Where and how do we find growth in global equities?
Andrea CicioneHead of Strategy
www.lombardstreetresearch.com
Where and how do we find growth?
In short, it’s tough
2
• The global cycle is maturing1
• Corporate earnings are falling2
• But alpha can still be captured3
www.lombardstreetresearch.com
Where and how do we find growth?
In short, it’s tough
3
• The global cycle is maturing1
• Corporate earnings are falling2
• But alpha can still be captured3
www.lombardstreetresearch.com
A slowing global cycle
4
…explaining recent poor equity returns
Source: OECD, MSCI, LSRSource: OECD, LSR
Global growth below trend and slowing…
-6
-4
-2
0
2
4
6
97 98 99 100 101 102 103
LI > 100, y/y > 0
LI < 100, y/y < 0 LI > 100, y/y < 0
LI < 100, y/y > 0
OEC
D G
lob
al LI (%
y/y
)
OECD Global LI
Recovery Expansion
DownturnSlowdown
2008-09 Global
Financial Crisis
Mar-2006
2011-12
Euro crisisLatest
95
96
97
98
99
100
101
102
103
104
105
1971 1976 1981 1986 1991 1996 2001 2006 2011 2016
-80
-60
-40
-20
0
20
40
60
80
OECD Global LI MSCI World y/y (rhs)
www.lombardstreetresearch.com
Credit cycle maturing
5
…leading to credit market re-pricing
Source: Bloomberg, LSRSource: MSCI, Bloomberg, LSR
Leverage is increasing in the US…
0.8
1.3
1.8
2.3
2.8
3.3
3.8
2000 2002 2004 2006 2008 2010 2012 2014 2016
Ex-Financials, Tech Ex-Financials, Tech, Energy
Net debt-to-EBITDA
MSCI USA
25
50
75
100
125
150
175
200
225
250
400 800 1200 1600 2000 2400
Jan-09 to Mar-11 Oct-11 to Jun-15 Jul-15 to Jun-16 Latest
S&P
500
CDX NA
IG (bp)
Increasing
leverage
www.lombardstreetresearch.com
Where and how do we find growth?
In short, it’s tough
6
• The global cycle is maturing1
• Corporate earnings are falling2
• But alpha can still be captured3
www.lombardstreetresearch.com
Corporate profits stagnating
7
…and things are worse elsewhere
Source: BloombergSource: BEA, Bloomberg
US profits stagnating despite low rates…
500
700
900
1100
1300
1500
1700
1900
2100
2300
2000 2002 2004 2006 2008 2010 2012 2014 2016
0
1
2
3
4
5
6
7
8
US corporate prof its (IVA, CCAdj) UST 2y yield (rhs)
%
-50%
-40%
-30%
-20%
-10%
0%
10%
US Euro area Japan UK
Surprise Change y/y
Q1 2016 Earnings
www.lombardstreetresearch.com
Not just a commodity story
8
…but weakness spreading to key sectors
Source: BloombergSource: MSCI, Bloomberg, LSR
Ex-Energy, ex-Materials EPS still ok…
0
5
10
15
20
25
30
2000 2002 2004 2006 2008 2010 2012 2014 2016
3
4
5
6
7
8
9
10
Energy+Materials Ex-Energy, Ex-Materials
EPS (12m t railing)
MSCI USA
-120%
-110%
-100%
-90%
-80%
-70%
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
S&
P 5
00
En
erg
y
Mate
rials
Ind
ust
rials
C.
Dis
cr.
C.
Sta
ple
s
Healt
hca
re
Fin
an
cials
Tech
Tele
com
Uti
liti
es
Sales Growth Earnings Growth
S&P 500 - Q1 2016 results - y/y changes
www.lombardstreetresearch.com
Poor productivity to squeeze margins
9
…but slowing productivity remains a drag
Source: BloombergSource: MSCI, Bloomberg, LSR
Margins are holding up for now…
-6
-4
-2
0
2
4
6
8
1990 1993 1996 1999 2002 2005 2008 2011 2014
7
8
9
10
11
12
13
14
15
Unit labour costs (y/y) Product ivity (y/y)
S&P 500 operat ing margins (rhs)
% %
-10
-5
0
5
10
15
20
25
Mkt FN MT IN EN CS HC TC UT CD IT
Q1 2015 Q1 2016
MSCI US operat ing margins%
www.lombardstreetresearch.com
Valuations expensive in DMs
10
EM price-to-earnings ratio vs cycle
Source: MSCI, Bloomberg, LSRSource: MSCI, Bloomberg, LSR
DM price-to-earnings ratio vs cycle
(0.4) 1.6 1.9 1.4 0.6 0.9 0.7 0.91.7 1.7
0
5
10
15
20
25
30
35
40
US CA JP AU GB CH DE FR IT ES
7.5-year z-score
Key Last
Avg
7.5y
range+/- 1
stdev
0.0 (0.5) 0.7 0.6 0.4 1.0 (1.1) 0.30.2 0.6
0
5
10
15
20
25
30
35
40
CN IN KR TW BR MX RU ZA TR EM
Key Last
Avg
7.5y
range+/- 1
stdev
7.5-year z-score
www.lombardstreetresearch.com
Where and how do we find growth?
In short, it’s tough
11
• The global cycle is maturing1
• Corporate earnings are falling2
• But alpha can still be captured3
www.lombardstreetresearch.com
Quant strategies
12
US sector selection, market neutral
Source: MSCI, Bloomberg, LSRSource: MSCI, Bloomberg, LSR
European sector selection, market neutral
80
90
100
110
120
130
140
150
160
170
Jun-11 Jun-12 Jun-13 Jun-14 Jun-15
Strategy MSCI World HFRI Equity Market Neutral
70
90
110
130
150
170
190
Jun-11 Jun-12 Jun-13 Jun-14 Jun-15
Strategy MSCI World HFRI Equity Market Neutral
www.lombardstreetresearch.com
Quant strategies
13
US sector selection, market neutral
Source: LSRSource: LSR
European sector selection, market neutral
Strategy Mkt Neutral HFRI Quant
Out-of-sample Return 40.8% 13.1% 12.6%
Volat ility (annualized) 10.5% 2.6% 6.7%
Sharpe Ratio 0.60 0.64 0.24
Downside Dev (annualized) 5.4% 1.7% 7.5%
Sort ino Rat io 1.30 1.44 0.32
Beta (vs S&P500) -0.09 0.15 -0.20
Correlat ion (vs S&P500) -0.11 0.71 -0.13
Alpha (ann. Vs S&P500) 7.96% 0.53% 7.39%
% Posit ive months 60.7% 68.3% 56.7%
Maximum monthly loss -6.1% -2.8% -5.4%
Maximum Drawdown -11.6% -5.5% -12.1%
Strategy Mkt Neutral HFRI Quant
Out-of-sample Return 80.0% 13.1% 13.1%
YTD Ret 9.9% -0.4% 0.9%
Ann.Ret 12.66% 2.53% 2.52%
Volat ility (annualized) 10.6% 2.6% 6.5%
Sharpe Ratio 1.11 0.66 0.26
Downside Dev (annualized) 6.1% 1.7% 4.2%
Sort ino Rat io 2.07 1.46 0.61
Beta -0.15 0.14 0.39
Correlat ion -0.20 0.63 0.79
Alpha (annualized) 13.05% 1.26% 0.41%
% Posit ive weeks 59.6%
% Posit ive months 63.3% 69.5% 55.9%
Maximum weekly loss -6.4%
Maximum Drawdown -11.2% -5.5% -12.1%
www.lombardstreetresearch.com
Brexit opportunities
14
…but the Undecided seem to favour Remain
Source: BloombergSource: Bloomberg
Remain and Leave neck and neck in polls…
0
10
20
30
40
50
60
70
Sep-15 Nov-15 Jan-16 Mar-16 May-16
Leave Remain Undecided
30
35
40
45
50
55
60
Sep-15 Nov-15 Jan-16 Mar-16 May-16
0
5
10
15
20
25
30
35
Remain Undecided (rhs, inv)
www.lombardstreetresearch.com
Brexit opportunities
15
Virtually no Leave-Undecided relationship
Source: Bloomberg, LSRSource: Bloomberg, LSR
Strong Remain-Undecided correlation
y = -0.8x + 57.8
R2 = 0.7
30
35
40
45
50
55
60
0 5 10 15 20 25 30 35
Remain
Undecided
y = -0.2x + 42.1
R2 = 0.1
30
35
40
45
50
55
60
0 5 10 15 20 25 30 35
Leave
Undecided
www.lombardstreetresearch.com
Brexit strategy
16
Europe also dragged down by Brexit risk
Source: Bloomberg, LSRSource: Bloomberg
EU-exposed UK stocks to rally if ‘Bremain’
1.15
1.20
1.25
1.30
1.35
1.40
1.45
1.50
Jan-14 Jul-14 Jan-15 Jul-15 Jan-16
11000
12000
13000
14000
15000
16000
17000
GBP/EUR Bloomberg BREXIT Equity Index* (rhs)
(* ) RR/, BARC, BKG, NXT, TCG, VOD, STHR, KGF, SVT, RGU
72
76
80
84
88
92
96
100
104
Jun-15 Sep-15 Dec-15 Mar-16 Jun-16
1.20
1.25
1.30
1.35
1.40
1.45
S&P 500 Stoxx 600 Europe GBP/EUR (rhs)