to 2017 and beyond investment outlook - hsbc · 2016-12-01 · to 2017 and beyond investment...

1For professional clients and institutional investors only

To 2017 and beyond

Investment Outlook

Joe Little,

Chief Global Strategist

1st December 2016

Global Strategy

Year end review & 2017 outlook


What has happened this year?As always, what you buy and when matters

2015 was a tough year for asset allocators. But 2016 has been much better, with occasional

episodic volatility (China worries, global growth concerns, Brexit)

Variability in asset performance reminds us that “what” we buy and “when” we buy it is the key

investment decision

Source: HSBC AMG Global Investment Strategy. As of 11 November 2016

US 10Y – Bloomberg/EFFAS Bond indices U, US30Y – Bloomberg/EFFAS Bond indices U, Global Agg – Global Agg TR Hed USG, Global IG – BAML Global Corporate Index, Global HY – BAML Global HY, Local EM debt – J.P. Morgan

EMBI Global Total, DM Equities – MSCI Daily TR Gross World USD, US Equities – MSCI Daily TR Gross USA USD, DM (ex US) Equities (H shares) – MSCI Daily TR Gross China USD, Asia ex Japan Equities – MSCI Daily TR Gross AC

Asia Ex, EM Equities – MSCI Daily TR Gross EM USD.

.

Total returns, USD (%)


What comes next?An environment of unusual uncertainty persists

Today’s environment is characterised by “unusual uncertainties”

This creates a risk of high, episodic volatility in financial markets

The good news is that this can create an opportunity for investors who have conviction and are

willing to be contrarian and active

We believe that exploiting tactical opportunities is key to success in the low return world

Unusual

Uncertainty

Confusion about asset

market valuations

A unique economic

environment

Uncertainty about the

power of policy

Political uncertainty


Today’s macro environmentAre we finally on the verge of global reflation?

Global activity data continues to improve

– A global growth rate of c 3% (PPP basis) in 2017 is not great… but it could be worse

– We are tracking an improving momentum in global activity since May

– Better economic data in Europe remains under-appreciated and can persist

– Cyclical indicators in China have stabilised, supported by policy. Structural risks persist

– In other EMs, activity has bottomed and is now improving

Fiscal policy is back in fashion

– The “end of fiscal austerity” means that global fiscal policy should now boost global growth.

– This increases the prospects of reflation

– And the burden of demand management will be shared more evenly between monetary and fiscal policy

Innovative monetary policies beginning to focus on “yield curve control”

– A mediocre growth/inflation mix still means that policy interest rates are “lower for ever”

– Global central banks will continue to innovate. Japan is leading the way

– There will be “policy divergence”, but the Fed will be “uber-gradual”


Fiscal and monetary policy co-ordinationThe end of austerity. And towards a “new view” of fiscal policy

*Fiscal boost calculated as the inverse change in the cyclically adjusted primary balance. 2017 estimated using IMF forecasts.

Source: HSBC AMG Global Investment Strategy, IMF Fiscal Monitor, October 2016

Concerns about the sustainability of high gross debt levels have dominated thinking in most advanced

economies since the crisis

But (i) a new populist political agenda, (ii) the lacklustre recovery and (iii) the perceived limits of

monetary policy are now forcing a reconsideration

In 2017, fiscal policy is no longer a drag on global GDP growth and could even be a significant boost

(ie US, UK). This is an important nuance; fiscal policy and monetary policy are “co-ordinated”

In turn this: (i) reduces the dependence on interest rates as a demand management tool, (ii) boosts

the odds on reflation, and (iii), implies that the macro environment is becoming much less “bond

friendly”Fiscal boost*, % of potential GDP


Fiscal and monetary policy co-ordinationInnovative central bankers

An “arsenal” of monetary tools and measures (negative rates, QE, direct financing) still means that

global liquidity conditions remain highly supportive for reflation

But central banks’ focus is now shifting away from the “size of balance sheet” toward “yield curve

control” (BoJ bond yield caps, Fed “dot plot”)

– Central banks are set to provide “forward guidance” for the path of interest rates into the medium term

Source: HSBC AMG Global Investment Strategy, as of October 2016

Monthly change in G4 central bank balance sheets (USD bn)


Global activity is improvingOur composite measures of where we are in the cycle

The Nowcast indicator measures the underlying rate of expansion in different economies at a monthly frequency. The indicator summarises information available in a large number of time series. It is updated weekly to incorporate the

recent data releases in each economy.

Source: HSBC AMG Global Investment Strategy, October 2016

Our “Nowcast” metric points to:

i. growth resilience in the US,

ii. accelerating momentum in the Euro area,

iii. a bounce-back in the UK and Japan

HSBC Global Asset Management “Global Nowcast Models”


Secular pressures on interest ratesWe are living in a low “r-star” world

Critically, across advanced economies, the equilibrium interest rate (“r-star”) has fallen, driven by

economic factors and investor preferences

A low “r-star” means that the terminal interest rate this monetary cycle will be lower than what we

have experienced in the past

Global savings glut and

shortage of safety assets

A shortfall of demand

versus supply

The 3 Ds: Demographics, Debt,

and Income Distribution

Lower trend GDP

growth

Persistently-low

inflation

“Lower for ever”

interest rates


Measuring market implied risk premiaUsing current pricing, we build a “pecking order” of future asset class returns

For illustrative purposes only

Source: HSBC AMG Global Investment Strategy (simulated data); Ang and Ulrich (2013), “Nominal bonds, real bonds and equity”; Ilmanen (2011), Expected Returns

Simulated results do not represent actual returns and should not be seen as an indication of future returns

How do we approach valuation analysis in a consistent and robust way?

We start with a scenario for policy rates in each major advanced and emerging economy

We then measure asset class “risk premia” (compensation for risk, uncertainty) that is implied given

today’s market pricing

Cash Government Bonds High-Grade Credit Spec-Grade Credit Global Equities Alternatives

Sty

lised

Exp

ecte

d R

etu

rns

Expected Risk

Alternatives Risk Premium

Equity Risk Premium

Credit Risk Premium

Term Premium

Cash Rate


Risk premia todayWhere is valuation anomalous?

Chart shows the today’s implied rewards (based on current pricing) for a range of asset classes

Source: HSBC AMG Global Investment Strategy, October 2016

Current pecking order of asset classes


The Fragile EquilibriumHow does the market perceive risk today?

“Severe Secular Stagnation” “Fragile Equilibrium” “Strong Demand Recovery”

Description of

Macro

Environment

Very weak demand growth

Negative real interest rates

are required

Corporates face a problem

with top-line (sales) growth

There is a meaningful threat

to fundamentals and balance

sheets

There is just enough demand

relative to supply

We have a low growth/low

inflation mix. The interest rate

cycle will be “slow-and-low”

To a certain extent, self-

equilibrating mechanisms pull

us back from low inflation or

rapid growth extremes

Demand is too strong

relative to available supply

Output gaps go positive

(growth is above potential)

and pressure on real interest

rates rises

Bond yields move back to

historic levels

Primary Source China/EM/Europe/Japan US

Impact on Asset

Pricing

Positive for: Developed Market

Government Bonds, IG Credits

Negative for: EM and commodity-

linked Equity, EM currencies

Fragile Equilibrium is maintained

USD overshoots,

May be positive for selective EM

Equity and EM Local FX Debt

Negative for: Developed Market

Government Bonds, IG Credit

Source: HSBC Global Asset Management, Global Investment Strategy

Market

Perceptions

Of Macro

Environment

Feb 2016

Dec 2015

May 2016

Oct 2016Jun 2016 Today


Key Investment Strategy ViewsSummary of Macro Views

The global growth/inflation mix looks lacklustre relative to historic standards. But set against an

environment of reduced potential, current cyclical trends look good

– And could be even better if fiscal stimulus proposals are delivered (eg US, UK)

– In Europe economic momentum is accelerating, driven by domestic demand

But the economic and market environment is “unusually uncertain”. Uncertainties about the

economic outlook, politics, and the effectiveness of policy can create “episodic volatility”

A reflation regime is replacing the persistent deflation worries of the post-crisis world, supported by:

(i) better global activity, (ii) sustained monetary support, and (iii) the end of fiscal austerity

However, interest rates are still set to be lower than what we have seen historically

– Global monetary policy is set to “diverge”. But the Fed rate cycle will be “uber-gradual”

– Critically, this implies that bond yields (even in the US) are not going to revert to long run historic norms

This unusual economic environment has important implications for how asset classes should be

priced

– The conventional view that “everything is overvalued” is just not right. We need to understand valuation in the

context of the economic and interest

rate outlook


Key Investment Strategy ViewsSummary of Asset Allocation Views

We continue to believe that the strategic case for UWs in global government bonds is strong

– A combination of better activity and fiscal policy being “back in fashion” reduces the reliance on rates and QE

as demand management tools.

– This makes the macro environment much less friendly for government bonds

– Bond valuations continue to look poor, even relative to our cash scenario

We are OW a diversified basket of risk assets

– Being UW bonds is a negative carry position and we need positive carry to compensate

– The market continues to offer a high premium to global equities. Better activity data should support the

corporate sector and policy is geared to reflation. Much of President Trump’s policy agenda appears to be

capital-friendly

– There are some obvious risks around political uncertainty. Not least the prospect of a more aggressive “reverse

globalisation” theme emerging (and its spillover into corporate fundamentals). This needs to be monitored

– EM risk looks to be attractively priced at this point. But we need to assess whether pricing accurately discounts

the uncertain political and fundamental risks. There will also be tactical opportunities given the severity of the

recent market sell-off

A combination of loose fiscal policy and (slightly) tighter rates should help the dollar

– The bond market already discounts “policy divergence” between the Fed and G10

– Yet the Fed can be gradualist and move rates ahead of the market’s rate expectations

For professional clients and institutional investors only

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to 2017 and beyond investment outlook - hsbc · 2016-12-01 · to 2017 and beyond investment...

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