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Five  key  investment  themes  for  2015    

   Exiting  QE  in  the  US  was  always  going  to  be  a  path  of  uncertainty  for  central  bankers,  globally  and  for  markets  and  investors.   There   is   simply   no   exact  precedent  for  the  recent  quantitative  easing   program   in   the   US   and,  therefore,   the   consequences   of  resuming   more   normative   monetary  policies   and   interest   rates.   And   this  uncertainty  is  compounded  as  the  US  is  now  on  a  course  that  diverges  from  Japan,  Europe  and  China,  all  of  which  are   heavily   committed   to   their   own  ongoing   QE   and   growth   stimulus  programs,   as   the   US   moves   to  increase  rates.        Richard  Iley,  Chief  Economist  at  BNP  Paribas,   speaking   at   the   recent   BNP  Securities   Services   event   in   Hong  Kong   for   key   institutional   investors  and   asset   managers,   entitled   “Let’s  Get   Real’,   provided   five   key   themes  for  2015  that  institutional  investors    

should   have   regard   to   and   which  might   provide   some   clarity   in   a  complex  global  economic  picture.  Iley  began   by   reflecting   on   asset   class  returns  last  year  and  pointed  out  that  the   best   returning   trades   in   2014  were  long  Chinese  equities  and  short  oil   and   the   long   German   10-­‐year  government   bonds,   but   on   a   hedged  basis   and   short   the   Euro.   Iley  remarked   that   many   of   the   themes  for   the   first   quarter   of   2015   have  remained   the   same   in   2015,   with  Chinese   equities   continuing   their  strong   bull   run   along   with   German  government   bonds   and   with   the   US  Dollar   strengthening   and   the   Euro  and,   to   a   lesser   extent,   the   Yen  weakening.   But   in   the   first   quarter  Japanese   equities   emerged   as   the  second   strongest   asset   class   and  European   equities   improved   on   a  relative  basis.    

 

                     

Source:    Macrobond,  BNP  Paribas  

 

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Iley  went  on  to  highlight  BNP  Paribas’  five  key  investment  themes  for  2015/2016:    

US economy and USD continuing outperformance More Euro and Yen weakness to come Japanese and European equities to remain attractive (on a hedged basis) China’s equity bull market is not fundamentally based and will reverse Low oil prices will remain for some time

 US  Economy  Strength    Iley   dismissed   the   recent   pockets   of  poor   labour   data   from   the   US   and  argued   based   on   labour   data   and  general  economic  data   trends   the  US  will   outperform   other   leading  economies.   The   markets   reacted   to  (marginally)   disappointing   data   on  US   jobless   claims   in   April,   though  much   of   that   uncertainty   was  removed   in   May   with   223,000   new  jobs  and  a  drop  in  the  unemployment  rate   to   5.5%,   after   a   lackluster   first  quarter.      

   Iley   commented   that   BNP   Paribas’  believes   the   strength   of   the   US  recovery   is   based   on   the   sustained  recovery   in   the   US   labour   market,  which   has   steadily   accelerated   since  2012.     Jobless   claims   are   the   lowest  since   2000;   with   5   million   job  openings;   and   the   labour   market  reaching   the   level   the   Federal  Reserve  defines  as  full  employment  –  a  5.2%-­‐5.5%  rate   –   and   still   heading  downwards.   Iley   also   points   to  consumer   confidence   at   its   highest  since  2006.    

   The   main   consequence   of   this  strength,   Iley   predicts,   will   be   two  years   of   steady   interest   rate   hikes,  probably   beginning   in   September.  This   in   turn   will   mean   an   even  stronger   US   dollar   versus   the   Euro  and   the   Yen,   whose   currencies   are  dampened   by   their   own   QE.   The   US  dollar   bull  market   has   recently   gone  into   reverse,   but,   as   with   other  commentators,   Iley   believes   that   the  US  dollar  will  resume  the  bull  run  as  the  economy  continues  to  strengthen  and  US  Dollar  rates  move  upwards.                                

Another  consequence  of   the  strength  of  the  US  economy,  according  to  Iley,  is   the   impact   on   the   US   government  bond  markets,  which  he  describes  as  “complacent”,   with   the   short-­‐end   of  the   curve   appearing   not   to   reflect   in  an   environment   of   rising   rates   and  falling   prices.   Yields   in   US   Treasury  bonds   fell   again   last   week   (3/5/15)  as   markets   seem   to   believe   that   the  US   jobs   numbers   contained   enough  weak   data   to   push   bask   US   Dollar  rate   increases.                                 .  

DXY:  US  dollar  spot  index  10/12/2014  –  10/05/2015  

Source:  Bloomberg  

 

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 More  European  &  Japanese  ‘QE’      Christine   Lagarde,   now   of   the   IMF,  said  in  a  speech  last  year  that:  “As  the  crisis   has   taught   us,   in   times   of  distress,   the   potential   gains   from  [international   monetary   policy]  cooperation   can   be   huge.”   She  continued,   “Think  of   the   coordinated  cut   in   policy   interest   rates   in   key  countries  at  the  height  of  the  crisis,  or  the   swap   arrangements   that   the   Fed  instituted   with   other   major   central  banks.”  But  now,   as   the  US   economy  emerges   fastest   from   low   growth,  sluggish   employment   and   low  inflation,  the  G3  (and  China)  are  once  again  on  different  and  uncoordinated  monetary  policy  courses.      On   ‘QE’   generally   and   particularly  with  regard  to  Europe  and  Japan,  Iley  commented   that   a   BNP   Paribas  colleague   had   remarked   that   he   had  never  seen  a  Central  bank  do  QE   just  once  –  the  US  had  3  rounds.      

 By   implication   a   long   period   of  intervention,   in   Japan   and   in   Europe  which  has  just  started  its  program.      As   QE   continues   and,   in   Europe,   is  expanded,   the   first   –   Iley   comments  that   the   now   consensus   view   is   that    the   currencies   of   Japan   and   Europe  that  will  continue  to  fall   further  with  BNP   Paribas   currently   expecting  Euro:US$   parity   by   year-­‐end  (currently   1.1199)   and   then   heading  lower   in   2016   and   the   Yen   hitting  128  (from  119.76  currently).      Whether   QE   measures   will   be  effective   in   raising   inflation   Iley  asserts   is   a   moot   point   as   in   the   US  QE   only   stabilized   inflation   and   the  ECB   ambitiously   seeks   to   raise  inflation   by   0.75%   with   similar   QE  measures.   However,   Iley   confirmed  that   the   BNP   Paribas’   view  was   that

   

Euro Stoxx50S&P500 versus the Nikkei and Euro Stoxx50

over 5 years - indexed

Nikkei 225S&P500

Source:  Bloomberg  

 

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the  QE  programs  will  have  an  impact  on   riskier   assets   –   raising   demand  and  prices.   So  QE  programs   in   Japan  and  Europe  indicate  that  risky  assets  and   in   particular   equities,   will  appreciate  as  the  S&P  has  done  in  the  US  during  its  own  QE  program.  These  

asset   classes   will   likely   prove  attractive   option   for   investors   but,  with  correspondingly  weak  domestic  currencies,   on   a   hedged   basis.   BNP  Paribas   currently   believes   that  22,000  on   the  Nikkei   is   a  possibility.    

 

China  Struggles      There  has  been  much  debate   in  Asia  about   the   countries   that   will   be   the  winners  and   losers   from  a  strong  US  dollar   and   the   focus   has   been  emerging   markets.   In   addition   to  reversing   fund   flows   to   those  markets   and   raising   the   cost   of  capital   those   countries   with   large  current  account  and/or  fiscal  deficits  are   usually   singled   out   as   they   are  dependent   on   capital   inflows.  Indonesia  and   India  both   suffered  as  the   Federal   Reserve   began   its  tapering  in  2013  (the  so-­‐called  Taper  Tantrum).   In   addition   for   certain   of  those   countries,   including   Indonesia  and   Brazil,   they   are   also   dependent  on  commodity  prices   in  dealing  with  deficits.    But  Iley  pulls  out  China  as  a  potential  casualty   of   the   forthcoming   rises   in  rates   in   the  US,  even   though   its   runs  both   a   current   account   and   fiscal  surplus.  And  he  points  to  the  Chinese  government’s   “dirty   peg”   between  the   Yuan   and   the   US   dollar   as   the  cause,  in  a  US  dollar  bull  market.        China’s   real   (inflation-­‐adjusted)  effective  exchange  rate  has  gained    19%   since   July   2014   and   has  appreciated  by   circa  50%  versus   the  yen   and  more   than   20%   against   the  Euro.   Richard   Iley   warns   that   this  currency   driven   downward   pressure  on   the   competitiveness   of   Chinese  exporters   may   lead   to   stagnant  export   numbers   in   an   economy  struggling   with   the   dampening   of  growth.  

Iley   describes   the   effect   of   the  US$   appreciating   as   a   “loss   of  competitiveness  at  the  worst  possible  time”.      This   factor   compounds   with  significant  medium  term  issues  in  the  real   estate   market   in   China.   The  contribution  of   real   estate   to  China’s  overall   GDP   increased   steadily   since  2001   and   now   represents  approximately   16%   of   GDP,  according   to   BNP   Paribas   and  Macrobond   and   accounts   for   23%  of  GDP  growth  between  2009  and  2013.      

 Source  BNP  Paribas  and  Macrobond    Iley   warns   that   the   massive   over-­‐supply  of  real  estate   inventory  –  and  the   pipeline   of   new   inventory   from  projects   previously   started   –   is  pushing   down   real   estate   prices   and  CAPEX   and   that   the   oversupply   will  take  several  years  to  fully  unwind,  in  a   weaker   economy.   This   implies  contraction   in   real  estate   investment  with   a   consequent   effect   of  depressing  the  previous  lift  from  real  estate  to  GDP  growth.      

CNY (Real Effective Exchange Rate)2010 = 100

 

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   China  Equities    And   what   of   Chinese   equities   which  over   2014   and,   again,   year   to   date,  have   been   the   most   successful   asset  class?      Iley   points   out   that   the   appreciation  of  the  A  share  market  is  not,  of  course,  based  on  fundamentals.  Iley’s  view  is  that   the   current   background   of  ‘fundamentals’   in   China   is  “unappetizing”.      He   says   “Since   Q2   of   2014,   when   A  shares   were   relatively   cheap,   the  Shanghai   Composite   Index   has   risen  by   86%   and   the   Shenzhen   Index   by  93%  over  the  past  two  years.”    This   growth,   he   asserts,   has   been  driven  by  speculation  and  he  points      

 to  the  margin  trading  numbers  as  an  indicator  of  the  extent  of  “hot”  money  in  the  market.      Margin   lending   numbers   have  reached   125   trillion   Yuan   or   2%   of  China’s   GDP.   But   Iley   also   cautioned  that   the   problem   with   speculative  bubbles   is   that   they  often   last   longer  than  expected.  Iley  gives  the  example  of   the   Shenzhen   Index   which  currently  has  an  average  trailing  P/E  ratio  over  50,  that  figure  had  been  as  high  as  70  in  2007.  And  so  although  a  bubble,   the   China   equity   market  might  yet  have  some  way  to  go  as  the  government   continues   to   look   at  ways   to   stimulate   growth   in   the  economy.  

   

 Source:  Macrobond,  BNP  Paribas        

Year

Equity margin debt outstanding in RMB trillions(sum of Shanghai & Shenzhen exchanges) Oil  

Iley’s  view  was  that  it  is  too  early  to  say  that   oil   has   hit   bottom   with   US  inventories   high,   at   480m   barrels,   the  highest  since  1930  and  climbing  at  10m  barrels   a   week.     And   in   a   peak   oil  consumption  season.  As  storage  capacity  fills,   oil  will   come  on   to   the  market   and  depress  prices.  Subject  of  course  to  geo-­‐political  instability.    

 

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This  article  has  been  produced  by  Asia  First  in  conjunction  with  and  with  the  assistance  of,  BNP  Paribas  Securities  Services  who  hosted  the  event  at  which  Richard  Iley  spoke.  Asia  First  provided  event  services  to  BNP  Paribas  Securities  Services    in  organizing  that  event.              

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BNP  Paribas  Securities  Services,  a  wholly-­‐owned  subsidiary  of  the  BNP  Paribas  Group,  is  a  leading  global  custodian  and  securities  services  provider  backed  by  the  strength  of  a  universal  bank.  It  provides  integrated  solutions  for  all  participants  in  the  investment  cycle,  from  the  buy-­‐side  and  sell-­‐side  to  corporates  and  issuers.  Covering  over  100  markets,  with  our  own  offices  in  34  countries,  the  BNP  Paribas  network  is  one  of  the  most  extensive  in  the  industry.  We  bring  together  local  insight  and  a  global  network  to  enable  clients  to  maximize  their  market  and  investment  opportunities  worldwide.  Key  figures  as  of  31  December  2014:  USD  8.95  trillion  assets  under  custody,  USD  1.717  trillion  assets  under  administration,  8,134  administered  funds  and  8,800  employees.