Tug of war - Q&A about 2019 - Global Asset Allocation Strategy December 2018 - Nordea
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Tug of war – Q&A about 2019 Global Asset Allocation Strategy December 2018 Investments │ Wealth Management
December 2018
OVERWEIGHT EQUITIES VS. FIXED INCOME
• The recent weakness in equities was caused by monetary
conditions, macro and political issues. However, we have not
seen a markedly deterioration in fundamental factors.
• Given the still supportive economic and earnings growth, we
remain overweight equities, as the recent sell-off has improved
risk/reward.
• Next year we expect a tug of war between tighter monetary
conditions and still strong growth dynamics that will cause higher
volatility.
EQUITY STRATEGY: OW EM, UW Europe
Tug of war • We recommend to overweight EM equities as we expect
Chinese stimulus to eventually bite.
• Europe remains an underweight given political headwinds and
lacklustre earnings growth.
• We move towards a slightly more defensive stance in the sector
strategy.
FIXED INCOME STRATEGY: Underweight HY bonds
• We reduce risk in the bond portfolio as well, by moving HY to
underweight and government bonds to overweight.
• Federal reserve is tightening its monetary policy, which creates
upward pressure in the short end of the yield curve, tightens
financial conditions and hence causes headwind for risky bonds.
• With default rates bottoming out in a mature cycle, spreads are
vulnerable going into next year.
This material was prepared by Investments |
Market performance & recommendations
ASSET ALLOCATION - N + Comments
Growth worries has led to renewed weakness in markets Equities
Fixed Income
EQUITY REGIONS - N +
North America
Europe
Japan
Asia excl. Japan
Latin America
Eastern Europe
Denmark
Finland
Norway
Sweden
EQUITY SECTORS - N +
Industrials
Cons Discretionary
Cons Staples
Health Care
Financials
IT
Comm. Services New sector
Utilities
Energy
Materials
Real Estate
BOND SEGMENTS - N +
Government
Investment Grade
High Yield
Source: Thomson Reuters / Nordea Emerging Markets
Current allocation Previous allocation
This material was prepared by Investments |2018 – Mean reversion; last years winners are this years losers
15,0 % Returns YTD 2018, EUR (unless otherwise stated, updated 30 November)
10,0 %
5,0 %
0,0 %
-5,0 %
-10,0 %
-15,0 %
Source: Thomson Reuters / Nordea
This material was prepared by Investments |2018 – Not a good year, not a very bad year either
2007
2018 until Nov 30 1992
1987 2012
2018 1984 2010
2015 1978 2006 2017
2011 1956 2016 1988 1999
2005 1948 2014 1986 1996
1994 1947 2004 1979 1983 2013
2001 2000 1970 1916 1993 1972 1982 2009 1997
1973 1977 1990 1960 1912 1971 1964 1976 2003 1991
1966 1969 1981 1923 1911 1968 1952 1967 1998 1989
1957 1962 1953 1902 1906 1965 1949 1963 1961 1985
1941 1946 1939 1896 1899 1959 1944 1951 1943 1980
1940 1932 1934 1895 1892 1926 1909 1942 1925 1955 1995
1974 1903 1929 1914 1894 1889 1921 1905 1919 1924 1950 1975
1930 1890 1913 1887 1888 1881 1886 1901 1898 1922 1938 1945 1958
2008 1917 1920 1884 1910 1883 1882 1874 1878 1900 1891 1918 1936 1927 1928 1935 1954
1931 1937 1907 2002 1893 1876 1873
1873 1877 1875 1871 1872 1897 1880 1885 1904 1915 1908 1879 1933
+10%+15%
+15%+20%
+20%+25%
+25%+30%
+30%+35%
+35%+40%
+40%+45%
+45%+50%
+50%+55%
-40%-45%
-35%-40%
-30%-35%
-25%-30%
-20%-25%
-15%-20%
-10%-15%
+5%+10%
-5%-10%
+0%+5%
-0%-5%
S&P 500 total return (USD) 1871-2018
Source: Thomson Reuters / Nordea
This material was prepared by Investments |Moving into late cycle and higher realized volatility
Source: Thomson Reuters / Nordea
This material was prepared by Investments |Will we see the longest equity bull market on record?
Still a long way to go before we are at “all time long” in the US The normal state for US equities is – Bull Market!
700% 160
Return, S&P 500 147 Duration
(months)
140
600%
582%
116
120
500%
97
100
400% 86
73 80
300% 60 60
305%
50 60
49
250% 44
200% 223% 229%
40
100% 126% 20
102% 102%
86% 80%
0% 0
1921 1942 1949 1957 1962 1974 1982 1987 2002 2009
S&P 500, total return Duration, months
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
This material was prepared by Investments |Boom, bust or base scenario in 2019?
Scenarios for equities in 2019 Scenarios for the 10-year US treasury yield
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
65% • Expansion: economic expansion continues while wage and inflation pressures remain moderate and rates rise slowly. (5-10%)
20% • Melt-up: US hard data catch up to soft data, China stimulus results in overheating, the trade war eases, and the rest of the world accelerates (15-20%).
15% • 2019 recession: Inflation rises while economic activity moderates. Fed behind the curve, the curve flattens and equities turn mid-2019. (-30%).
This material was prepared by Investments |What are the expected hot topics for 2019?
“Peak growth” Inflation and monetary policy Trade war
Downside risks have risen for the global A maturing cycle, the fear that Fed The trade war has deeper roots than just
economy during 2018, and earnings always “tighten until something breaks”, the trade deficit, which means that US
growth is slowing next year. Lately, and the fact that we are moving from QE /China related conflicts most likely will
investors have put more weight on that to QT in the western part of the world, stick around next year. Being the worlds
everything is peaking, rather than still put both inflation and monetary policy two largest economies, markets are right
solid levels. Risky assets performance in front and center for investors in 2019. to be concerned. We are hoping for de-
2019 will of course depend on that escalation, but an escalation is more
fundamentals stay solid, but also to a likely.
large extent on market sentiment.
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
This material was prepared
9 by Investments |Where are we in the business cycle?
Phases: Repair Recovery Expansion Downturn
Weak Moderate Strong Weak
Economic growth
improving improving slowing growth Slowing down
Economic
Credit growth Weak Rising High Negative
Monetary policy Easing Tightening begins Tightening / tight Easing
Low Moderate High Moderate
Inflation
Bottoming Rising Rising falling
Yield curve Steep Flattening Flat / Inverted Steepening
Financial
Below avg. About avg. Above avg. Below avg.
Valuation
rising Rising Rising Falling
Profits increasing Profits rising Profits increasing Profits falling
Fundamentals
Debt and leverage declining Debt and leverage declining Debt and leverage rising Debt and leverage rising
Above avg. Below avg. Below avg. Above avg
Volatility
Declining Stable Rising declining
Credit preferred Both Credit Equity preferred Neither Credit
Credit vs. Equities
over Equity and Equity over Credit nor Equity
2018 2017
This material was prepared by Investments |Where is the global economy headed?
Global growth set to decelerate somewhat Chinese stimulus will provide a boost
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• Up, but at a slower pace than in 2018. However, the slowdown is likely to remain limited in 2019, and the economy is set to keep growing above potential.
• Major risks stem from a slowdown in the US as fiscal stimulus wanes and monetary tightening kicks in. Also, the loss of momentum in Europe is worrying.
• The momentum in China has weakened, but policy easing will eventually stabilise growth. Put together, the macro backdrop is ok but with risks.
This material was prepared by Investments |Will earnings continue to grow in 2019?
Earnings growth will normalize in 2019 Earnings growth will still be supportive for equity performance
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• Earnings expectations for 2018 will be met, but the more important question is if earnings will continue to grow in 2019. We think so, but at a lower rate.
• Top-line growth will continue to get support from improving consumption and investments, though margin pressure might start to take its toll on earnings.
• 16% earnings growth this year surprised investors positively, but has not led to price performance. Skepticism characterizes investors outlook for 2019.
This material was prepared by Investments |Will profit margins collapse due to higher wages, financing and other input cost?
Margins normally correct in recessions, or due to external shocks Wage growth and financing cost should take its toll
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• Estimates point to further growth in already high margins next year. That sounds too good to be true, but we seldom see compression outside recessions.
• We expect that higher wage growth, financing costs, and a stronger USD in 2018 will take their toll on margins.
• However, both top line growth and pricing power have surprised to the upside and this could continue in 2019, keeping margins high.
This material was prepared by Investments |How high can yields go?
Interest rates decoupled from economic reality The end is nigh: Markets are eyeing the end of the Fed cycle
Expect convergence in
2019
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• Monetary factors remain a key risk to the bull run in equities, as a late cycle environment implies monetary tightening.
• In 2017 rates decoupled from weaker economic growth, and something has to give.
• Bad news should be good news: moderating growth limit the upside to core interest rates from here.
This material was prepared by Investments |Are we close to the pain threshold in yields?
Markets: Short term lifts in the real rate hurt equities short term Economy: Higher rates beginning to dent parts of the economy
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• Have rates moved too far already? Both the Feb. and Oct. correction was pre-empted by rapidly rising real rates.
• This, together with the recent weakness in US housing suggests that both financial markets and the economy are starting to react to higher rates…
• …indicating that core rates are close to the pain threshold aka. neutral rate. In our view, a self-correcting mechanism should keep a lid on yields.
This material was prepared by Investments |Will the dollar contribute to financial headwinds in 2019?
The USD has appreciated against all currencies this year Stretched positioning will temper further appreciation pressure
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• The stronger dollar has boosted European investors’ returns from US-dollar based equity investments, but we don’t expect this to continue in 2019.
• We expect USD to stabilize and weaken due to valuation, changes in liquidity and positioning. Short term though, risk-off sentiment points the other way.
• Going forward a weaker dollar will also serve to ease the recent stress in Emerging Markets currencies, in the backdrop of a solid global growth picture.
This material was prepared by Investments |Will geopolitics matter next year?
The usual suspects apply when it comes to (geo)politics Oil has also experienced a wild ride YTD, but what about 2019?
Source: Thomson Reuters / Nordea
• The short answer is yes. However, our usual caveat applies: while affecting markets short term, the lasting effects are usually far smaller.
• Most concerning is the trade war, which could cause more lasting effects, and also the result of of Brexit. Italy and North Korea could pop up as well.
• Oil and the machinations around this central commodity spans both geopolitics, the global economy and is thus a constant companion to the market.
This material was prepared by Investments |Will equities continue to derate?
Equities are priced below long-term average Its not abnormal that equites derate in FED hiking cycles
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• Global equities have derated close to 20% since January 2018; due to extremely strong earnings growth and muted equity price development.
• Weaker cyclical outlook and higher bond yields are among the reasons for this derating.
• The derating can continue, but then equites would start to price in an economic recession, and we do not think a recession is likely next year.
This material was prepared by Investments |Where is sentiment heading?
Get used to higher volatility and more swings in sentiment… …which in itself is very volatile
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• Sentiment is in itself a fickle indicator, and will most likely shift from bullish to bearish, and vice versa, several times during next year.
• With volatility moving higher as the cycle matures, we expect the swings in sentiment to increase as well. Prepare for a more bumpy ride during 2019.
• Currently, sentiment is beaten down and markets are still reluctant as risk-off is dominating. Should good news appear, there’s thus room for improvement.
This material was prepared by Investments |Which risk factors to look out for in a late cycle environment?
Risk 1: Further deterioration of the growth/inflation trade-off Risk 2: The missing HY link an a late cycle playbook
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• Although the market is pricing the end of the Fed cycle, a Fed policy error is still ranking high in the list of classic late cycle risks.
• A further deterioration of the growth inflation trade-off would leave the Fed with no choice but to move policy rates above the pain threshold.
• Wider HY spreads are a classic late-cycle phenomenon. Significant spread widening would mean more tightening, adding to the list of monetary worries.
This material was prepared by Investments |Is the credit cycle about to end?
Big differences in yield levels Lower oil price has increased the pressure for spread widening
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• The credit cycle still has legs to run, but credit environment is turning more challenging as financing conditions tighten and the global economy moderates.
• For that reason, we downgrade high-yield bonds to underweight in our recommendations and increase government bonds to overweight.
• Bond market returns have been modest this year, and we expect that to continue.
This material was prepared by Investments |Where is the best value in equity regions?
US equities have been the strongest this year Emerging Markets have taken the lead in earnings
Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea
• We find the best value in Emerging Markets. The region has the strongest earnings outlook and the lowest valuation.
• Europe remains underweight with lagging earnings and continued political risks, although the latter may turn into positives from time to time.
• In the US, fundamentals are healthy but positioning is growing worrisome, and earnings are normalising, which is why we prefer neutral.
This material was prepared by Investments |What are the best candidates from a sector perspective?
Defensives in the lead during the selloff We favour IT over CS, but neutralize other bets as risks has increased
Sector Recommendation Relative weight
Industrials Neutral -
Consumer Discretionary Neutral -
Consumer Staples Underweight -2%
Health Care Neutral -
Financials Neutral -
IT Overweight +2%
Communication Services Neutral -
Utilities Neutral -
Energy Neutral -
Materials Neutral -
Source: Thomson Reuters / Nordea Real Estate Neutral -
• We recommend overweight in IT, which benefit from both cyclical and structural factors.
• We neutralize underweights in some defensive sectors by reducing the IT overweight and lower Energy and Materials to neutral.
• With the changing sector setup, we introduce Communication Services and Real Estate at neutral weight.
This material was prepared by Investments |Nordea Global Asset Allocation Strategy Contributors
Global Investment Strategy Strategists Assistants
Committee (GISC) Sebastian Källman Victor Karlshoj Julegaard
Strategist Assistant/Student
Leif-Rune Husebye Rein sebastian.kallman@nordea.com Victor.julegaard@nordea.com
Chief Investment Strategist Sweden Denmark
leif-rune.rein@nordea.com +45 5547 7088
+47 95 86 92 05 Ville Korhonen
Fixed Income Strategist Mick Biehl
Michael Livijn ville.p.korhonen@nordea.com Assistant/Student
Chief Investment Strategist Finland Mick.Biehl@nordea.com
michael.livijn@nordea.com +358 50 581 8261 Denmark
+46 8 579 42 619 +45 5547 5935
Espen R. Werenskjold
Antti Saari Senior Strategist Amelia Marie Asp
Chief Investment Strategist espen.werenskjold@nordea.com Assistant/Student
antti.saari@nordea.com Norway Amelia.Marie.Asp@nordea.com
+358 95 300 7019 +47 91 36 51 91 +45 5547 2195
Andreas Østerheden Frederik Saul
Senior Strategist Assistant/Student
Andreas.osterheden@nordea.com Frederik.Saul@nordea.com
Denmark +45 60126102
+45 5547 3349
Sigrid Wilter Slørstad
Senior Strategist
sigrid.wilter.slorstad@nordea.com
Norway
+47 90 94 40 57
This material was prepared by Investments |DISCLAIMER
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