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
2For professional clients and institutional investors only
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 (%)
3For professional clients and institutional investors only
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
4For professional clients and institutional investors only
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”
5For professional clients and institutional investors only
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
6For professional clients and institutional investors only
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)
7For professional clients and institutional investors only
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”
8For professional clients and institutional investors only
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
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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
10For professional clients and institutional investors only
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
11For professional clients and institutional investors only
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
12For professional clients and institutional investors only
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
13For professional clients and institutional investors only
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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