trumpflation! - investment clock · trumpflation! issue #8 november 2016 multi asset views from...
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For professional investors only, not suitable for retail investors.
TRUMPFLATION!
Issue #8
November 2016
Multi asset views from RLAM
Royal London Asset Management manages £101 billion in life insurance, pensions and third party funds*. In March we launched six risk-rated Global Multi Asset Portfolios (GMAPs) blending active and passive exposures with a tactical asset allocation overlay.
*As at 30/09/2016
This month’s contributors
Trevor Greetham
Head of Multi Asset
Hiroki Hashimoto
Senior Quantitative Analyst
The Investment Clock was already in
Overheat before Trump’s reflationary
policies are taken into account. Stocks
tend to beat bonds when global growth is picking up and we expect this trend to
continue.
The recent sharp rise in bond yields is consistent with the Overheat phase when
central banks usually tighten policy. While
Fed rate hikes have the potential to rattle
stocks in the short term, we don’t expect
aggressive tightening and continue to see a
positive outlook for the asset class.
The markets had another political surprise with the election of Donald
Trump as US President. There are major uncertainties but investors see
the glass as half full with reflationary fiscal policies expected to boost
the US economy. The Investment Clock was already picking up signs of
an acceleration in global growth on the back of low interest rates and
low energy prices. We prefer stocks to bonds, especially in Japan, but
with near term sentiment overbought we are not chasing the rally.
Investment Clock already in Overheat
The Investment Clock model that guides our asset allocation has spent the last six
months in the Overheat phase of the business cycle characterised by above trend
growth and rising inflation. Reflationary fiscal policies under Trump are likely to
keep us there by boosting US growth and raising inflation risks. Stocks tend to beat
bonds when global growth is picking up and we expect this trend to continue.
Unfazed by rising yields
The election of Trump marks a transition from monetary ease towards fiscal ease
and this has been taken badly by the bond market. Most of the rise in yields has
been driven by an increase in long term inflation expectations. This makes sense.
Mindful of downside risks presented by high levels of personal and government
debt we expect central banks to keep policy relatively loose and let inflation rise
from its current low level. This is a positive backdrop for stocks. We especially like
Japanese equities which tend to do well when the dollar is strong.
Seasonality positive but stocks are overbought
The summer doldrums are well and truly over and US equity markets are
making new highs, as often happens in the typical year-end rally. While we see
positive fundamentals there remain many important unknowns as to how a
Trump presidency will operate. With our investor sentiment indicator now at
euphoric levels, we are not chasing the rally.
Focus Chart: Stocks vs Bonds and Investment Clock Growth Score
Please visit www.investmentclock.co.uk for our blog and information about our
multi asset range. For product details, contact: [email protected]
2 For professional investors only, not suitable for retail investors.
INVESTMENT CLOCK IN OVERHEAT BEFORE TRUMP
Chart 1: The Investment Clock is in Overheat
We tell the time on the Investment Clock model that
guides our asset allocation using global growth and
inflation indicators. We have been moving into the
Overheat phase for the last six months with the US
election result likely to reinforce this direction.
Global growth remains above its long run trend as
evidenced by the ongoing fall in unemployment rates
across the world. Our forward looking global growth
scorecard has also turned positive recently on the back
of low interest rates and low energy prices.
Meanwhile, inflation has started to pick up from a very
low base and our forward looking global inflation
scorecard is also in positive territory, helped in this
case by a rising trend in commodity prices.
Trump’s victory is likely to keep us in Overheat. On most measures there isn’t much spare capacity in the US economy.
Reflationary fiscal policies are likely to boost US growth and raise inflation risks. We expect the Fed to hike interest rates
gradually to offset some of the additional stimulus if and when it comes through but aggressive tightening is not in prospect.
The Fed will be watching to see if discouraged workers rejoin the workforce, keeping wages under control, and they will be
mindful of downside risks presented by high levels of personal and government debt.
Chart 2: Global growth trend positive Chart3: Inflation scorecard also positive
Source: RLAM, DataStream. Source: RLAM, DataStream. Tactical models like the Investment Clock are the start of our investment process not the end of it. Commodities are usually the best performing asset class in the Overheat phase but we choose instead to overweight stocks in the multi asset funds we manage. Stronger activity in China is positive but the US Federal Reserve will be a lone hiker among the big central banks in 2017 and dollar strength is a headwind for commodities. Meanwhile, stocks often continue to do well during the Overheat phase of the cycle as long as central banks are not aiming to engineer a slowdown. We think this is one such instance.
INFLATION RISES
INFLATION FALLS
GR
OW
TH
M
OV
ES
B
ELO
W T
RE
ND
GR
OW
TH
MO
VE
S A
BO
VE
T
RE
ND
Industrial Metals
Precious Metals
RECOVERY OVERHEAT
REFLATION STAGFLATION
STOCKS
BONDS CASH
Corporate
Bonds
High Yield
Bonds
Government
Bonds
Inflation-Linked
Bonds
Softs Energy
Source: RLAM. For illustrative purposes only.
COMMODITIES
3 For professional investors only, not suitable for retail investors.
STOCKS RESILIENT TO RISING YIELDS
Chart 4: US bond yields and inflation expectation
Most of the recent rise in government bond
yields has been driven by an increase in long-
term inflation expectations rather than an
increase in real yields. This is a fundamental
difference when compared to the last big bond
sell-off, the so-called “Taper Tantrum” of 2013,
in which real yields rose on concerns then Fed chairman Ben Bernanke would reduce central
bank bond purchases as a precursor to raising
interest rates.
This distinction underlines our view that this is
a more equity-friendly bond sell-off. It’s no bad
thing for corporate earnings or for stock prices
if central banks are willing to let inflation run
higher from current low levels.
Chart 5: Stock returns are seasonal; Summer doldrums over
The summer doldrums are well and truly
over. US equity markets are making new
highs, as often happens in a year end rally.
Stock markets exhibit pronounced
seasonality with almost all of the gains in a
typical year coming in the October to April
period. This seasonality most likely reflects
the real economy and the upsurge in
consumer spending each year between
Thanksgiving (“Black Friday”) and
Christmas.
Source: RLAM., DataStream World USD Total Return, average calendar year profile since 1973
Chart 6: Investor Sentiment overly optimistic near term
While we see positive fundamentals and
positive seasonality for stocks, there
remain many important unknowns as to
how a Trump presidency will operate. We
expect to see periodic setbacks. With our
investor sentiment indicator now at
euphoric levels, we are minded to trim
exposure rather than chase the rally in the
near term.
4 For professional investors only, not suitable for retail investors.
TRUMP TO MAKE JAPAN GREAT AGAIN?
Chart 7: Japanese stocks and the dollar
Japan is our favourite equity market. Domestic
monetary and fiscal policy are working
together to create growth and there is an
explicit desire for inflation to overshoot for a
few years – good news for stocks. In addition,
the market tends to do well when global
growth is picking up and the dollar is strong.
Recent policy changes have reinforced this
behaviour. In September the Bank of Japan
pledged to keep 10-year bond yields close to
0%. Consequently, Japanese bonds don’t sell
off when US treasuries sell off, and the
widening interest rate differential weakens the
yen to the benefit of Japanese stocks.
Chart 8: Emerging Market stocks and the dollar (inverted)
A strong dollar is good for Japan but bad for
the emerging markets. Emerging markets as a
group export commodities, which tend to
struggle when the dollar is strong. A strong
dollar also raises the cost of capital for big
emerging markets like Brazil that are running
current account deficits.
On top of this Trump’s victory raises the
spectre of trade friction with the US. However,
we expect Trump to move towards bilateral agreements rather than resorting to a self-
defeating increase in tariffs – and there are
compensating factors. China will be more
cautious about tightening policy in 2017 with
Trump in the White House and this should
help intra-emerging market trade.
Chart 9: Europe vs. the World and the euro exchange rate
Euro weakness usually helps European stocks
to outperform but not when combined with
political risk. The rise of populism, as
evidenced by Brexit and Trump, raises political
risks ahead of a busy electoral period in
Europe, with the Italian referendum on
December 4 and important elections next year
in Holland, France and Germany. An increase
in influence for parties opposed to the single
currency could create market stress.
Our funds remain underweight European
stocks and the euro, though we wonder if
political risk is being overdone in the short
term with French elections not due until
April/May 2017.
5 For professional investors only, not suitable for retail investors.
WHERE WE STAND
Overweight stocks, especially Japan; underweight bonds and European stocks
-- - = + ++
Multi Asset
Stocks
Property
Commodities
Bonds
Cash/Absolute Return
-- - = + ++
Regional Equity
UK
US
Europe
Japan
Pacific ex. Japan
Emerging Market
Multi Asset: Overweight Equities; underweight bonds
We have been overweight equities since 2012 in funds managed using the Investment Clock approach on the back of a continued
global recovery with loose policy and muted inflation. With business confidence picking up in major economies we remain
moderately overweight and would be prepared to add more on weakness.
We are neutral to slightly overweight UK commercial property. While we expect some downside to capital values in the next few
months as uncertainty around Brexit negotiations hurts UK growth, a positive supply/demand backdrop and a large rental yield
cushion should make property resilient, especially when the additional policy ease we are expecting kicks in.
We are neutral commodities. Commodities are getting support from loose policy and better growth in China but excess supply
and US dollar strength are ongoing headwinds.
We are underweight bonds. Quantitative easing and pension fund buying has pushed yields to levels that make no sense in the
long run. With global growth picking up and inflation rising, we expect yields to rise.
Equity Regions: Overweight Japan; underweight Europe
Japan is our favourite equity market on the basis of reflationary fiscal and monetary policy and a tendency to do well when the
dollar is strong. We are overweight in our funds, with the yen hedged where possible.
With expectations of a December rate hike in America on the rise, we have been trimming our emerging market equity
overweight and we continued to do so in the light of Trump’s surprise victory.
We have been underweight Europe since the Brexit vote on the basis that political risk would rise. Europe has been a big
underperformer lately and Italian government bond spreads over Germany have blown out, suggesting some bad news is now
in the price.
We are broadly neutral UK equities. While there is downside pressure on the domestic economy, loose policy and a weak pound
are positives for stock prices.
6 For professional investors only, not suitable for retail investors.
MARKET RETURNS: BOND YIELD RISES ON TRUMP
Note: Standard indices sourced from DataStream and Bloomberg. (*) Property Returns as of October 2016.
For professional clients only. Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go
down as well as up and investors may not get back the amount originally invested. Issued by Royal London Asset Management November 2016. Information correct at that date unless otherwise stated. The views expressed are the author’s own and do not constitute investment advice. Royal London Asset
Management Limited, registered in England and Wales number 2244297; Royal London Unit Trust Managers Limited, registered in England and Wales
number 2372439. RLUM Limited, registered in England and Wales number 2369965. All of these companies are authorised and regulated by the Financial Conduct Authority. All of these companies are subsidiaries of The Royal London Mutual Insurance Society Limited, registered in England and Wales number
99064. Registered Office: 55 Gracechurch Street, London, EC3V 0RL. The marketing brand also includes Royal London Asset Management Bond Funds Plc,
an umbrella company with segregated liability between sub-funds, authorised and regulated by the Central Bank of Ireland, registered in Ireland number 364259, and subject to limited regulation by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority
are available from us on request. Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland. Our ref: N RLAM W 0004
Multi Asset %1M %12M %1M %12M
UK Stocks -1.9 11.2 -1.9 11.2
Global ex UK Stocks 2.0 4.5 -2.1 27.3
Gilts -3.1 7.4 -3.1 7.4
UK Cash 0.0 0.5 0.0 0.5
UK Property* 0.5 2.7 0.5 2.7
Commodities -1.1 3.7 -3.7 25.5
Equity Regions %1M %12M %1M %12M
UK -1.9 11.2 -1.9 11.2
North America 3.5 8.5 0.8 31.2
Europe ex UK -1.3 -5.8 -6.1 13.7
Japan 6.6 -6.8 -3.8 22.7
Pacific ex Japan -1.0 9.2 -5.8 32.6
Emerging Markets -3.8 7.9 -9.1 29.3
Global
Equity Sectors %1M %12M %1M %12M
Consumer Discretionary 2.8 0.2 -1.3 21.3
Industrials 5.1 8.9 0.6 31.8
FX Financials 7.5 7.5 3.3 29.2
USD 1.24 -1.7 21.3 Consumer Staples -3.8 2.1 -7.3 21.1
EUR 1.17 -5.1 21.5 Utilities -3.9 4.9 -7.3 25.7
CHF 1.26 -4.3 22.7 Healthcare -0.7 -5.6 -3.9 13.7
JPY 139.3 -8.4 32.9 Energy 1.7 12.8 -1.4 33.3
AUD 1.66 -3.3 25.4 Materials 4.2 18.8 -0.3 42.5
CAD 1.66 -2.0 20.6 Telecoms -0.7 2.0 -5.0 21.8
Technology -0.6 9.6 -3.9 33.1
CB rates Bonds %1M %12M %1M %12M
Fed 0.50 0.00 0.25 Conventional Gilts -3.1 7.4 -3.1 7.4
BoE 0.25 0.00 -0.25 Index Linked Gilts -6.4 18.9 -6.4 18.9
ECB -0.40 0.00 -0.20 GBP Credit -2.4 7.9 -2.4 7.9
BoJ -0.05 -0.01 -0.13 Global High Yield -1.7 10.3 -1.7 10.1
Bond Yield Commodities %1M %12M %1M %12M
US 10 Year 2.32 48 10 Energy -7.1 -13.5 -9.5 4.8
UK 10 Year 1.38 12 -44 Agriculture -1.3 4.8 -3.8 26.8
EU 10 Year 0.20 3 -27 Industrial Metals 16.8 33.0 13.8 61.0
JP 10 Year 0.02 6 -29 Precious Metals -7.5 11.1 -9.9 34.4
Local GBP
Local GBP
GBPLocal
Local GBP
Local GBP
chg 1M
(bps)
chg 12M
(bps)
1 GBP
buys
chg 1M (%)chg 12M
(%)
%1M
(vs GBP)
%12M
(vs GBP)
Rate (%)
Yield (%)
US treasury bond yields rose sharply over the month.
Japanese stocks outperformed over the month in local terms, helped by yen weakness, while emerging markets lagged.
The US dollar strengthened vs. the euro and yen. Sterling experienced a relief rally as political news around Brexit slowed down.
Commodities were lower on the month as gains in industrial metals were more than offset by losses in energy.