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ABSOLUTE STRATEGY RESEARCH

22nd June 2018

Authorised and Regulated by the Financial Conduct Authority 1-2 Royal Exchange Buildings, London, EC3V 3LF

Investors Capitulate on Emerging Markets Three key points stand out from ASR’s latest Multi-Asset Survey. First, the loss of confidence in the business cycle has now become more entrenched. The probability of an improvement in the business cycle over the coming year has dropped to 40% in June from 58% in December 2016. However, this slowdown in global growth is not yet seen as a major threat to the economy, with the probability of a global recession in the next 12 months stable at 31%. That said, our Multi-Asset Survey ‘Optimism Indicator’ – a composite indicator of nine key ‘cyclically sensitive’ questions – is at the lowest level since the Survey was launched in December 2014.

Secondly, despite the cyclical rethink, investors’ confidence in the equity market remains positive. Our panel still expects global equities to rise in the coming year with a 59% probability and has a high degree of confidence (69% probability) that stocks will beat bonds, in part reflecting a further rise in bond yields. However, beneath the surface, investors have turned more cautious. While there is still a small majority of investors in favour of Cyclicals over Defensives (53% probability), this is well down on the 67% probability seen in December 2016. We are also struck by the contrast between the optimism towards equities and the persistent loss of confidence towards US corporate credit. The probability of US investment grade credit outperforming US Treasuries has declined to 47% in June, from 66% in December 2016.

Thirdly, investors have capitulated on Emerging Market equities, and now favour US equities vs the Rest of the World. Our panel now expects EM to underperform DM in the coming year. The probability of EM equities outperforming DM over the next 12 months collapsed to 47% in June from 60% in March – the biggest change in probabilities this quarter. At the same time, investors have turned bullish on US equities relative to ‘international’ (non-US) equities, with a 55% probability of US equity outperformance vs 46% three months ago.

Table 1: ASR Multi-Asset Survey 2Q18 Results; Fieldwork 31st May to 13th June

Source: ASR Ltd. / Extel WeConvene

2Q18 Survey - Fieldwork conducted

between 31 May & 13 Jun 2018

2Q18

Implied

Prob.

1Q18

Implied

Prob.

QoQ

Change

US 2-year Treasury yields higher 76 75 0

German 10-year Bund yields higher 72 NA NA

US 10-year Treasury yields higher 70 70 0

US core inflation at 2% or higher 69 67 3

VIX higher 69 65 4

Global equities outperform bond returns 69 66 2

Global corporate earnings higher ($) 68 70 -2

US real yields higher 63 61 1

US yield curve flatter 60 58 3

Global equities outperform commodities 58 48 10

US equities outperform non-US equities ($) 55 46 8

EM sov. bonds beat US HY corp. bonds ($) 49 59 -9

US IG corp. bonds beat US Treasuries 47 51 -4

EM equities outperform DM equities ($) 47 60 -13

20% drawdown in US equities 40 44 -4

Global business confidence higher 40 43 -3

Global recession 31 31 0

Japanese core inflation at 2% or higher 28 31 -3

Survey based on 214 Participants

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Dorothee Deck +44 (0) 20 7073 0756 [email protected]

Charles Cara +44 (0) 20 7073 0738 [email protected]

David Bowers +44 (0) 20 7073 0733 [email protected]

Biggest Q/Q Changes in Expectations

Most Likely

Least Likely

http://www.absolute-strategy.com/x/research.html

http://www.absolute-strategy.com/x/research.html?aid=18

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ASR Multi-Asset Survey | 22nd June 2018

A b s o l u t e S t r a t e g y R e s e a r c h 2

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The probability of an improvement in global business confidence has declined steadily, from 58% in December 2016, to 40% in June 2018. However, this has not dented investors’ confidence in the US labour market or raised fears of a global recession in the coming year. Investors remain convinced that US 2-year and 10-year yields will continue to rise. This is expected to lead to a further flattening of the yield curve (60% probability), consistent with what the forwards markets currently suggest. At the time of writing, the futures markets are discounting a 20 b.p. flattening of the 2s-10s curve 12 months forward.

Survey Highlights: 6 Key Messages

1) Loss of confidence in the cycle becomes more entrenched

In the past 12 months, investors have progressively lost confidence in the cycle. They now believe that the best of global growth is behind us and that global business confidence is unlikely to improve from its current elevated levels. However, global growth is not expected to slow enough to trigger a recession in the next 12 months, or pose a threat to the US labour market. The probability of a global recession remains stable at 31%, and a small majority of investors still believe that the US unemployment rate is unlikely to deteriorate.

Chart 1: Business confidence expected to slow down, but not enough to trigger a recession in the next 12 months


2) Top convictions remain around US rate normalisation

The top convictions this quarter are that US Treasury yields will rise, both at the short end and the long end, with implied probabilities of 76% and 70% for 2-year and 10-year yields respectively, as the Fed normalises its monetary policy and moves to quantitative tightening.

Chart 2: Top convictions remain around US Treasury Yields moving higher, leading to a flattening of the yield curve


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Business Confidence (LHS) Global Recession (RHS-Inv)

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2Y UST yields higher 10Y UST yields higher US yield curve flatter 50






The deepening loss of confidence in the global business cycle has been accompanied by increased worries about the US credit cycle. The probability of US investment grade credit outperforming US Treasuries has declined substantially to 47% in June, from 66% in December 2016 (Chart 3). Investors take the view that if the business cycle fails to improve and if the Fed continues to tighten monetary policy, then corporate credit increasingly looks vulnerable, given the rise in leverage and the dilution of ratings (almost half the US IG bond market is now BBB-rated). However, what is notable in Chart 3 is the growing divergence between the probability of higher equity markets and the probability of a stronger business cycle.

3) The preference for equities vs bonds remains intact, despite the less positive macro views

Investors still expect global equities to beat bonds in the coming year (69% probability), driven by higher equity prices and lower bond returns. However, this optimism seems somewhat at odds with i) the deepening loss of confidence in the global business cycle and the US credit cycle (Chart 3), ii) the expectations that equity volatility will rise (69% probability), and that iii) Emerging Market equities will underperform Developed Markets (Chart 5).

Chart 3: Global stocks to beat bonds, despite macro views


4) Equities are supported by earnings growth expectations

Investors’ confidence in Global equities is supported by expectations of positive corporate earnings growth in the coming year, as opposed to valuation expansion. However, recent developments are somewhat surprising. In the past six months, investors have barely reassessed their views on global equities (59% probability of a rise in June vs 61% in December), while they have considerably reduced their expectations of positive earnings growth (68% in June vs 74% in December) and valuation expansion (48% in June vs 54% in Dec.).

Chart 4: Investors confident on EPS growth / uncertain about PEs


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Business Confidence (LHS) US IG Credit > US Treasuries

Global equities > bond returns 50

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4Q14 2Q15 4Q15 2Q16 4Q16 2Q17 4Q17 2Q18

Global equities higher ($) Global earnings higher ($)

Global equity valuations higher 50






Our 2Q18 survey reveals a clear capitulation on Emerging Market equities (Chart 5) and Sovereign Debt (Table 1, page 1). This follows the significant declines in EM assets seen in recent weeks: - EM / DM equities down 10% since early February, - EM / Global Sovereign Bonds down 7% since early January, - EM Sovereign Debt / US HY Credit down 7% since early April. (*) The ASR Multi-Asset Survey Optimism Indicator shown in Chart 6 is the average of 9 implied probabilities in the survey: Macro 1. Global business confidence being higher 2. Absence of a global recession 3. US unemployment rate being flat or lower

Fixed Income & Credit 4. US 10-year treasury yields being higher 5. US investment grade corporate bond returns outperforming US Treasuries 6. US TIPS returns beating US Treasuries

Equities 7. Global equities being higher 8. Global cyclical stocks outperforming defensives

Asset Allocation 9. Global equity returns outperforming global bond returns

5) Major Rethink of Regional Equity Preferences

The biggest changes in investor expectations this quarter have been concentrated in regional equity allocation. Investors have now turned bearish on Emerging Market equities vs Developed Markets. They now see a 47% probability of EM equities beating DM equities in the next 12 months, down substantially from 60% only three months ago (see Chart 5). This follows the 5% underperformance of EM vs DM stocks between the first and the second quarter surveys this year, and the 10% underperformance since the recent peak in early February.

Our panel now expects US equities to outperform the rest of the world, with a 55% probability in June. This compares with 46% three months ago and 35% a year ago. It is only the second quarter since the survey was launched that investors favour US vs non-US equities.

Chart 5: Investors drastically reassess their regional preferences within the equity market


6) Investor optimism at its lowest since Survey was launched

This quarterly survey reveals the least optimistic views and some of the lowest conviction levels on record since December 2014.

Chart 6: ASR Multi-Asset Survey Optimism Indicator (*), at its lowest level since the survey was launched in December 2014


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US equities > non-US equities ($) EM equities > DM equities ($)

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Corresponding Uncertainty Score (Avg. % of 'No Strong Opinions') - RHS

ASR Optimism Indicator (%) - LHS

Optimism Indicator Historical Average

ASR Optimism Indicator (%) Corresponding Uncertainty Score (%)






Survey Responses: Macro Environment & Tail Risks

In the past three months, investors have become more confident that global business confidence was unlikely to improve from its current elevated levels. This could be ‘as good as it gets’ for global growth.

The probability of an improvement in global business confidence has declined significantly to 40% in June 2018 from 52% in September 2017 (see Chart 7).

However, the expected slowdown in the cycle is not perceived as posing a major threat to the economy. A global recession remains unlikely over the next 12 months, with a 31% probability, broadly stable since December 2016 (see Chart 8).

On balance, investors believe that the US unemployment rate is unlikely to rise in the next 12 months, placing a probability of 46% on this event. However, with the unemployment rate approaching multi-decade lows, we are not surprised to see this probability up from 40% in December 2017 (see Chart 9).

Chart 7: Probability of global business confidence being higher

Source: ASR Ltd. / Extel WeConvene Chart 8: Probability of a global recession in the next 12 months

Source: ASR Ltd. / Extel WeConvene Chart 9: Probability of a rise in the US unemployment rate


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Very LikelySomewhat LikelyNo Strong OpinionSomewhat UnlikelyVery Unlikely

Probability of Global Business confidence being Higher in the Next 12 Months

2Q17 1Q18 2Q18

62 63

54 53 5551

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52

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Panel's Implied Probability (%) Baseline Probability in the 10 Years to June 2018 (%)

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Probability of a Global Recession in the Next 12 Months

2Q17 1Q18 2Q18

27 30 28

39 36 38 36 3833

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Probability of a Higher US Unemployment Rate in the Next 12 Months

2Q17 1Q18 2Q18

39 40 43 45 43 40 4146 44 40 43 46

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Survey Responses: Core Inflation

Investors have become increasingly convinced that US core inflation would hit 2% in the next 12 months, placing a 69% probability on that event, up significantly from the 53% probability recorded in September 2017. This follows the strong increase in US core inflation to 1.8% in April 2018 from 1.3% in August 2017. In contrast, inflation expectations have been much more stable in the Eurozone and Japan in recent months. Investors remain convinced that core inflation will not hit 2% in Japan in the next 12 months (28% probability, Chart 12). They also believe this scenario is unlikely in the Eurozone (40% probability, Chart 11).

Chart 10: Probability that US core inflation will be 2% or higher

Source: ASR Ltd. / Extel WeConvene Chart 11: Probability that Eurozone core inflation will be 2% or higher

Source: ASR Ltd. / Extel WeConvene Chart 12: Probability that Japanese core inflation will be 2% or higher


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Probability that US Core Inflation will be 2% or Higher in the Next 12 Months

2Q17 1Q18 2Q18

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Probability that Eurozone Core Inflation will be 2% or Higher in Next 12 Mths

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Probability that Japanese Core Inflation will be 2% or Higher in Next 12 Mths

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Survey Responses: US Interest Rates & Yield Curve

Historically, the area of interest rates is where investors have registered some of the strongest convictions in the survey. This is true again this quarter. As of June, investors remain convinced that 2-year and 10-year US Treasury yields will move higher in the next 12 months, placing probabilities of 76% and 70% on those events respectively, broadly unchanged in the past five quarterly surveys (see Charts 13 and 14). Investors continue to expect a flattening of the yield curve, but conviction levels are more modest. They place a 60% probability on a further flattening of the curve in the coming 12 months (Chart 15). At the time of writing, the futures markets are discounting a 20bp flattening in 12 months’ time (US 10-year minus 2-year yields).

Chart 13: Probability that 2-Year UST yields will be higher

Source: ASR Ltd. / Extel WeConvene Chart 14: Probability that 10-Year UST yields will be higher

Source: ASR Ltd. / Extel WeConvene Chart 15: Probability that the US yield curve will be less positive


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Probability of Higher US 2-Year Treasury Yields in the Next 12 Months

2Q17 1Q18 2Q18

6471 73 77 79 76 73 76 75 76

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Probability of Higher US 10-Year Treasury Yields in the Next 12 Months

2Q17 1Q18 2Q18

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Probability that the US Yield Curve will be Flatter in the Next 12 Months

2Q17 1Q18 2Q18

61 61 5963 64

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Survey Responses: USD, US Real Yields & TIPS

A small majority of investors expect the USD to rise in the next 12 months, consistent with their expectation of a rise in US real yields. This translates into an implied probability of 55%, up from 53% in March. As of June, investors see a 63% probability of a rise in US real yields in the coming year, broadly stable since we started asking the question in September 2016. Investors continue to expect US TIPS to outperform US Treasuries in the coming year, with a probability of 58% in June, vs 60% in March. However, the level of uncertainty remains very high, with over a third of the panel reporting ‘no strong opinion’ (Chart 18).

Chart 16: Probability of a rise in the USD trade-weighted index

Source: ASR Ltd. / Extel WeConvene Chart 17: Probability that US real yields will be higher

Source: ASR Ltd. / Extel WeConvene Chart 18: Probability that US TIPS will outperform US Treasuries


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Probability of a Rise in the USD Trade-Weighted Index in the Next 12 Months

2Q17 1Q18 2Q18

7366 64 65 63

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Probability that US Real Yields will be Higher in the Next 12 Months

2Q17 1Q18 2Q18

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Probability that US TIPS Returns will Beat US Treasuries in the Next 12 Mths

2Q17 1Q18 2Q18

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Survey Responses: US Corporate Credit & EM Debt

Consistent with their view that global business confidence is unlikely to improve from current elevated levels and that rates will move higher, investors have become significantly less confident on US credit in recent months.

The probability of US investment grade bond returns outperforming USTs in the next 12 months has declined steadily from 66% in Dec. 2016 to 47% in June 2018 (Chart 19).

Similarly, investors now expect US high yield credit to underperform US investment grade (from neutral 6 months ago, Chart 20)…

… and they have turned negative on EM sovereign bonds vs US High Yield corporate bonds (Chart 21). They now see a 49% probability that EM sovereigns will beat US HY, down from 62% in September 2017.

Investors are very uncertain about this call, with 37% of the panel reporting ‘no strong opinion’. Historically, EM sovereigns have tended to underperform US HY in USD terms in periods when global equities have beaten bonds.

Chart 19: Probability that US IG bond returns will beat US Treasuries

Source: ASR Ltd. / Extel WeConvene Chart 20: Probability that US HY bond returns will beat US IG

Source: ASR Ltd. / Extel WeConvene Chart 21: Probability that EM sovereign bond returns will beat US HY


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Probability of US IG Bond Returns Beating US Treasuries in the Next 12 Mths

2Q17 1Q18 2Q18

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Probability of EM Sov. Bond Returns ($) Beating US HY in the Next 12 Months

2Q17: NA 1Q18 2Q18

62 60 59

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Survey Responses: Global Equity Drivers

Investors continue to expect equity markets to rise globally, driven by earnings growth, as opposed to valuation expansion. They assign a 59% probability that global equity prices will rise in USD terms in the next 12 months, broadly unchanged in the past six quarters (Chart 22). They remain confident that corporate earnings will grow in the coming year, placing a 68% probability on this scenario, although their conviction level has declined markedly from the 74% probability reported six months ago (see Chart 23). On balance, investors now expect valuation multiples to contract vs widen six months ago. This also represents a significant change from the positive views held six months ago. The probability of a rise in equity valuations has declined from 54% in December to 48% in June.

Chart 22: Probability that global equity markets will be higher

Source: ASR Ltd. / Extel WeConvene Chart 23: Probability of positive global corporate earnings growth

Source: ASR Ltd. / Extel WeConvene Chart 24: Probability that global equity valuations will be higher


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Probability that Global Equity Markets will be Higher ($) in the Next 12 Mths

2Q17 1Q18 2Q18

7065 64 61

57 6155 55

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Probability of Positive Global Corporate Earnings Growth ($)

2Q17 1Q18 2Q18

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Probability that Global Equity Market Valuations will be Higher

2Q17 1Q18 2Q18

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Survey Responses: Equity Risk Appetite

Investors still believe that a bear market in the US is unlikely within the next 12 months.

The risk of a 20% drawdown in US equities at some stage within the next 12 months is estimated at 40% in June, down from 44% three months ago (Chart 25).

However, the probability of this risk looks elevated compared with the experience of the past 10 years, when 20% drawdowns in US stocks have been seen 10% of the time.

Investors are convinced that the VIX will move higher in the coming year, placing a 69% probability on this event (Chart 26). This is not surprising, given that the VIX averaged 13 during the 2Q18 polling period, shortly after hitting a six-year high of 37 in February this year.

Historically, periods of rising equity volatility have been associated with the under-performance of stocks vs bonds, credit vs Treasuries and cyclical stocks vs defensives. Chart 27 shows that investors are broadly neutral on Cyclicals vs Defensives.

Chart 25: Probability of a 20% drawdown in US equities

Source: ASR Ltd. / Extel WeConvene Chart 26: Probability that the VIX will be higher

Source: ASR Ltd. / Extel WeConvene Chart 27: Probability that Global Cyclicals will beat Defensives


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Probability of a 20% Drawdown in US Equities Within the Next 12 Months

2Q17 1Q18 2Q18

#N/A #N/A #N/A #N/A #N/A #N/A

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Probability that Implied Equity Volatility will be Higher in the Next 12 Mths

2Q17 1Q18 2Q18

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Probability that Global 'Cyclical Stocks' will Beat 'Defensives'

2Q17 1Q18 2Q18

59 59 5951 51 52 52

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Survey Responses: Regional Equity Allocation

Regional equity allocation is where we have seen some of the biggest changes in expectations in 2Q18.

Investors now have a preference for US equities vs the rest of the world, while they were still negative on the region in March.

They now place a 55% probability on US equities outperforming in the next 12 months, up significantly from 46% in March 2018 and 35% in June 2017. This is only the second quarterly survey since 1Q15 when investors have expressed a preference for US equities (Chart 28).

Similarly, investors have now turned negative on Emerging Market Equities vs Developed Markets. They now see a 47% probability of EM equities outperforming DM in the coming year, down substantially from 60% in March 2018 and 63% in September 2017. This represents the biggest change of expectations this quarter (Chart 29).

Asian equities are still preferred to their European peers, with an estimated probability of outperformance of 59% (Chart 30).

Chart 28: Probability that US equities will beat non-US equities

Source: ASR Ltd. / Extel WeConvene Chart 29: Probability that EM equities will outperform DM equities

Source: ASR Ltd. / Extel WeConvene Chart 30: Probability that Asian equities will beat European stocks


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Survey Responses: Asset Allocation

Investors remain confident that equities will beat bonds globally in the next 12 months, with a probability of 69%. This is up slightly from the 66% probability reported three months ago (Chart 31).

This is consistent with expectations of a rise in equity markets (59% probability) and higher 10-year government bond yields in the US and Germany (70% and 72% probability, respectively).

Investors continue to believe in the strength of the US labour market. They see a 46% probability that the US unemployment rate will be higher in a year’s time (Chart 32).

This is important because historically, increases in US unemployment have been associated with rotation out of stocks into bonds.

Investors now expect equities to outperform commodities in the coming year, with a 56% probability. This compares with 48% three months ago. However, uncertainty remains very high, with 38% of the panel expressing ‘no strong opinion’ (Chart 33).

Chart 31: Probability that global stocks will beat global bond returns

Source: ASR Ltd. / Extel WeConvene Chart 32: Probability of a higher US unemployment rate

Source: ASR Ltd. / Extel WeConvene Chart 33: Probability that global equities will beat commodities


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Survey Responses: Commodities

Once again this quarter, the commodity space has attracted the highest level of uncertainty. On balance, investors expect the price of gold to rise in the coming year, with a probability of 56%. However, the degree of uncertainty about the asset class is very high, with 37% of the panel reporting ‘no strong opinion’ (see Chart 34). Unsurprisingly, this uncertainty extends to the performance of other commodities relative to gold. Investors expressed a small preference for oil and industrial metals relative to gold. But over a third of the panel reported ‘no strong opinion’ on the subject. Oil / gold and industrial metals / precious metals have historically been good cross-checks for other risk-on pairs such as equities / bonds, cyclical stocks / defensive stocks, US high yield / investment grade credit (strong positive correlation).

Chart 34: Probability that the gold price will be higher

Source: ASR Ltd. / Extel WeConvene Chart 35: Probability that oil will outperform gold

Source: ASR Ltd. / Extel WeConvene Chart 36: Probability that industrial metals will outperform gold


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Indicators of Anchoring, Responsiveness & Capitulation

Charts 37 to 42 illustrate the degree of ‘anchoring’ in investors’ views.

They highlight the degree to which investors’ expectations have changed (or not) in the past three years, following changes in the macro-environment or financial market performance.

The implied probabilities in the survey are represented by the angle of the arrows. An arrow pointing upwards is consistent with the panel expecting the financial measure to rise, or the event to materialise, in the following 12 months and vice versa.

Blue (red) arrows highlight a significant increase (decline) in implied probability versus the previous quarterly survey, i.e. greater than 4%. Click here for more details.

Chart 38 and 39 are good examples of ‘anchoring’ in investors’ views.

Expectations of a rise in 2-year UST yields and global equity markets have been very stable in recent quarters. This may be partially due to the

Chart 37: How to Read the Following Charts – More details here

Source: ASR Ltd. / Extel WeConvene / Thomson Reuters Datastream Chart 38: Probabilities of US 2-year Treasury yields moving higher

Source: ASR Ltd. / Extel WeConvene / Thomson Reuters Datastream Chart 39: Probabilities of a rise in global equity prices in USD terms

Source: ASR Ltd. / Extel WeConvene / Thomson Reuters Datastream



https://www.absolute-strategy.com/x/research?id=63694#page=16

https://www.absolute-strategy.com/x/research?id=63694#page=16




trending nature of those series. However, we feel that in the case of global equities, there might be some element of behavioural bias. When global equities lost 9% of their value between 2Q15 and 3Q15, investors barely re-assessed their expectations. The probability of a rise in equities went from 64% in 2Q15 to 61% in 3Q15 (Chart 39). Similarly, in the past 6 months, the outlook for equities has barely changed, while views on corporate earnings and equity valuations have been significantly reduced.

In contrast, Charts 40 to 42 offer good examples of more dynamic behaviours on the part of investors.

In recent quarters, investors have been more active in revising their expectations about US TIPS / UST (Chart 40), US Credit / UST (Chart 41), as well as EM equities vs DM (Chart 42). This could be explained by the ‘less-trending’ nature of those series, by more frequent or more sudden changes in their fundamental drivers, or simply by different behavioural biases.

Chart 40: Probabilities of US TIPS beating US Treasuries

Source: ASR Ltd. / Extel WeConvene / Thomson Reuters Datastream Chart 41: Probabilities of US Inv. Grade credit beating Treasuries

Source: ASR Ltd. / Extel WeConvene / Thomson Reuters Datastream Chart 42: Probabilities of EM equities outperforming DM

Source: ASR Ltd. / Extel WeConvene / Thomson Reuters Datastream






Charles Cara +44 (0) 20 7073 0738 [email protected]

Three major groupings of investors Cyclical Growth (35%): Expects business confidence to remain steady, supporting high risk assets such as Equities and cyclical stocks. Treasuries at risk of a sell-off Credit Risk (34%): Sees Corporate Credit and Equities exposed to a fall in business confidence. Muted Growth (31%): Does not expect business confidence to rise. Concerned about inflation hitting bonds, but expects equities to be flat. Methodology We use a ‘model based clustering’ technique to group together respondents with similar views. We determine the optimal number of groups by finding the smallest number of groups that maximises the (Bayesian) information coefficient. Further details are at the end of this article.

Credit Risk Concerns Rise An AI based analysis highlights that confidence in Cyclical Economic Growth seems to be fading and that concerns about Credit Risk are returning.

Each quarter, we use artificial intelligence or machine learning techniques to categorise our panellists into different “tribes”, to get more detail about how investors’ viewpoints are changing. Our approach is ‘unsupervised’ which means we don’t predefine the size or characteristics of the groups, but instead find the ‘most likely’ way our panel would divide. We then interpret the average views of each of the groups (Charts 43 to 47).

Again, this quarter our analysis says that the optimal split of our panellists is into 3 groups and their views look similar to last quarter. But there has been a big shift in the numbers of panellists in each group, with the ‘Cyclical Growth’ group shrinking from 54% to 35% of the panel, while the `Credit Risk’ group has increased from 15% to 34%.

The largest group ‘Cyclical Growth’ has shrunk from over half the panellists to 35%. This group is the most bullish on the economy. They have the strongest inflation expectations and so are the most confident that bond yields will rise and that the yield curve will not flatten further. They expect equities to rally on strong earnings. They still have faith in EM Equities, Cyclicals and equities beating bonds and commodities. This group believes the cycle has further to go and inflation is appearing.

The second largest group is now ‘Credit Risk’, which has risen from 15% to 34%. These panellists expect Business Confidence to fall so far that US unemployment will start to rise. Despite falling activity levels, they see inflation in the US, expect US yields to rise and the curve to flatten. They are not the most pessimistic group on Eurozone and Japan inflation returning. Despite their Eurozone inflation view, they see Bund yields rising. This is the group that is most concerned about credit risk and unlike the other two groups expect US credit (High Yield and Investment Grade) to underperform Treasuries. They also expect equities to fall despite higher corporate earnings. This group is looking to find safety in Defensives and maybe even Gold. But still there is the feeling that this group is struggling to find investments they want to hold: they are not even positive on USD.

The final group ‘Muted Growth’ is slightly smaller than the other two and has views in between them (Chart 49). They expect business confidence to fall but not enough to raise US unemployment. While they see inflation returning in the US, they strongly believe there is no inflation in Japan or the Eurozone. Even so they expect Bund yields higher along with Treasuries. They expect equities higher on stronger earnings, but do not buy into the idea of a Cyclical and EM led rally in equities. This group is the most bullish on the USD.



http://www.absolute-strategy.com/x/research.html?aid=18

mailto:[email protected]?subject=Absolute%20Strategy%20Weekly




Chart 43: Average response of the three groups identified in our Machine Learning Analysis







Chart 44: Comparison of ‘Cyclical Growth’ Group (35%) with Survey

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More Likely than Consensus

More Unlikely than Consensus

Views expressed in ‘notches’ Source: ASR Ltd. / Extel WeConvene

Chart 45: Comparison of ‘Muted Growth’ (31%) Group with Survey

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Chart 46 Comparison of ‘Credit Risk’ (34%) Group with Survey

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Chart 47 Comparison of ‘Credit Risk’ (34%) Group with Cyclical Growth (35%) Group

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Chart 48: Fitting two normal distributions to a dataset

Source: W. Härdle, Fraley & Raftery

Chart 49: MAS categorisation, 1st 2 PCA components

Source: ASR Ltd

How we find our groups of similar investors

The basis of this group analysis is that there are only a limited number of generic categories of investors. An investor’s answers are the combination of their generic categories’ answer and some individual variation (i.e. ‘noise’). We want to match an investor to their generic category.

Our approach is ‘unsupervised’: ahead of the analysis we do not know either the number of generic categories, or even their views! However, this is not an insurmountable problem. We can use a Bayesian approach: that is, we create a model of the generic categories and see whether we can get it to fit the data. The parameters of the model (the number of clusters and their means and variances) are then adjusted until the ‘most likely’ model is found. So, in the example in Chart 48, the data is the bars, which are modelled by superimposing two normal distributions (the generic type). Increasing the number of distributions might lead to a better fit. However, this runs the risk of over-fitting, and so each extra group increases a penalty factor when calculating the how good a fit the model is. This technique is widely used in the pharmaceutical industry.

Transferring this idea to our survey, the bars would be the responses to a question, and so the two distributions in the chart are equivalent to two basic investor categories. Of course our survey has 30 questions with discrete responses which makes the maths more complex. We start with a PCA to reduce the number of dimensions. For our survey the fitting of answers to categories results in Chart 49.

We have used the algorithms provided by the mclust package in R.



https://en.wikipedia.org/wiki/Principal_component_analysis

http://www.stat.washington.edu/mclust/




Multi-Asset Survey – A Glance at the History

Table 2: ASR Multi-Asset Survey – Implied probabilities since the survey was launched

Source: ASR Ltd. / Extel WeConvene.

Market Levels During the Fieldwork Periods

Table 3: Average levels of market & macro series during field work periods

Source: ASR Ltd. / Thomson Reuters Datastream

Question 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18

Global business confidence higher NA 62 63 54 53 55 51 49 58 55 50 52 47 43 40

Global recession 27 30 28 39 36 38 36 38 33 29 28 30 27 31 31

US unemployment rate higher NA NA NA 39 40 43 45 43 40 41 46 44 40 43 46

US core inflation at 2% or higher NA NA NA NA NA NA NA 56 69 70 56 53 59 67 69

Eurozone core inflation at 2% or higher NA NA NA NA NA NA NA NA NA 46 37 38 42 40 40

Japanese core inflation at 2% or higher NA NA NA NA NA NA NA NA NA 31 26 27 31 31 28

US 2-year Treasury yields higher NA NA NA NA NA 64 71 73 77 79 76 73 76 75 76

US 10-year Treasury yields higher 70 70 74 68 68 63 65 70 74 75 71 72 69 70 70

US yield curve flatter 61 61 59 63 64 56 59 57 52 58 58 54 60 58 60

US real yields higher NA NA NA NA NA NA NA 62 65 63 60 63 63 61 63

US TIPS returns beat US Treasuries 47 48 61 49 56 55 60 64 69 64 56 57 60 60 58

German 10-year Bund yields higher NA NA NA NA NA NA NA NA NA NA NA NA NA NA 72

US IG corp. bonds beat US Treasuries 62 62 64 60 60 65 65 62 66 62 61 59 56 51 47

US HY corp. bonds beat US IG NA NA NA NA NA NA NA NA NA NA NA 52 50 46 45

EM sov. bonds beat US HY corp. bonds ($) NA NA NA NA NA NA NA NA NA NA NA 62 60 59 49

Global equities higher ($) 70 65 64 61 57 61 55 55 62 58 58 59 61 58 59

Global corporate earnings higher ($) NA NA NA NA 54 51 56 59 69 70 70 70 74 70 68

Global equity valuations higher NA 58 57 54 50 55 52 49 55 50 50 55 54 48 48

US equities outperform non-US equities ($) NA 37 36 42 38 43 45 46 56 43 35 39 42 46 55

EM equities outperform DM equities ($) NA NA NA NA NA NA NA NA NA NA NA 63 60 60 47

Asian equities beat European equities ($) NA NA NA NA NA NA NA NA NA NA NA NA 58 59 59

Global cyclical stocks outperform defensives 59 59 59 51 51 52 52 56 67 60 56 57 57 54 53

VIX higher NA NA 68 50 65 57 66 70 67 71 73 71 74 65 69

20% drawdown in US equities NA NA NA NA NA NA 48 50 44 38 38 38 39 44 40

Gold higher 47 53 52 53 56 56 55 57 50 55 53 NA NA NA 56

Industrial Metals outperform Gold NA NA NA NA NA 47 47 NA NA NA NA NA NA NA 56

Oil outperforms Gold NA NA NA NA NA NA NA NA NA NA NA 47 54 53 52

Global equities outperform bond returns 75 74 74 67 67 67 63 68 77 74 72 73 70 66 69

Global equities outperform commodities NA NA NA NA NA NA NA NA NA NA NA 55 54 48 58

USD trade weighted index higher 73 66 64 65 63 56 59 61 65 58 51 54 55 53 55

Number of Participants 100 120 165 210 183 210 221 201 202 243 192 207 229 204 214

Asset under Management ($ billion) 1,197 2,193 2,812 2,631 2,919 3,014 3,160 2,976 4,200 5,821 4,458 5,319 6,013 5,303 4,065

2Q17 vs. 3Q17 vs. 4Q17 vs. 1Q18 vs. 2Q18 vs.

2Q17 1Q17 3Q17 2Q17 4Q17 3Q17 1Q18 4Q17 2Q18 1Q18

Global Composite PMI 53.6 -0.2 Pts 53.8 0.2 Pts 54.2 0.4 Pts 53.3 -0.9 Pts 54 0.7 Pts

US unemployment rate 4.3 -0.2 % Pts 4.2 -0.1 % Pts 4.1 -0.1 % Pts 4.1 0.0 % Pts 3.8 -0.3 % Pts

US core inflation 1.5 -0.1 % Pts 1.4 -0.2 % Pts 1.5 0.2 % Pts 1.8 0.3 % Pts NA NA

Eurozone core inflation 1.1 0.3 % Pts 1.1 0.0 % Pts 0.9 -0.2 % Pts 1.1 0.1 % Pts NA NA

Japanese core inflation 0.0 0.1 % Pts 0.2 0.2 % Pts 0.3 0.1 % Pts 0.5 0.2 % Pts NA NA

US 2Y Treasury yields 1.32 -1 b.p. 1.36 3 b.p. 1.77 41 b.p. 2.25 48 b.p. 2.50 26 b.p.

US 10Y Treasury yields 2.18 -36 b.p. 2.17 -1 b.p. 2.36 18 b.p. 2.86 51 b.p. 2.94 7 b.p.

US 10Y - 2Y yields 0.86 -35 b.p. 0.82 -4 b.p. 0.59 -23 b.p. 0.62 3 b.p. 0.43 -18 b.p.

US real yields 0.25 4 b.p. 0.21 -4 b.p. 0.42 22 b.p. 0.56 13 b.p. 0.72 17 b.p.

US TIPS / US Treasuries 51 -2% 51 0% 51 1% 53 3% 53 1%

German 10Y Bund yields 0.27 -12 b.p. 0.40 13 b.p. 0.34 -6 b.p. 0.64 30 b.p. 0.44 -20 b.p.

US IG corp. bonds / US Treasuries 486 0% 488 1% 496 2% 505 2% 503 0%

US HY corp. bonds / US IG 43.45 -1% 43.43 0% 43.46 0% 44.28 2% 44.87 1%

EM sov. bonds ($) / US HY corp. bonds 110 1% 111 1% 110 -1% 108 -1% 104 -4%

Global equities 917 6% 956 4% 998 4% 1,035 4% 1,040 1%

Global trailing earnings 29.6 6% 30.6 3% 30.6 0% 32.8 7% 33.6 2%

Global equities PE 19.1 -1% 18.6 -2% 19.1 3% 18.8 -2% 18.3 -3%

US equities / non-US equities 1,708 -5% 1,662 -3% 1,707 3% 1,749 2% 1,782 2%

EM equities / DM equities 7.07 -1% 7.30 3% 7.05 -4% 7.33 4% 6.94 -5%

Asian / European equities ($) 2.41 -3% 2.44 1% 2.57 5% 2.63 2% 2.62 0%

Global cyclicals / defensives 55 0% 56 2% 59 5% 61 3% 62 2%

VIX 10 -11% 11 2% 11 1% 18 66% 13 -28%

US Equities maximum annual drawdown -0.2 0.5 % Pts -0.2 0.0 % Pts -0.2 0.0 % Pts -4.6 -4.4 % Pts -4.1 0.5 % Pts

Gold higher 680 5% 706 4% 681 -3% 702 3% 687 -2%

Industrial Metals / Gold 171 -8% 190 11% 199 5% 198 0% 214 8%

Oil / Gold 55 -15% 60 8% 72 20% 73 2% 90 23%

Global stock returns / global bond returns 175 1% 178 2% 187 5% 191 2% 197 3%

Global equities / commodities 42 13% 42 -2% 41 -3% 41 0% 38 -7%

USD trade weighted index (DXY) 97 -5% 92 -5% 93 1% 90 -3% 94 4%




For full Research Library click here This research report is issued by Absolute Strategy Research Ltd, which is authorised and regulated by the Financial Conduct Authority (“FCA”). Absolute Strategy Research Services Inc. is registered as an investment adviser with the US SEC, and is responsible for all communications and dealings with, and only with, US persons. The report is intended only for investors who are Eligible Counterparties or Professional Clients, as defined by MIFID and the FCA, and may not be distributed to Retail Clients. Absolute Strategy Research Ltd does not solicit any action based upon this report, which is not to be construed as an invitation to buy or sell any security. This report is not intended to provide personal investment advice and it does not take into account the investment objectives, financial situation and the particular needs of any particular person who may read this report. This research report provides general information only. The information contained was obtained from sources that we believe to be reliable but we do not guarantee that it is accurate or complete, and it should not be relied upon as such. Opinions expressed are our current opinions as of the original publication date appearing on this material only and the information, including the opinions contained herein, are subject to change without notice. This research report may not be redistributed, retransmitted or disclosed in whole or in part, without the express written permission of Absolute Strategy Research Ltd. © Absolute Strategy Research Ltd 2018. All rights reserved. Absolute Strategy Research Ltd. 1-2 Royal Exchange Buildings, London, EC3V 3LF. Phone: +44 (0) 20 7073 0730 Fax: +44 (0) 20 7073 0732. www.absolute-strategy.com. Absolute Strategy Research Ltd is registered in England and Wales. Company number 5727405. Registered Office: Salisbury House, Station Road, Cambridge CB1 2LA.

Survey Methodology: What we Mean by Implied Probabilities

ASR’s Multi-Asset Survey is a Survey of Probabilities.

Every quarter we contact around 200 asset allocators and multi-asset strategists from

around the world.

We ask them “how likely” they think certain financial and economic events are to occur in

the next 12 months. All thirty questions are framed with a binary outcome (will ‘X’ happen or

will it not happen?) within a fixed time horizon.

Each question offers five options: (1) very likely (2) somewhat likely, (3) no strong opinion,

(4) somewhat unlikely, (5) very unlikely.

We then ascribe notional probabilities to each of the five options. For example, if someone

responds “very likely”, we apply a 90% probability to their response. If they reply “very

unlikely”, we apply a 10% probability. If someone says “no strong opinion”, then we apply a

50% probability (the equivalent of tossing a coin).

By applying the different probabilities to all the responses, we can calculate an overall

probability. This is more sophisticated than other surveys, which just calculate a “net

balance” (e.g. % respondents that are ‘optimists’ minus % respondents that are

‘pessimists’). Our approach better captures differences in convictions.

Small changes in the implied probabilities matter: a 5% point change over a quarter often

indicates an important shift. A 10% point change can reflect a profound change in

expectations.

These “implied probabilities” are powerful as they can be used in multiple ways. First, we

can compare them with the probabilities that are implied in the market. Secondly, we can

compare them with our views and see where we are most different from the consensus. And

thirdly, we can compare them with the historic base (how often has this event occurred over

the past decade). An implied probability of 50% may sound like a neutral call but if the

event has only occurred 20% of the time over the past decade, then this 50% probability is

in fact a much more aggressive call that it appears.

This approach has one additional benefit, in that we can see how investors’ expectations are

affected by changes in the financial markets themselves. Is there evidence of momentum –

to what extent do respondents’ expectations for the next 12 months move with what has

happened over the past 12 months? Can we see evidence of anchoring – to what extent do

investors cling onto their views even when the market is going against them? Is there

evidence of crowding and contrarian tendencies – when investors think something is “very

likely”, does that indicate a crowded trade?


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