After Iran attacked two US military bases in Iraq on January 8 in retaliation for the assassination of Qassem Soleimani, Iran’s top military commander, by the US, oil rallied sharply, at one point rising to over $70 a barrel. That was no surprise: Investors priced in the risks of a destabilization in the region. However, that impact quickly faded as Iran made clear it intended to avoid a war.
Now the focus is moving back to oil fundamentals, and here there has been a surprise. The latest statistics from the US Department of Energy show a build-up of crude oil inventories, whereas the market expected large draws. This data is putting even more downward pressure on oil prices. Unless we see a further escalation in the US-Iran conflict, we believe movements in the oil price will remain contained.
On a tactical horizon, we have neutralized our previous overweight in equities as well as neutralized last month's underweight towards fixed income.
Our neutral position in alternatives is unchanged.
Within Fixed Income:
- This month we have an overweight toward high- yield and emerging-market debt and an underweight in government bonds.
- The reason for this relative positioning is that the overweight categories offer a spread pick-up versus (low-yielding) government bonds.
- We are overweight towards emerging-market (EM) equities and have an underweight towards EU equities.
- All other equity categories are neutral this month.
Figure 1: Our asset class overweights/underweights in our model portfolio as of January 1, 2020 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. Our overall view remains unchanged. Fundamentals are still positive. Presuming the phase-one US-China trade deal goes through, the trade dispute will calm down, which in turn would reduce the likelihood of two rate cuts by the Fed this year. The market is now predicting one rate cut in 2020. We think the Fed would prefer to stay on hold as long as possible. The likelihood of a recession is low and current rates are modestly stimulative. The exact timing and number of future cuts are highly dependent on trade developments and what happens with Brexit.
Valuations remain neutral. Treasury yields are above their near-term lows but only slightly above our 2019 year-end forecast of 1.75%. 10Y Treasuries are slightly rich compared to other currency-hedged developed sovereigns, and still cheap if unhedged. Investor sentiment for 10s and 30s is near neutral. Technicals are also neutral. It looks like the market is in a trading range, albeit a potentially wide one, bound roughly between 1.44-1.97% on the 10Y.
Europe: Negative. Fundamentals have moved to neutral from positive last month. Progress on the US-China trade talks has injected optimism into European rates by limiting downside risks to global growth for 2020. In her first meeting as ECB chair, Ms. Lagarde suggested she intends to find a balance between the different factions within the ECB. The ECB will perform a comprehensive strategic review this year, the second one since 2003. We think this document will explore some of the questions that are regularly asked to the ECB (such as the side effects of QE and target inflation levels), but without providing an outspoken view on any specific matters. Instead, the strategic review should serve as a communication tool for topics that will important for the ECB in the coming years. Valuations remain very negative. Sentiment is balanced due to more clarity about Brexit. The agreement on a phase-one trade deal has removed a tail risk, but investors are still anxious that the EU might become the next target of US trade tariffs. The market is settling on lower growth rather than a recession. Technicals are neutral because yields, while still negative, have risen to more constructive levels.
UK: Modestly positive. Fundamentals remain positive. Of significance for fundamentals in the near term will be the Conservatives' new super-majority in parliament. A big fiscal boost is not expected, but business investment might improve on improved sentiment. Valuations are modestly positive. Currently, 10-year gilt yields are 0.83%. Sentiment is neutral. The risk of a no-deal Brexit has gone away for now, but longer-term it could still be a drag. The market is worried that Boris Johnson and his team want to push through a deal by end 2020, which is practically impossible, and we subscribe to this view. Technicals are also neutral. Supply into the first quarter of 2020 is light.
Japan: Negative. Fundamentals are still positive, but less so than last month. On December 5, the Japanese government approved a stimulus package aimed at fuelling economic growth. The size of the program (half of it for public-sector spending) amounts to 4.7% of Japan's nominal GDP. While the package is seen as positive in the short run, longer-term it raises the question of fiscal discipline. On the other hand, the phase-one trade deal is a positive development for Japan as a significant part of Japan's commerce is directly or indirectly affected by the potential outcome of these negotiations. Valuations are still very negative as the Japanese 10yr rate trades in the middle bound and slightly below zero due to buying by the Bank of Japan. Sentiment is positive; Japanese sovereign bonds have been sensitive to the US-China trade talks. Technicals are neutral.
Fixed income – Investment-grade
US investment-grade: Neutral. Fundamentals are neutral. Growth is moving back to trend levels after likely peaking last year. 3Q19 earnings generally beat expectations, yet those expectations had previously been lowered. Revenues and EBITDA grew at the slowest pace in three years, and interest coverage ratios are declining. Valuations are very negative. Since the last House View, credit spreads have tightened by around 10bps, with an OAS of 95bp. Spreads remain fairly rich versus their long-term average, and adjusting for leverage and duration they look even less attractive. Credit curves remain steep, particularly at the back-end, with 10s and 30s at the steepest levels in two years. Sentiment is neutral. The phase-one trade deal and more clarity about Brexit have driven spreads to new YTD tights, and we expect to see further spread grinding in the near term. Technicals are positive. The January outlook is calling for USD 115-130 billion of supply, which would be below both the 3-year and 5-year averages. We should continue to see inflows into the asset class due to the yield advantage in the US.
European investment-grade: Neutral with slightly positive bias. Fundamentals have improved to neutral from negative last month as a slight pick-up in economic activity is expected for 2020. Valuations are now negative. After the rally at the end of November, we reached year-end tights and we think there will be further tightening. The ECB is buying more corporate bonds than ever before — on average EUR 1 billion of corporate bonds per week. Sentiment is neutral; there's not much to worry about at the moment in Europe, and the German confidence indicator has increased too. Technicals are positive. No new supply is expected, resulting in almost no liquidity in the market and pushing spreads tighter.
Fixed income – High yield
US high yield: Negative. Fundamentals are neutral. Stable economic fundamentals remain supportive for credit and high-yield debt, but macro and political headlines could cause near-term uncertainty. Q3 earnings were generally OK - "better than feared" seems to be the consensus, and an oil price above USD 60 is a feel-good factor for the energy sector, which accounts for a large part of the index. Q4 guidance has been lowered for a number of global/cyclical companies. Valuations are negative. Spreads have tightened meaningfully since the last House View and remain well within long- term averages. Yields are near 5.25% and a tale of two stories: 3.6% for BB YTW and 10.81% for CCC YTW. Sentiment is balanced and technicals are slightly positive.
European high yield: Neutral. Fundamentals remain neutral. Although European economic indicators seem to be stabilizing, company results are generally deteriorating. Defaults, while low, are rising. Valuations are unattractive due to the enormous spread tightening during 2019; we are not at all-time tights yet, but getting pretty close. Sentiment is neutral, but improving as the market is optimistic that a recession can again be avoided. Also, other risks (Brexit, trade dispute, Italy) are disappearing one by one. That said, earnings revisions have put the market under pressure. Technicals are strong due to positive flows, no supply and limited premiums. The BB space is being influenced by investment-grade investors and may be impacted by a high level of issuance, ECB buying program, or weakness in investment-grade space.
US leveraged loans: Negative. Fundamentals are still neutral. The macroeconomic backdrop is conducive for this asset class. Earnings are generally growing and default expectations remain low through 2020, but secured leveraged has increased, which is not good. Valuations are neutral. There's not much upside at the moment, and loans that are available at a discount are very risky. Sentiment is negative. Demand for the asset class has diminished and outflows continue each week. Technicals are neutral. Mutual fund flows were negative during most of 2019 and are likely to stay negative this year. CLOs continue to be the largest buyer of loans, more than offsetting the declines from retail funds.
Fixed income – Emerging market (EM) debt
Emerging markets: Modestly positive. Fundamentals are neutral. Emerging-market growth will be higher this year than in 2019. A rebound in China in response to policy supports and higher export performance points to a strong start to 2020. Growth in ex-China emerging markets will also strengthen, albeit at a modest pace. Accommodative monetary policies, strengthening emerging-market currencies, and the declining probability of a US recession in 2020 also contribute to the supportive backdrop. Valuations are modestly positive. Since the last House View, EM sovereign credit spreads have tightened 28bps, closing at +305bps (compared to a 5-year average of +348bps). During the next three months, we expect EM hard-currency spreads to tighten around 10 bps and EM local markets to outperform hard-currency bonds. Sentiment is modestly positive, mainly due to the US-China phase-one trade deal, but also easy central banks and slower global growth momentum. Technicals are likely to remain supportive due to seasonality and defensive investor positioning. The demand for global yield is likely to drive further inflows into emerging-markets bonds, albeit at a lower amount than in 2019.
Fixed income – Securitized
US securitized: Modestly positive. Little has changed in this asset class. Fundamentals remain healthy and stable in most securitized sectors. The US consumer is in a good place: household debt-to-income ratios remain well below historical averages and home valuations continue to increase. ABS credit trends are still in good shape from a historical perspective. That said, the deteriorating quality of the underlying loans is a slight concern. We are concerned about potential downgrades in underlying collateral, which would cause mezzanine tranches to fail tests. Valuations are now neutral. Most sectors remain off their 52-week tights, achieved last year, leaving room to tighten. A negative factor for valuations is the fact that convexity is negative, meaning that the sensitivity of a bond's price to changes in interest rates increases as yields increase. Agency MBS tightened month over month while implied volatility moved lower, another negative for valuations. Sentiment is positive: around half of respondents expect to increase their allocations to securitized products, according to a leading survey. Technicals are also supportive. Supply in the primary market has been in line to slightly above last year's pace, but pent-up demand (reinvestment and outright) continues to drive oversubscriptions. Agency MBS technicals are negative because supply will likely remain elevated due to the low rates and the Fed's balance-sheet runoff.
European securitized: Modestly positive. Fundamentals have improved to mildly positive from neutral last month. Consumer fundamentals are favorable. Arrears are stable to improving and conditional prepayment rates (CPRs) are still high. Credit conditions have tightened. Valuations are positive as spreads have been broadly stable. Rates are less volatile and lower rates have translated into floors on coupons/Euribor being less in the money. Floors are not fully priced in. The relative value of ABS is still very attractive compared to covered and corporate bonds. Sentiment is neutral. The strong investor interest in ABS is being balanced by end-of-cycle fears and concerns about new geopolitical issues. Technicals are supportive due to strong demand for a lower amount of consumer-related EUR-denominated supply in certain sectors (mostly Spain and Portugal). Negative supply in legacy is also supportive.
USD: Neutral. If there is a pickup in global growth this year, this should result is some downward pressure on the dollar. Such a situation tends to be associated with higher cross-border capital flows and lower demand for US Treasuries, which would imply dollar depreciation. Risks to the dollar are skewed to the downside, and we would move to a more bearish outlook if we were to see the following: a more robust recovery in the euro area, a rollback of tariffs on China, and/or cuts from the Fed. The United States remains in a unique position by providing the world with a combination of growth, safety and yield.
Euro: Neutral. There are a number of reasons to believe the euro will be higher rather than lower this year. These include the fact that the currency is cheap, most investors are underweight euro, and some of the euro's fundamentals, such as policy rates, have hit rock bottom. The euro has upside potential over the next 12 months, but given the carry drag, the timing of long is important and we do not see a turning point coming soon. Investors should continue to use the euro as a funding currency. This month we are slightly negative on the EUR/USD currency pair. Fundamentals are positive, valuations are negative, and sentiment and technicals are neutral.
JPY: Neutral. In 2020 we expect the yen to be range-bound due to an improvement in global growth. There are several reasons why the yen could trigger its status as a safe haven: the higher-than-average odds of a US downturn this year, new trade tensions, uncertainties stemming from the US presidential election, and investors' underweight. Any unwind in investors' positions could be a catalyst to strengthen the yen. For the USD/JPY currency pair, we are neutral this month. Specifically, fundamentals are negative, valuations and technicals are positive, and sentiment is neutral. Regarding valuations, our analysis concludes that the yen is still one of the world's cheapest currencies.
GBP: Positive. We are positive on sterling due to an increase in political stability since the Conservative landslide, attractive valuations, and that fact that investors are underweight on UK assets. However, we are mindful that Brexit-related uncertainties could linger longer than expected. We expect a lot of sterling performance to take place in the first half of 2020 as securing a Brexit deal will relieve some pent-up demand for UK assets. We are positive on GBP/USD. Fundamentals, sentiment and technicals are positive for this currency pair, and valuations are neutral. The pound remains significantly undervalued versus the dollar.
This month we neutralized our previous overweight in equities. Below some thoughts on each region.
US: Slightly positive. Fundamentals are modestly positive. Trade risks remain, with more potential downside risk to economy. Valuations remain modestly positive. Since the last House View, the SPX has risen by around 1.7%, with 2020 EPS forecasts roughly unchanged. Therefore, 2020 multiples are a touch higher, but not enough to change our opinion. Based on absolute metrics, US equity is on balance slightly richer than last month. Based on relative value metrics, equity looks more favorable than Treasuries. Sentiment is still negative, but improving. Technicals are favorable.
Europe ex-UK: Neutral. Fundamentals are still negative, but improving. Value momentum over growth would support European equities, but the likelihood of this is rather limited due to structural challenges in the financial sector, which accounts for about a third of the index. Valuations are still negative, as European equities have become dearer from a P/E perspective. Sentiment has improved to neutral as the asset class is attracting more inflows. However, fiscal stimulus would be necessary to boost sentiment further as the sentiment boost from the ECB is fading. Technicals are modestly positive.
UK: Negative. Fundamentals remain positive. The certainty of Britain's definitive exit from the EU on January 31 means the Brexit-related trade negotiations can now get started. The removal of near-term political uncertainty regarding Brexit and of the prospect of a market-unfriendly Labour government is positive for the UK economy and for UK equities. Recent economic data has been mixed. Earnings forecasts by the market are driven by the high weighting to internationally exposed companies. 2020 forecasts call for 6% growth, but the recent strength in GBP will put further downward pressure on earnings in the near term. Valuations remain attractive, particularly from a dividend yield perspective. Sentiment continues to improve, reflected in the strengthening GBP and UK domestic stock valuations. Technicals are broadly neutral. The market is currently rangebound.
Japan: Modestly positive. Fundamentals remain negative but have improved a bit. Japan faces structural challenges. GDP and CPI are under 1%, and its ageing population and high debt will not help. Much of the listed market is exposed to global trade. Valuations are now negative. Japan has a typical trading range of 12-16x PER. It is now 15x, so modestly above average. With an ROE of 7-8%, a premium to book is undeserved. Sentiment is neutral. Technicals are positive: the 120 dma is now in a clear uptrend.
Emerging markets: Positive. Fundamentals are positive, and even more so than last month. The Global PMI jumped to over the critical level of 50, while the EM PMI remains unchanged at 51.0 and the EMI PMI Services increased to 53.2. There is a high correlation between emerging-market equity returns and the global manufacturing PMI. Dovish central banks also support emerging-market rates and equities. Valuations are still slightly negative (expensive), but we expect healthier valuations in 2020. Sentiment is neutral. Sentiment has turned bullish as global emerging market have become the most preferred region among FMS investors. Technicals are supportive.
China: Modestly positive. Fundamentals have become more positive. The Chinese Manufacturing PMI has jumped back to expansionary territory. The PMI recovery could be boosted further by policy stimulus for infrastructure investment and better US-Chinese trade relations. The New Export Orders PMI has also strengthened (though it remains under 50). Valuations are still negative. 2020 earnings growth looks to be slightly lower than in 2019, and the blended forward EPS continues to go down. Sentiment is neutral. Technicals are positive, with higher highs and higher lows.
REITs: Mildly positive. Fundamentals are positive. Listed Real Estate markets fell -1.7% since the last House View versus +1.3% for global equity markets. Investment and financing markets are still supportive but we expect earnings downgrades in the medium term. Berlin residential is witnessing an improvement in sentiment, and an orderly Brexit could unlock investment in the UK. Valuations are neutral. Listed real estate is still relatively expensive compared to equities, but the spread versus credits has improved further (relatively cheap). US REITs are trading at a premium, but the yield spread versus US equities remains supportive for valuation. Sentiment has flipped from negative to positive this month. Technicals are still modestly positive. If we see a downgrade in global equity earnings, REITs will benefit.
Distressed credit: Negative. The only change to our opinion from last month is that sentiment has improved (is now neutral). Sentiment strengthened in December following the rally in commodities and positive news about trade and Brexit. Fundamentals remain negative as downside risks (China/global trade, European slowdown, Brexit) are still there. Also, default rates are expected to increase modestly throughout 2020 (while remaining below historical averages). 3Q2019 earnings were better than expected, but it should be noted that earnings estimates had been lowered in recent months. Management teams still appear to be cautious about 2020. Valuations are neutral. CCCs materially underperformed high-yield debt on a total and excess-return basis in 2019. We expect CCC spreads to remain range-bound in early 2020. Technicals are also neutral. Net flows into high yield were positive in 2019, as the rate move is driving the search for incremental spread. New issue supply is still constrained and the forward calendar among lower-quality issuers is light as well. Given end-of-cycle fears, stressed and distressed issuers increasingly rely on out-of-court restructurings and/or refinancing from existing and new predatory lenders.
Commodities – oil: Positive. Fundamentals are still negative. Global growth expectations have been downgraded, leading to downgrades in the forecast for oil demand. The build-up of inventories was above the normal seasonal pattern. Also, in December OPEC+ announced an increase in headline production cuts, and Saudi Arabia's committed to an additional 'voluntary' production cut. US shale production has peaked, which should help balance the market in 2020.
Valuations are positive due to the strong dollar and positive roll yield. Sentiment has improved thanks to the phase-one trade deal; it is now positive. 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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