Absolute Return Strategies: Outlook for 2020 - Absolute Return Portfolio Management Team 5 December 2019 - Fisch Asset ...
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Absolute Return
Strategies:
Outlook for 2020
Absolute Return Portfolio Management Team
5 December 2019Fisch Asset Management Page 2 | 6 CIO outlook 2020 By Beat Thoma, Chief Investment Officer The benign market environment should continue for the time being. However, an economic slowdown or rising inflation could throw a spanner in the works. Economic outlook The global financial market environment is currently in an equilibrium state of moderate growth, expansionary central bank policy and low inflation (the so-called “Goldilocks scenario”). However, we are seeing a trend towards a slowdown in global economic growth mostly due to trade war uncertainties. Interest rates continue to trend downwards globally. However, markets have lately started to anticipate a somewhat less loose monetary policy from the Fed, which in turn has prompted our macro model to signal a possible turnaround in interest rates in the US, in particular. Other regions, such as Europe and Japan, could follow in the medium term if economic growth stabilises again and trade war uncertainties ease. A number of meaningful, early economic indicators remain positive and are surprisingly robust (copper prices, consumer credit banks and credit card companies in the US). In particular, the global transport sector remains stable (e.g. container shipping). And the trend in European transport indices also continues to point upwards. The Chinese currency (yuan) remains stable. This is a positive development of global relevance as it is essential that the significant monetary easing on the part of the Chinese central bank has an undisturbed and positive effect on the economy, without agitating currency markets. Thus, the potential for future interest rate cuts by the Chinese central bank remains intact. Favourable environment for financial markets Looking at the big picture on financial markets, we have been observing the two phenomena “Goldilocks” (mentioned above) and “Wall of Worry” for some time. The “Wall of Worry” refers to widespread doubts on the part of investors and analysts about the systemic health of the financial system from multiple perspectives. As long as the Wall of Worry is in place, however, there are usually no market bubbles or major exaggerations. Valuations on financial markets appear fair rather than excessive and speculation is restrained. Together, these two phenomena have historically contrived to form a favourable environment for financial markets, as they combine positive fundamental, monetary and psychological factors. A combination that, however, is often ignored and appears rather unspectacular. Historically, inflation has typically sounded the death knell for Goldilocks. As soon as inflation rises too high, loose monetary policy becomes very difficult to maintain, and at the same time the economy overheats. Excessive confidence in the longer-term stock market outlook and complacency on the part of investors lead to an overly positive sentiment, which is a contrarian indicator.
Fisch Asset Management Page 3 | 6
Chart: Inflation expectations remain low, but first signs of trouble need to be watched closely
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May 19 Jun 19 Jul 19 Aug 19 Sep 19 Oct 19 Nov 19
US dolllar 5-year by 5-year forward inflation linked swap
Source: Thomson Reuters Eikon, November 2019
Market-based inflation expectations, as measured by the five-year forward inflation-linked swap five
years ahead, are still low. But there are initial signs of a trend reversal and a level above 2.6% would
constitute a warning signal.
Summary
What would need to happen for the “Goldilocks scenario” to end? We are seeing two main dangers
here:
1) an economic slowdown
2) a more restrictive monetary policy by the central banks (higher interest rates or/and an end to
quantitative easing (QE)).
A more restrictive monetary policy would likely occur if the economy accelerates or inflation
expectations rise. Neither strong inflationary pressures nor robust economic growth currently exist.
Therefore, we expect a continuation of the favourable Goldilocks environment for the time being.
However, the tide can turn quickly on inflation, as there is a great deal of liquidity in the system. This
excess liquidity can lead to unexpected inflationary effects via multiplier effects or simply lead to higher
inflation expectations. Developments must therefore be closely monitored.Fisch Asset Management Page 4 | 6 Absolute Return Outlook 2020: Late cycle but still constructive Executive summary — Economic premia: The prevailing “Goldilocks scenario” drives the overweight in economic premia, with equity being slightly overweight and credit being neutral. — Stabilisers: Expensive valuations imply an underweight in duration, resulting in an overall underweight in stabilisers (with trend being neutral). — Overall risk: The overall risk positioning is neutral, particularly as we are in a late stage in the cycle. Our strategy is well suited for a higher volatility environment, owing to its integrated stabilisers and the built-in market timing of convertible bonds. Upside potential remains The current economic cycle as well as valuation considerations drive our medium-term view, which forms the basis of our Absolute Return Outlook 2020. — Economic cycle: The current late cycle environment is dominated by the so-called “Goldilocks scenario” (moderate growth, low inflation, and expansionary central bank policy). We view global markets as remaining constructive, and expect low but positive economic growth. However, the ongoing US/China trade conflict and the upcoming US presidential elections are dominant topics that could have a negative impact. On the plus side, the elections could provide an incentive for President Trump to be more open towards negotiations, but we nevertheless expect elevated volatility until these dominant topics are resolved. — Valuations: Consistent with the late cycle stage, valuations appear stretched. This is especially true for equity risk premia in the US, while Europe is neutral. Credit spreads are rather tight at below- average levels compared to history. We observe a particularly high valuation for the interest rate premium, which is driven by a combination of prevailing low interest rates and a flat yield curve. These considerations form the view on our main risk factors: — Equity: Although equity valuations are rather stretched, we see the “Goldilocks scenario” as the key driver for equity markets. Aside from global growth, the expected further monetary expansion should be supportive for global equities. Overall, our view on global equities is still constructive, and we therefore slightly overweight the equity factor going into 2020 relative to our strategic asset allocation. — Credit: We view credit spreads as fair relative to current default rates. However, tighter spreads and significant concerns about certain segments of the market (especially CCC-rated bonds and the energy sector), make 2020 a year that may have a more negative skew than most years. In this environment, in-depth credit analysis and prudent security selection are crucial. In overall terms, we are neutrally positioned relative to the strategic asset allocation for 2020.
Fisch Asset Management Page 5 | 6 — Duration: We expect interest rates to stay rather low. For example, Fed Chair Powell clearly stated that they would need to see a significant and persistent increase in inflation before the central bank considers raising rates. Therefore, as long as inflation concerns remain constrained, and the yield curve is flat, we will maintain our underweight in duration relative to the strategic asset allocation. Nevertheless, duration is still pertinent for diversification reasons in case we see a larger drawdown in economic premia. Additionally, our exposure to the safe-haven currencies JPY, USD and CHF provide stabilising effects. — Trend: As trend-following strategies exhibit right-skewed returns (meaning frequent small losses with infrequent large profits) and are difficult to time, we believe consistent investment in these strategies for diversification reasons is prudent. We position trend neutral relative to our strategic asset allocation. Conclusion We see a benign market environment, which continues to offer upside potential. We are neutrally positioned with regards to the overall volatility of the portfolio versus the strategic asset allocation. On the one hand, the prevalent “Goldilocks scenario” mainly drives our slight overweight in economic premia (equity and credit). On the other hand, expensive valuations drive the underweight in duration and, therefore, the overall underweight in stabilisers (duration and trend). Our strategy is well suited to the late cycle environment, which is typically characterised by higher volatility, owing to its integrated stabilisers and the built-in market timing of convertible bonds. Furthermore, in this environment our short-term indicators as well as the security selection within the sub-strategies are even more relevant.
Fisch Asset Management Page 6 | 6 Disclaimer This documentation (“Document”) is provided solely for information purposes and is intended for professional investors only. Non-professional investors who obtain this documentation are please asked to discard it or return it to the sender. This presentation is not a prospectus or an offer or invitation to buy financial products. This Document is provided for marketing reasons and is not to be seen as investment research. This Document is not prepared in accordance with legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead of the dissemination of investment research. HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE PERFORMANCE. The performance data do not take account of commissions and costs incurred on the issue and redemption of units. Gross performance figures neither include costs which are charged to the investment fund. Such costs and commissions result in a decrease of the achieved performance. Investments in financial products are associated with risks. It is possible to lose the entire amount of the invested capital. In addition, financial products investing primarily in emerging markets and/or in high yield bonds carry higher risks in general. Emerging markets bonds are bonds from issuers with a registered office or primary activity in an emerging country (“EM”). They are exposed to higher political, social and economic risk that can manifest itself in restrictions on capital transactions or other constraints. This can make it impossible for the bond issuer to pay the coupon or repay the principal. Operating and supervision conditions may deviate from the standards prevailing in developed countries. Bonds with high yields entail a greater risk of issuer default, and are a riskier investment than higher quality investment grade bonds. Convertible bonds, subordinated bonds, perpetual bonds and floating rate bonds are complex financial instruments. Regarding the specific risks of an investment, please refer to the currently valid fund documentation. Insofar as the information contained in this Document comes from external sources, Fisch Asset Management AG cannot guarantee that the information is accurate, complete and up to date. Statements concerning future developments and estimates are based on assumptions that may be inaccurate, that could change or that are based on simplified models. Fisch does not know whether its statements concerning future developments will be correct. Fisch may also change its opinion concerning a future development. In such case, Fisch has no obligation to inform anyone about the change in opinion. The purchase of a product managed by Fisch should only be based on the currently valid documents (fund prospectus, fund agreement, KIIDs, etc.). The currently valid documents are available at www.fundinfo.com. Before reaching a decision to buy, each professional investor must determine based on their specific situation whether they are even permitted to buy the product, and if yes, whether they have the necessary risk tolerance for the corresponding product. Fisch expressly states that this Document is not intended for private investors and advises professional investors to first consult financial, legal and tax experts who are familiar with their specific situation and understand the product. This Document is especially not intended for US persons (private or professional) as defined by the FATCA legislation or under SEC regulations. US persons may not invest in any investment funds managed by Fisch, and Fisch is also not permitted to manage mandates from US persons. If Fisch learns that a US person is invested in a product it manages, it will inform the fund management company and, if necessary, other persons and demand that the US person sell the product. Fisch accepts no liability for damages arising directly or indirectly as a result of this Document.
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