What a week! Over the course of three days, investors were treated to a triple whammy of encouraging news. First, it was smooth sailing at Christine Lagarde’s first press release as head of the European Central Bank. As expected, she announced that the ECB would keep rates unchanged and press forward with its bond-buying program. At the same time, she struck a slightly more optimistic tone: Although the ECB has lowered its long-term economic forecast, it is forecasting inflation to increase to 1.6% by 2022 – still below target but at least going in the right direction. And in a sign of her determination to set her own style in her new role, she rejected being cornered into rigid ‘dove’ versus ‘hawk’ categories, instead expressing the hope that she will be seen as a wise ‘owl’.
As Ms. Lagarde was winning plaudits for her balanced performance, balance was nowhere to seen in Britain as the Tories swept to victory with a landslide result. Boris Johnson's 'Get Brexit Done' election slogan paid off spectacularly. With an absolute majority in parliament, the withdrawal agreement will fly through parliament just in time for the scheduled Brexit on January 31. The pound rallied, reflecting investors' confidence in a more stable political climate and a smoother Brexit.
A day later, the relief spread. On Friday the 13th, China and the US confirmed they had a reached a "phase one" trade deal. As a result, Washington is holding back on new tariffs and lowering some existing ones. Although some major topics of disagreement remain unresolved and a successful implementation of this mini-deal is by no means certain, the deal nevertheless marks a significant de-escalation in a conflict that had weighed heavily on investor sentiment this year.
Investors and analysts can therefore head home for the Christmas holidays in good spirits — but only temporarily. After the UK leaves the EU, the next gargantuan task will begin: negotiating the future trade relationship between Britain and the EU. Whether all that can be finalized by the end of 2020 is unclear. Recent history suggests that 11 months is wishful thinking. New uncertainties are therefore inevitable.
On a tactical horizon, we have an overweight to equities, an underweight towards fixed income and a neutral position towards alternatives.
Within Fixed Income:
- We are underweighting government bonds this month.
- Investment-grade credit, high-yield bonds and emerging market debt have an overweight.
- Securitized debt remains neutral in our fixed-income model portfolio.
- The overweight categories offer a spread pickup versus (low-yielding) government bonds, leading to this relative positioning.
- We have an overweight towards US equities and emerging-market (EM) equities.
- All other equity categories are either neutral or negative this month.
Figure 1: Our asset class overweights/underweights in our model portfolio as of December 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: Modestly positive. Fundamentals are still modestly positive. As US and global economic growth appears to be slowing, we believe the Fed is likely to cut rates another two times by mid-2020. The FOMC has begun to expand its balance sheet by USD 60 billion a month to help alleviate a potential tightness in bank reserves and an oversupply in T-Bills. On valuations, we are neutral. We are currently at 1.75%, which is our forecasted year-end value for the 10-year Treasury. 10Y Treasuries remain slightly rich to other currency-hedged developed sovereigns, but this richness has diminished recently and they are still cheap if unhedged. Sentiment, after fluctuating in recent months, is back to bearish. Therefore, we are roughly neutral on sentiment, but with a positive bias. Technicals are neutral.
Europe: Negative, with a neutral bias. Fundamentals are still positive, but less so than last month. There was a strong sell- off last month, mainly due to a pause in the escalation of the US-China trade war and hopes of further progress in the trade talks. Also, the earnings season surprised overall on the positive side. The sell-off was also supported by some bottoming out in the (German) car sector in combination with a delay in imposing tariffs for EU cars by President Trump. Valuations are very negative. German yields have deviated from any measure of "fair value" as estimated by nominal or real growth. The curve steepened, so carry and roll rose. The attractiveness of issuing at historically low yields in the (ultra) long end of the curve is still motivating steeper curves across eurozone countries. The curve remains flat in the shorter end due to the very low yields, a weak economic picture with downside risks, and the support by the ECB. Sentiment rose to neutral from negative last month due to new hopes of progress with the US-China trade talks and more stable manufacturing data. Technicals are mixed, so neutral. The medium and ultra-long down trend in yields is still unbroken.
UK: Positive. Fundamentals remain positive. Third-quarter GDP was 0.3% Year-on-year growth (1%) is now at the lowest reading since 2010. Consumers are still holding up as the rest of the economy falters. The compositive PMI Services has now joined the Manufacturing PMI in contractionary territory. Valuations are positive; a 7 bps cuts are priced in for February 2020 (17 bps in total). Sentiment is neutral. The market believed the Conservatives would emerge as the biggest winner in the election. This is probably a neutral outcome for gilts. Technicals are neutral too. Supply is picking up, which could be challenging for the longer end of the curve.
Japan: Neutral. Fundamentals are modestly positive. GDP Q3 growth disappointed (0.2% vs 0.9%), though with an upward revision of Q2. Domestic demand was strong, but that was mainly due to front-loaded consumption ahead of the VAT hike. The unexpected sluggishness was partly due to a drag on inventories, which should be temporary, as well as weak net trade. Mr. Abe has suggested a new fiscal package to stimulate growth in Q4 and 2020, and the market is anxiously waiting for this to happen. A big debate right now is how much stimulus the Bank of Japan can still add. The 10-year point of the curve is on the lowest end of the range defined by the central bank, now at around -0.08%, leaving valuation levels still very negative. Sentiment is neutral. Despite progress on the US-China trade talks, the general slowdown in growth with downside risks prevents sentiment from becoming too positive. Any deterioration in market sentiment would be highly supportive for the yen. Technicals are neutral.
Fixed income – Investment-grade
US investment-grade: Modestly positive. Our opinion has not changed from last month. Fundamentals are still neutral. Growth, after likely peaking last year, is moving back to trend levels. This not-too-hot, not-too-cold environment is good for corporate bonds. The consensus for 3Q earnings is for revenues to be up 3.6% and earnings down 2.9% — both would be the lowest levels since 2016. Corporate leverage remains lofty. Valuations are a pain point. Spreads have tightened 5 bps over the last month. Spreads remain fairly rich versus their long-term average, and when adjusted for leverage and duration they look even less attractive. Sentiment is neutral: Instead of trade, the 2020 US election is now biggest concern for investors. According to an investor survey, investors are turning more bullish after improvements in the US/China trade rhetoric. However, the same survey also revealed that investors expect 20% probability for an economic recession in the US during the next 12 months. Technicals are positive. Supply has picked up as issuers race to print deals before the calendar hits the seasonably lighter period at year-end. Inflows into this asset class continue as the yield advantage in the U.S. should drive demand: Currently, the US accounts for 93% of global investment-grade fixed-income yield.
European investment-grade: Modestly positive. Fundamentals have been upgraded to neutral from negative last month. The latest PMIs indicate stabilization and manufacturing improvement, and we expect upside for the next few months. The European investment-grade spread has become a little tighter (currently 102 bps), and there is room for further tightening, so we are neutral on valuations. Yields have increased, averaging now at 0.50%. Sentiment is still neutral. The German confidence indicator has increased. Technicals are positive. It's a record year again for issuance, and the ECB is participating heavily in this, driven by the lack of government bonds. New paper has been well absorbed, leaving no premium for investors.
Fixed income – High yield
US high yield: Negative. Fundamentals continue to be stable. Q3 earnings season were generally in line with expectations — "better than feared" seems to be the consensus. As expected, Q4 guidance was lowered for some of the more global/cyclical companies in this asset class. We continue to see pressure on energy-related companies. Defaults are modestly higher, but they remain below long-term averages. Valuations are negative. Spreads have tightened modestly from the last House View and continue to be well inside long-term averages. Yields under 6% continue to appear fair. Sentiment is neutral and technicals are modestly positive. Flows have fluctuated and new issuance is up over 2018 by around 27% year to date.
European high yield: Neutral. Fundamentals are neutral. European economic indicators seem to be stabilizing and the fear of a recession is fading. But inflation is still (very) low. Company results are deteriorating in general, combined with lower margins in cyclical sectors. There have also been several downward outlook revisions. Valuations are very negative. Spreads in Europe are at 370 bps, which is 140 tighter than the beginning the year (510 bps). The BB OAS is 250 bps and OAS for single B is 545 bps. The current low level of defaults is still used as argument to buy European high yield. Overall sentiment still seems defensive. Leading indications point to slowing growth, but investors seem convinced that monetary policy will provide a put. Technicals are strong as the search for yield continues and investors increase their risk appetite.
US leveraged loans: Negative. Fundamentals remain neutral. Earnings are generally growing except in retail, chemicals, etc., and a US GDP growth of 1.5%- 2.5% is still a decent backdrop for this asset class. Valuations are neutral. Secondary prices are down from their 2018 highs due to retail outflows and a more discerning buyer base in CLO accounts. BBs have rallied back much faster than single Bs. There is still value in single Bs and in distressed/CCC loans provided you pick wisely, but the risk is high. Sentiment is negative. Rates have been coming down and CLOs, the main buyer of leveraged loans (67% of the market), are very rate-sensitive. Technicals are neutral. Mutual-fund flows have been negative during the last eight months and these flows will likely continue to be slightly negative. Primary activity has been active throughout 2019, though deal quality remains poor, with many aggressive B3 deals continuing to print.
Fixed income – Emerging market (EM) debt
Emerging markets: Modestly positive. Fundamentals remain negative. The European Central Bank (ECB) and US Federal Reserve (Fed) continue to add to the easing bias tone. Global growth has been downgraded this year, but growth in China is likely to stabilize as trade talks improve and emerging markets' trade with China has a significant impact on EM commodities and supply chains. Real rates in emerging markets are still high. With inflation expectations declining and growth disappointing, we expect further flexibility in emerging-market central-bank policies. Valuations are positive. Sovereign credit spreads tightened 8bps since last month. Spreads are at 340 bps. (The 5-yr average is +348 bps). Emerging-market assets offer an appealing growth premium over developed markets, supported by an attractive yield. Sentiment is slightly positive. The main drivers are easy central banks, slowing global trade, and easing US-China trade tensions. A combination of a stronger euro and yuan would drive the dollar lower, which would be advantageous for emerging-market assets. Hard-currency technicals are neutral. Technicals are likely to remain supportive. The record issuance in September was well digested and investor positioning is defensive. The demand for global yield is likely to drive further flows into EM hard currency.
Fixed income – Securitized
US securitized: Modestly positive. Fundamentals remain healthy and stable in most securitized sectors. While delinquency and default trends in certain ABS sectors have increased, we view this more as normalization. The housing market is showing signs of moderating, but remains positive. Home valuations continue to increase. A lower rate environment is supportive for affordability. We are neutral on valuations in most securitized sectors. That said, most sectors remain off the 52-week tights achieved last year, leaving room to tighten. Agency MBS (nominal and option adjusted) tightened month over month while implied volatility moved lower, which is negative for the sector.
Sentiment is neutral. According to a recent survey among investors in global securitized products, market participants remain positive in their view towards participation in private label securitized. 50% of respondents expect to increase their allocations to securitized products (mainly due to better underwriting standards) while 97% of respondents expect to stay in line or add to their securitized products allocation. Technicals are positive. Supply in the primary market has been in line with to slightly above last year's pace, but pent-up demand continues to drive oversubscriptions. New issuance has been elevated ahead of the upcoming holiday, but it's being met with strong demand.
European securitized: Modestly positive. Fundamentals are neutral. Consumer fundamentals look healthy, while at the macro level cracks have appeared. Arrears are stable to improving and credit conditions have tightened. Valuations are slightly positive this month. Spreads were broadly stable over the month. Floors on coupons/Euribor are creating longer-duration securities. However, floors are not fully priced in. Investor interest in ABS is still quite strong and the relative value for ABS is still very attractive versus covereds and corporates. On the other hand, concerns about geopolitical issues, the trade war and end-of-cycle fears are keeping sentiment neutral. Technicals are modestly positive.
USD: Neutral. The path of the USD remains driven by macro factors: the Fed and trade tensions. We still don't see a compelling case for broad US dollar weakness. US data has generally been a bit stronger than expected, which eases recession fears. In addition, the possibility of a pull-back from trade tensions has raised growth expectations and made near-term Fed cuts less likely, allowing the rate differential to widen again. The US dollar remains one of the highest yielders in the G10 – the carry argument favors being long dollar.
Euro: Neutral. The euro may weaken against higher-yielding currencies as the euro's negative yield makes it attractive as a funding currency, particularly as the ECB is committed to low rates. In order for the euro to rally significantly, there would need to be a distinct pickup in growth which would drive FX unhedged equity inflows. Support for the single currency would come from greater progress toward Brexit, more government stability in Italy, and news of policy stimulus in China. The euro is significantly undervalued versus the US dollar. Germany's center-right CDU party has suggested that Germany could increase fiscal stimulus should the economic downturn deepen. This scenario would lift Bund yields and reduce euro outflows. Specifically for the EUR/USD currency pair, we are slightly negative this month. Fundamentals for this currency pair are positive, valuations and technicals are negative, and sentiment is neutral.
JPY: Positive. The yen remains one of the only cheap recessionary hedges left in the global macro space. It is significantly undervalued from a structural perspective. As the extent of monetary policy divergence between Japan and the rest of the world narrows, the yen is likely to become less undervalued. Deteriorating market sentiment arising from the US-China trade dispute would likely be supportive for the JPY due to weaker risk sentiment. That said, rising global bond yields, particularly in Europe, may lead to the yen's weakness due to its negative correlation to bond yields. Regarding the USD/JPY currency pair, our overall opinion is negative this month. Specifically, fundamentals for this currency pair are negative, valuations and technical are positive, and sentiment is neutral.
GBP: Neutral. There are reasons to be constructive on sterling. The risk of a no-deal looks marginal since the Tory's overwhelming election victory, which implies we are unlikely to revisit the lows already witnessed in GBP. Sterling is attractive on various metrics. It still offers a positive yield and is about 19% undervalued compared to the USD. And while domestic growth has been weak, the UK probably has better prospects for fiscal stimulus policies than many other economies. This combination of valuation, carry and positioning will appeal to many global investors. For the GBP/USD currency pair, we are neutral. Fundamentals, valuations and technicals are positive, and sentiment has improved to neutral.
Overall, we have an overweight toward equities in our model portfolio this month. Within equities, we are overweighting US and emerging-market (EM) equities. Below some more thoughts on each region.
US: Neutral. Fundamentals, valuations and technicals are modestly positive. Sentiment is still negative, but less so than last month. The weekly NDR sentiment indicator is rising into excessive territory. Valuations are less positive than they were last month. Since the last House view, S&P has been up by around 4.3% and 2020 EPS forecasts are a bit lower. Therefore, 2020 multiples are a bit higher.
Europe ex-UK: Neutral. Fundamentals and sentiment are negative. Sentiment has dropped to negative because we think sentiment is too bullish. Inflows into European equities are the strongest they have been since early 2018. Valuations are neutral. The P/E ratio (16.7) is lower compared to the world average. That market seems expensive from a P/E perspective and relatively cheap compared to other regions. The dividend yield (3.4%) is above the world average (2.6%). Technicals are positive with great momentum.
UK: Positive, from negative last month. Fundamentals have deteriorated from neutral last month to negative. Recent economic data has been mixed. And while the labor market remains robust with positive real wage growth, hard activity data has been soft. Sentiment has flipped to positive from negative last month as the risk of a no-deal Brexit has declined. This is reflected in the strengthening of the GBP and of UK domestic stock valuations. Valuations and technicals remain modestly positive. The dividend yield of 4.6% remains very attractive versus other markets.
Japan: Neutral, with a positive bias. Fundamentals remain negative. Japan remains a low-growth, low-inflation economy that is very dependent on external growth and trade. Valuations have slipped to neutral from positive last month. The market is up 5% in a month and 15% in three months, but earnings have not grown. The new multiples are 1.2x book, 15x P/E and 2.3% yield. We believe Japan has a valuation range of roughly 12-15x PER, and it's moved towards the top of that. Further market improvements will require earnings growth, which is possible if global growth resumes and trade issues are resolved. Sentiment and technicals are positive. The main indicator we look at is the 120 dam, which has a great track record in Japan. This indicator has turned, which is often significant.
Emerging markets: Positive. Fundamentals are positive. Global PMIs are slightly higher at 49.8 while the EM PMI is unchanged at 51.0. The EM PMI Services has strengthened to 51.8. EM central banks remain the most dovish since 2009, and this supports EM rates and equities. Valuations are still negative, but less so than last month. EM equities are down 14.5% year to date, the worst year since 2015, and the expected earnings growth for 2019 is minus 9.2%. The upgrade in valuation is due to expected better earnings growth in 2020, a narrowing discount to developed markets, flattening revisions, and early signs of a turnaround of heavily weighted stocks in the index. Sentiment has normalized back to neutral from extreme levels, but positioning is still too bearish according to FMS and flow trends. Technicals are positive.
China: Modestly positive. Fundamentals remain modestly positive. The Chinese manufacturing PMI has fallen to 49.3, which is close to a three-year low and underperforming other emerging market economies. The New Export Orders PMI is also weaker. Valuations are still negative, but have been upgraded. Reasons for the upgrade include a material improvement in EPS for consumer discretionary and communications services (Tencent). In fact, last month saw the first month-on-month EPS improvement in 2019. 2019 EPS now stands at +2.7%. Sentiment is neutral. Chinese stocks still trade at around their 5-year average. Technicals are modestly positive as the index for local Chinese shares is approaching its recent local high. Higher highs and higher lows call for a positive technical outlook.
REITs: Neutral. We have become more bearish on REITS. Fundamentals have turned positive from neutral last month.
Listed real estate markets are down -0.5% (below forecast) since the last House View versus +5.2% for global equity markets (above forecast). 3Q19 results reflected a better-than-expected outlook for general equities, wheras it reflected a continuation of trends for listed real estate. Valuations remain positive. On a three-month basis, REITs have overshot equity markets if rate movements are taken into account. Sentiment has deteriorated to negative, while technicals remain positive.
Distressed credit: Negative. Our opinion is unchanged. Fundamentals are negative. Our house view for modest, albeit slowing growth in 2019/2020 is still intact. However, risks to downside (Chinese tariffs, global trade, European slowdown, Brexit, etc.) still exist. Investors have little patience with non-performers. The market has become very event driven as management teams demand a more proactive stance to restructuring. This weighs on sentiment, which remains negative this month. Valuations are neutral. Spread and equity volatility in highly levered names has returned to heightened levels. After tightening 280 bps at the start of 2019, spreads in CCCs widened 208bps between May and mid-November. CCCs are materially underperforming high-yield debt on a total and excess return basis. Technicals are neutral.
Commodities – oil: Neutral. Fundamentals look challenged. Global growth expectations have been downgraded, leading to downgrades in the forecast for oil demand. The build-up of inventories last month was above the 'normal' seasonal pattern. Valuations are modestly positive. The carry or roll yield dynamics of the oil-futures curve are supportive. The front end of the curve has moved into backwardation, while the long end of the curve has moved into contango. Sentiment and technicals are 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.
The content of this document is for information purposes only and should not be considered as a commercial offer, business proposal or recommendation to perform investments in securities, funds or other products. All prices, market indications or financial data are for illustration purposes only. Although this information is composed with great care and although we always strive to ensure accuracy, completeness and correctness of the information, imperfections due to human errors may occur, as a result of which presented data and calculations may differ. Therefore, no rights may be derived from the provided data and calculations.
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