modestly positive. The US economy continues to provide a supportive backdrop for credit fundamentals and US high-yield companies. We continue to see more upgrades than downgrades. The Q4 earnings season met or exceeded most expectations. Cost pressures are still cited as impacting the bottom line. Guidance for 2019 has become more conservative.

Valuations have deteriorated from neutral last month to negative this month as the market is still trading well within long-term averages. Sentiment is fairly balanced, but skewed to positive. Technicals are positive. The recent uptick in the supply calendar until February was very well received by the market. Recent activity has been muted and no meaningful pick-up is expected in the near term.

European high yield: Positive. The credit cycle has slowed down in the EU. Company results have worsened (due to low/no sales growth, margin pressure) but defaults are still low. Expectations have been revised downward and so there's room to beat. Fundamentals are therefore neutral this month.

Valuations are neutral because high-yield spreads are decent, relative to defaults. The current low level of defaults is used as an argument to still buy high-yield debt. Sentiment is neutral. Leading indicators all point to slowing growth, but investors appear to be convinced that the economic environment will not deteriorate further. Technicals are positive as supply has been very low. Redemptions, calls and coupons are driving liquidity.

US leveraged loans: Negative. Fundamentals are neutral as earnings are generally meeting expectations and the macroeconomic backdrop in the US remains sound. Valuations are still positive but less so than last month, reflecting the recent rally. Some loans are trading above par. Sentiment and technicals are both negative due to Brexit-related uncertainty.

Fixed income – Emerging market (EM) debt

Emerging markets: Positive. Fundamentals are neutral. The global economy is experiencing a rough patch, but looser financial conditions, dovish monetary policies, and the dissipation of political event risk will be positive for the asset class during the second half of 2019. Tail risks regarding global growth and the intensification of the trade tensions have negatively impacted the risk environment for emerging markets. Oil remains crucial to our outlook on fundamentals given its correlation to risk assets and bond yields. Since its recent lows, Brent crude has climbed by more than 30%.

Valuations are positive after spreads widened. Modest spread tightening is expected on a tactical horizon. EM/developed-market bond yield differentials have compressed in recent months, but are still attractive over developed markets.

Overall risk sentiment is supportive as some emerging-market countries are still growing. Emerging markets have generally performed well this year, albeit starting from a low base due to the currency crisis. We have a risk-on framework in how we view this asset class. Implied volatility has fallen across the board. Prolonged tailwinds from global central banks and a mildly weaker outlook for growth should support flows into EM hard-currency assets.

Technicals are modestly positive. Around USD 119 billion in gross issuance (sovereign financing) is forecast for 2019. Low net supply will keep technicals supportive for both EM sovereign and corporate bond assets.

Fixed income – Securitized

US securitized: Positive. Fundamentals are positive as the housing market, affordability and consumer fundamentals continue to be tailwinds. Underwriting standards are supportive. Valuations are modestly negative as spreads should be range-bound. We are also negative about agency mortgaged-backed securities (AMBS) as they are rich (though we are neutral on the private part of the market). Sentiment is neutral. Technicals are supportive as the Fed's absorption of mortgage-backed securities still offers support. Low primary issuance at the start of the year combined with robust demand has left the market feeling much more positive.

European securitized: Positive. Economic fundamentals are modestly positive. ABS fundamentals show no signs of turning, arrears are stable to improving, and CPRs are still high. The UK consumer sector shows no signs of deteriorating. That said, growth is slowing and consumer confidence is waning in the eurozone.

Valuations keep coming down and are now close to zero. Primary supply of CLO is sluggish, but bigger-size tickets in the secondary market are being well bid, especially on short duration. Market sentiment has improved to close to neutral this month due to increased inflows.
Technicals are more positive than they were last month due to the lack of supply and in spite of waning demand from the ECB and from banks. There is high demand for the asset class: The first deal since the introduction of the new European securitization regulation was six times oversubscribed.


Equities overall: This month our overall view on equities remains favorable and we expect positive performance on a three-month horizon.

US: Positive. Reflationary deficit spending should drive nominal growth and support corporate earnings growth. Potential wage inflation could put pressure on margins. The US equity market is close to fair value. Sentiment is negative. Technicals are close to zero.

Europe ex-UK: Positive. The current stage of the macroeconomic cycle in Europe is supportive for equities, but further upside is limited. Valuations are mixed and close to neutral on average. Sentiment remains neutral based on a combination of different indicators. Technicals are positive.

UK: Negative. The outlook for the UK economy is uncertain due to Brexit, which is why fundamentals remain neutral. Valuations are close to neutral as equity returns have been highly dependent on the pound. Sentiment is negative. Technicals are positive.

Japan: Negative. Though structural reforms will help to modestly lift economic growth, overall fundamentals are modestly negative. Valuations are still marginally positive. Sentiment is neutral, while technicals are negative.

China: Positive. Earnings revisions have peaked and the momentum on economic data has turned negative. That said, support from the authorities has increased. Valuations remain close to neutral. Sentiment and technicals are positive.

Emerging markets: Positive. Economic fundamentals are neutral as PMIs have likely peaked. Valuations are neutral as the developed-markets discount has narrowed slightly; but valuations are still high, which helps on a relative basis. Sentiment is positive. Technicals are neutral.

Alternative Assets

REITs: Positive. Fundamentals are modestly positive this month. Full-year-2018 results provided support for the office and logistics sectors. Retail stocks, however, took a step back from their YTD rally due to the weak 2019 outlook that accompanied full-year results. The real estate sector remains vulnerable to interest rate movements. But over the longer term, interest rates should remain under control.

Valuations are negative as the asset class is looking rather expensive. The EBIT yield for real estate versus equity is below average and below its own history globally. The dividend yield for real estate is still attractive versus equities, mainly in Europe and the UK. The yield for real estate vs credits is negative in the US. Sentiment is supportive. Technicals are a tailwind.

Distressed credit: Positive. Fundamentals are positive due to our house view of modest, albeit slowing growth in 2019 no obvious risks to derail modest global growth. Valuations are neutral because yields have bounced back. CCCs have performed well YTD 2019, but we believe total returns will be impacted by moderate spread/yield widening. Sentiment is now balanced. Technicals are neutral. High-yield debt witnessed large outflows in 2018, but flows have meanwhile reversed. New-issue supply is still constrained and the forward calendar among lower-quality issuers looks light too, which is supportive.

Commodities – oil: Positive. Oil demand is in line with an expanding world economy. Inventories have increased and US shale production has risen. OPEC wants to maintain production cuts, which is supportive. Fundamentals are positive despite large oil production worldwide. Valuations are negative as the oil-futures roll yield is negative. Sentiment is positive as analyst readings are bullish and the CFTC trend has turned positive. Technicals are neutral.

Commodities – ex-energy: Positive. Fundamentals are neutral. The cyclical picture remains stable. The Chinese PMI is below 50. Consumption and exports have been mixed, however. Overall, we judge the economic developments for ex-energy commodities as positive, but not overly so. Wheat inventories are elevated, but supply is going down. Inventory levels for soybeans and corn are at around average. Copper inventories have been falling recently. Valuations are negative due to a negative roll yield. We think the dollar should remain stable, which should be a neutral driver. Sentiment has shifted from positive last month to neutral this month. Technicals are modestly positive.


EUR/USD: Negative. The economic and monetary-policy divergence between the EU and the US is negative for the euro/dollar exchange rate. Carry is supportive for the dollar, but fair-value measures favor the euro. Sentiment and technicals are negative for this currency pair.

USD/JPY: Positive. Lower GDP growth and inflation in Japan vis-à-vis the US is positive for this currency pair. The carry differential is positive for the dollar, but PPP and Real Effective Exchange Rate (REER) measures support the yen. Sentiment is negative, and technicals are positive.

GBP/USD: Positive. Similar GDP growth in the UK and the US as well as lower inflation in the UK support this currency pair. Valuations are neutral due to supportive REER and PPP, but carry is negative. Sentiment is neutral. Technicals are close to neutral.

About the House View

Aegon Asset Management operates from centers of expertise in North America, the UK, Continental Europe and Asia. The Aegon Asset Management House View is updated on a monthly basis, and is an excellent example of how we leverage our international expertise. First, we collate a global set of asset class views from our international teams. The asset class views are subsequently reviewed from macro, rates and asset allocation angles and an overarching committee then establishes the global House View. The outcome of this disciplined global process provides portfolio managers with latitude while at the same time ensuring that our products and solutions remain aligned.


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