Download PRIVATE BANKING INSIGHTS – Market Commentary

PRIVATE BANKING INSIGHTS – Market Commentary
Yves Cochez
Senior Vice President
Chief Investment Strategist
KEY TAKEAWAYS
HEXAKOSIOIHEXEKONTAHEXAPHOBIA
Do you fear the number 666? On March 6,
2009, investors showed that they suffer from
this very specific arithmophobia. When the S&P500 briefly touched
666, investors got so sick that they spent the following 6 years
driving the equity index as far as possible from this satanic number.
It is really amazing how this widespread phobia resulted in one of
the longest and most powerful equity bull markets in history. On
March 6, 2015, the S&P500 closed at 2071.26 for a total gain of 211%,
or 20.8% annualized gain. Now, we really need to hope and pray
that investors do not suffer from too many other afflictions, such as
vertigo or some kind of rearview mirror syndrome.
At 72 months, the current bull market is already the third longest in
history (since 1929). If the current positive trend is maintained, by
July 2016, it will have morphed into the second most enduring bull
market in history. In order to dethrone the all-time record of 4,494
days (or nearly 150 months), the bull market will have to go on until
at least June 26, 2021. In terms of magnitude of the gains, a further
18% gain would turn this bull market into the second best on record,
while the S&P500 would need to climb another 119% (to 4543.12) to
reach the top of the charts.
March 2015
• Equity bull markets don’t die just because
they age. They usually end with the next
economic recession. Tight monetary and
credit conditions are the warning signals
that a recession is imminent. With odds
of a recession still very low, we expect
the current 6-year old bull market to run
further and become the second longest
on record.
• Bond markets are, and will continue to
be, somewhat disconnected from the
economy. QE in both Europe and Japan
will result in a significant reduction in the
net supply of global government bonds
available for private investors. Bond
yields also reflect investors’ perception
that the Fed funds rate will peak at a
much lower level in this cycle.
• While the Fed is clearly uncomfortable
with the current abnormal monetary
policy setting, raising rates too soon in an
environment of low and falling inflation
as well as global monetary easing, will
most likely lead to even more significant
dollar strength. The ability of the current
expansion to translate into higher wages
has also yet to be established.
• U.S. equities have significantly
outperformed overseas markets since
2009, but have underperformed so far this
year. We expect this change in fortune to
be sustained in the medium term.
• U.S. profit margins are rolling over from
record high levels. The strong USD will
also act as a powerful headwind for USbased multinational companies.
As a reminder, a bull market means that rising prices are not
interrupted by declines larger than 20%, but corrections are a
common feature. Six years into the longest bull market ever
(that would be December 1993, with the bull market lasting from
December 1987 until March 2000), the environment was not too
dissimilar than where we are today. The US dollar had just entered a
1
• Financial conditions and economic
momentum are shifting in favor of
international markets. Valuation levels
will also be another impediment for
a continuation of U.S. stocks’ past
outperformance.
PRIVATE BANKING INSIGHTS – Market Commentary
long-term uptrend (which would be sustained until 2001), the US economy was outperforming on a global basis and
the Federal Reserve was about to embark on a tightening cycle. Sounds familiar?
You can see it in the air, see it on the streets, hear it on the shop floor: This growth is for real, with forecast of 3%-plus
gains in GDP for each of the next two years. Measured against past recoveries, that may not sound like much. But it
means more factories humming, better sales in stores, and more jobs, not only in services but in long-beleaguered
manufacturing as well. Even more important, this moderate expansion looks sustainable. The economy has become
much healthier than many people seem to realize. Time and thrift have brought the problems of the past decade,
which seemed so intractable only a couple of years ago, down to manageable proportions. Low interest rates have
helped consumers and businesses heal their wounded balance sheets; […].Consumer confidence indexes began to
tick up, and business mood surveys noted an increase in optimism. […} Make no mistake, hardships remain -- not
least for the many people whose jobs are insecure or whose hopes of employment will be frustrated for a long time
to come. Behind those concerns are structural changes that will keep the expansion low-key. […] Near-term growth
will also be held down by the cyclical miseries of America’s major trading partners. Japan and much of Europe
remain in recession, and Mexico’s economy came to a virtual standstill in the past year. While U.S. exports will grow
faster this year and next, partly because trade with Mexico will pick up again, the big gains won’t come until Europe
and Japan return from the cellar.
If you like the flow and the style of the previous section, it is probably because I didn’t write it – it’s a newspaper
article from Fortune Magazine, dated January 10, 1994.
While 1994 was not a particularly good year for US equities (the actions of the Fed – 6 rate hikes during the year –
were mostly to blame), the equity bull market stayed alive and US stocks finished the decade on a very strong note
(26.2% annualized gain in the next 5 years). At the same time, tighter monetary conditions, higher financing costs
and a surging US dollar wreaked havoc on emerging markets (Tequila crisis, Asian currency crisis and Russian debt
default).
BULL MARKETS DON’T DIE JUST BECAUSE THEY AGE
Since 1929, bull markets have lasted anywhere from less than a year to nearly twelve years and there is no way to
tell in advance how long the current run will last. One thing we do know however is that bull markets don’t end just
because they get too old or because the Federal Reserve is raising rates. The reference to 1994 (right in the middle
of the longest bull market ever) has to be put in that context. The experience of 1994 shows that even a very badly
communicated tightening of monetary policy (dramatically different than the communication and guidance overkill
from Fed officials today) and several EM crises were not sufficient conditions to halt the march towards higher stock
prices.
Bull markets usually end with the next economic recession, or more precisely a few months in advance as the stock
market is a discounting mechanism. Tight (not just tighter) monetary and credit conditions are the warning signals
that a recession is imminent. In turn, inflation tends to be the main factor forcing central banks to tighten monetary
policy. Excessive valuations and/or too much reliance on credit tend to make matters significantly worse but are
usually not what causes recessions and bear markets. External shocks or geopolitical events can be highly disruptive,
can cause a jump in market volatility and a temporary price correction, but a bear market will take hold only if these
events lead to significant economic weakness (a euphemism for recession).
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PRIVATE BANKING INSIGHTS – Market Commentary
I think that a silver medal is definitely within reach for the current bull market (it will need to last until July of
next year) and the gold medal is not totally unthinkable. This view is underpinned by my belief that the current
economic expansion will rank among the longest in history, with inflation and interest rates likely to remain low for
much longer. Also, many of the excesses that are typical at market peaks are not present yet, such as extremely rich
valuations, euphoric investor sentiment and rapid credit growth.
ODDS OF A RECESSION ARE VERY LOW
As can be seen on the following chart, with the exception of Black Monday in 1987, bear markets usually start ahead
of an economic recession. Recessions typically lead to a large drop in corporate earnings and uncertainties about the
length and the magnitude of the economic decline result in higher risk premiums (lower valuation multiples). In the
current cycle, a recession would be particularly devastating as central banks have very limited ammunition left to
revive economic growth through more accommodative monetary policies.
However, as I have argued in previous editions of this newsletter, the current recovery has been one of the weakest
on record and inflationary pressures, six years into this cycle, are still very minimal. Based on the output gap (which
measures the difference between the current GDP level and the level we would have reached if the economy had
been growing at its potential growth
rate), the U.S. economy is still operating
below potential. Economies go through
cycles and a recession develops when
the economy is overheating and central
bank policy needs to be tightened in
order to deal with rising inflationary
pressures.
Over the past few years, the U.S.
economy has been the bright spot on
a global basis with much weaker (and
at times negative) growth momentum
in other large advanced economies.
Nevertheless, the annual growth rate
has remained at or below 2.5% since
2010, a disappointing showing on the heels of the deepest recession since the 1930s. The good news is that the growth
momentum seems to be accelerating. Good news is good news, despite investors’ growing concerns that stronger
economic data will force the Fed to hike rates sooner rather than later (more on this later). Job creation in particular
has shown a vigor not seen since the late 90s. Consumer confidence has recovered close to its highest levels in
more than 10 years. This augurs well for household spending going forward. Other factors will act as tailwinds for
consumer spending in coming months. Households’ balance sheets have been largely repaired and access to (still
cheap) credit has improved as banks are also much more willing to lend than in years past. While wage gains have
been limited, low inflation should help purchasing power, and the recent US dollar strength will keep the prices of
imported goods down. Other areas of the economy are also showing signs of renewed strength, in particular capital
spending. Most companies have so far used a large part of their record free cash-flows towards share buybacks and
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PRIVATE BANKING INSIGHTS – Market Commentary
increased dividends, but we expect a shift towards a bigger emphasis on capital spending going forward as capacity
utilization rates rise and profit margins cannot be raised any longer. Fiscal retrenchment is also largely behind us
after a few years of belt tightening. On a global basis, things are also looking brighter with growing signs of a more
robust economy in Europe and increasingly aggressive central banks outside the U.S. As always, there are some
caveats. The rapid increase in the value of the dollar is eating into US multinationals’ competitiveness and earnings
and will limit the extent to which net exports can add to economic growth. The oil price plunge will negatively
impact capital spending and employment prospects in some regional economies, but overall, lower energy prices
will, with the typical lag, be a net positive for the economy. Leading economic indicators are pointing towards a
further improvement in the economy and are certainly not consistent with looming recession risks.
DECIPHERING THE MESSAGES FROM THE BOND MARKETS
If you have recently paid some attention to developments in the bond markets, you would be excused for doubting
the actual and future strength of the economy. Indeed, bond yields have actually moved lower over the past few
months and have reached levels which seem at odds with a robust economy. While it seems difficult to make sense
from these very depressed bond yields, it is important to recognize that bond markets are, and will continue to
be, somewhat disconnected from the economy. Contrary to sin city, whatever happens in Frankfurt or Tokyo does
not stay there. While the Fed is in the starting blocks to raise rates, we have witnessed in recent weeks a flood of
monetary easing decisions on a global basis with interest rate cuts in more than 20 countries and the start of QE
in the Euro area. The spread between the 10-year Treasury yield and the yield on comparable bunds in Germany is
reaching unprecedented levels, making US bonds particularly attractive for global investors (with the added benefit
of investing in a strong currency). QE in both Europe and Japan will result in a significant reduction in the net supply
of government bonds in these markets. The existence of negative deposit rates across several European countries
will most likely reinforce the impact from QE.
The current shortage of government bonds in the face of still strong demand (particularly from commercial banks
due to regulatory requirements
and, in the case of Europe,
punitive deposit rates) is
the primary factor driving
bond yields lower on a global
basis. Nevertheless, economic
developments are not completely
irrelevant. Long bond yields
reflect the consensus view of
where short-term rates will
be over the next few years as
well as a term premium. The
term structure is based on the
expectations hypothesis - the
expected return from holding a
long bond until maturity should
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PRIVATE BANKING INSIGHTS – Market Commentary
be the same as the expected return from rolling over a series of short bonds with a similar total maturity. Forwards
rates (rates at which investors agree today to lend in the future) are used to measure the expected future shortterm rates. While forward rates are readily available, the return on a long bond is uncertain unless it is held until
maturity. Investors will therefore require a compensation for this interest rate risk, the so called “term premium”.
Today, term premiums are very low and, in some cases, negative. This would be consistent with the perception
that forward short-term rates are pricing too much policy tightening. Term premiums also need to offer some
protection against inflation risk and the current term structure seems to indicate that investors collectively expect
very subdued inflationary pressures in the next few years. Obviously, supply/demand dynamics will at the end of
the day determine the value of the term premium and, from that perspective, the picture is heavily skewed towards
abnormally low term premiums.
THE FED, INFLATION AND GROWTH
As mentioned, equity bull markets usually go on until evidence build that a recession is in store. Aggressive
tightening by central banks - in an effort to ward off excessive inflation - is what typically pressure down the
economy towards the abyss of recession. Monetary and credit conditions are therefore useful tools that can provide
early warning signals of future economic trends. Recessions have always been preceded by a sharp rise in real shortterm rates (today, they are below zero based on core inflation), a flat to inverted yield curve (despite recent flattening,
the yield curve is still relatively steep), tighter lending conditions (banks are today very much willing and able to
lend) as well as wider credit spreads and poor liquidity in corporate bond markets (with the exception of the energy
sector, the current environment remains very supportive for credit markets).
When the Fed eventually starts raising rates, short-term rates will move higher (albeit from record low levels - as in
“zero”) but real rates might stay relatively stable if inflation starts to rebound from record low levels (as in negative
0.1% last month).
The debate surrounding the timing of the Fed liftoff has intensified in recent weeks. Despite trying to be as
transparent as the waters
off the coast of Cancun, Fed
officials have not gone as far
as publishing a report with the
exact timing for the first rate
hike in almost 9 years.
Fed watchers are trying to
make sense of every bit of
information they can gather
from Fed chairwomen
Janet Yellen and other Fed
officials, with the latest hot
topic centered around the
word “patience”, when it
will be removed from the
FOMC statement and how
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PRIVATE BANKING INSIGHTS – Market Commentary
this would have to be interpreted. The reality is that the Fed will have to get back to a data-dependent mode and, by
definition, forecasting Fed policy based on economic data is not as easy as looking for (and maybe not finding) the
word “patient” in a statement. While recent market gyrations and volatility seem to indicate that the fate of financial
markets will be vastly different if the Fed hikes in June or September (or maybe wait until next year), the reality
is that this will likely only have a short-term impact on the markets as monetary conditions will still remain very
accommodative with rates at extremely low levels.
Fed officials are clearly uncomfortable with the current abnormal monetary policy setting. They are eager to start
a “normalization” process but, at the same time, inflation trends provide them with the luxury of being patient and
wait until they deem the economic recovery strong enough to be able to stand on its own (often referred to as “escape
velocity”).
Let’s leave aside the fact that the Fed has
implemented ZIRP (Zero Interest Rate
Policy) since the end of 2008 and let’s focus
on the most recent economic data in order
to gauge the pressures for the Fed to tighten
monetary policy at this juncture.
Looking at labor markets, there is a sense
of “mission accomplished” for the Fed with
the unemployment rate down to 5.5% and
12 consecutive months of 200,000+ net job
creations. Indeed, nearly 3.3 million new jobs
have been created over the past 12 months,
the best performance since 1997.
As indicated, the current economic expansion is already in its sixth year, both consumer and business confidence
indices are elevated, balance sheets have been repaired, credit growth has picked up and leading indicators point to a
continuation of these positive trends.
If we stop the analysis here, it seems be a no-brainer, why wait any longer?
But the Fed mandate is a fine balancing act between reaching full employment and achieving price stability (or
inflation close to 2%). Looking at this side of the equation, the picture is quite different and overheating seems like
a very distant worry. The Fed does not need to raise rates just because growth is strong – what matters is whether
strong growth is actually sowing the seeds for a more pronounced inflation breakout.
There is no doubt that job creation has accelerated in recent months but the underlying details for the labor markets
are not as rosy as the headline would suggest. Ahead of this year’s compensation discussions, I tried to make the
case to my management that wage pressures are building fast (one can always find a nice chart or some piece of
information to make a compelling case). Now that wage and bonus negotiations are behind us (me), I can look at the
broader picture and face the reality that wage growth remains lackluster. Hourly wages are growing at an anemic
1.6% on a yearly basis and the employment cost index is up only 2.2% over the past year. Additional data points
also suggest that the job market can further recover before wage inflation becomes a serious threat. The labor force
participation rate is still hovering near multi-decade lows and the number of full-time jobs is still below the pre6
PRIVATE BANKING INSIGHTS – Market Commentary
recession levels. The Phillips curve (which
represents the relationship between the
rate of inflation and the unemployment
rate) appears to have become irrelevant
or at least a lot flatter than in previous
cycles as the sharp drop in the official
unemployment rate has so far had very
limited impact on wage inflation. Indeed, a
lot has changed since the great recession.
The economy suffered a traumatizing blow
and strong deflationary forces are pulling
prices down on a global basis.
For all the talk about deflation in Europe,
let’s not forget that headline inflation
came in at -0.1% in the U.S. last month.
Granted, this is a very minimal decline
and is mostly the consequence of the
recent plunge in oil prices. However, the
Fed’s preferred measure of inflation - the
core personal consumption expenditure
inflation rate - stands at 1.3%, way below
target and still coming down. The surging
US dollar complicate matters even
more for the Fed as it does equate to a
tightening of overall monetary conditions.
As such, a stronger dollar removes some
of the pressure for the Fed to raise rates.
Developments overseas will also have
to be taken into consideration. The
combination of rate cuts overseas and the prospect of higher rates in the U.S. has already resulted in massive dollar
strength. Fed officials are keenly aware that, at some point, the dollar will start hitting the economy (we have already
seen the adverse impact of the dollar’s rise on corporate earnings).
Despite an obvious willingness to normalize monetary policy and despite a relatively strong and healthy economy,
the Fed can and should remain…patient. The ability of the current expansion to translate into higher wages has
yet to be established and the combination of weak commodity prices and a strong dollar will help keep inflation
at bay. Raising rates too soon in an environment of low and falling inflation as well as global monetary easing will
most likely lead to even more significant dollar strength. It would also seem to make sense to wait and assess the
effectiveness of QE in Europe and a confirmation of recent positive economic data – higher rates in the US will
most likely be less disruptive if implemented in a context of a more robust rebound in global growth. Developments
in some developing economies should be taken into consideration as well. While emerging markets are today
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PRIVATE BANKING INSIGHTS – Market Commentary
much better armed to deal with higher
US rates and a stronger dollar (large FX
reserves, floating exchange rates and
local currency debt markets), some areas
of weakness remain in economies where
dollar denominated debt has grown rapidly,
particularly for the corporate sector.
Excessive dollar strength and higher interest
rates could lead to a vicious cycle of capital
flight, additional local currency weakness,
tighter monetary policy in an effort to shore
up the currency and more pronounced
economic softness. The 1994 Fed tightening
cycle resulted in the Tequila crisis. Let’s hope
that untimely Fed actions do not result in a Caipirinha crisis this time around (as you can see, I am an expert when it
comes to Latin America).
LEADERSHIP CHANGE
Most of the ingredients are still in place for a continuation of the bull market in US stocks:
- The US economic expansion has further to run – current economic conditions are indicative of a mid-cycle
environment with very limited recession risks in the foreseeable future. At the same time, global growth is expected
to pick up and a broader and more synchronized recovery will provide a further boost to stocks.
- Inflation is not an imminent threat: limited signs of wage inflation, weak commodity prices and a strong dollar
combine to keep inflation in check.
- Interest rates are unlikely to move significantly higher: we expect the Fed to be patient and gradual in their
monetary policy decisions and long bond yields will remain depressed due to global supply/demand imbalances.
- Global liquidity is not going away: the combined QE purchases from the BOJ and the ECB are larger than the latest
round of QE in the US.
- Corporate balance sheets are healthy: net debt to equity ratios are indeed close to record low levels. Equity and
credit markets tend to run into trouble once companies have increased their leverage for at least a few years
While we forecast further gains for US stocks, we believe that the early part of this year is an indication of what is
likely to unfold in coming months, i.e. a continuation of recent overseas outperformance. So far this year, US stocks
are broadly while European and Japanese equities are up 10%+ in local currency. This change in fortune was long in
the tooth and our portfolios have been positioned already for a while in order to benefit from this emerging trend.
Given the extent of US equities’ outperformance since the market bottom in March 2009 (up 205% compared to only
101% for non-US stocks), there is still significant catch-up potential for foreign markets.
Our preference for international markets is driven both by factors specific to these markets as well as some growing
headwinds which have started (and will likely continue) to adversely impact US stocks:
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PRIVATE BANKING INSIGHTS – Market Commentary
Monetary policy divergence: QE is over in the US and while the Fed’s balance will remain relatively stable in
coming months, it will start to shrink as a share of GDP. Moreover, interest rate hikes are coming, whether in June,
September or even later, it does not change the fact that we are getting closer to tighter monetary policy in the US.
A shift in monetary policy always leads to rising market volatility as investors discount the potential for a policy
mistake. In this particular cycle, the Fed will be raising rates in an environment of lower potential growth rate
and intense deflationary forces globally. As such, there is a nontrivial risk that the Fed will end up tightening too
aggressively. As already noted before, outside the U.S., the exact opposite trend is taking place with central banks
easing monetary conditions through official rate cuts, the implementation of negative deposit rates and quantitative
easing.
The strong US dollar, a trend likely to continue, will contribute to a rebalancing of growth in favor of international
economies. It will also help ease deflationary forces which have plagued some foreign economies over the recent
past.
Profit margins are rolling over: corporate
profitability is at record high levels in the
US while still relatively depressed on a
global basis. However, margins are likely to
roll over going forward. Cost pressures are
likely to build further in coming months
with some level of wage price inflation and
higher funding costs. Moreover, margins
have benefited from limited capital spending
in recent years, but this is about to change.
While capital spending will help boost
demand, the resulting increase in productive
capacity will further erode profit margins.
As a result, earnings growth will rely solely
on top line growth and, given the large and increasing share of foreign profits for US companies, the US dollar will
act as a significant headwind in the near term. Although the US economy is not overly sensitive to exports (they
account for only 13% of GDP), foreign sales account for a much more significant share of total S&P500 revenues
(close to 35%). The negative impact of a strong dollar (and plunging oil prices) became clear during the most recent
corporate earnings season, not only in terms of actual profits but also in terms of forward guidance. As a result,
2015 consensus EPS for the S&P500 plunged from $127 at the end of last year to $119 today and, for the first time in
this cycle, 12-month forward earnings estimates are moving lower. Although earnings usually only decline during a
recession, given the near-term headwinds of a strong currency and downward pressures on margins, it is not totally
inconceivable that corporate earnings could actually decline in 2015. In any case, the outlook for profits appears
much more robust outside the U.S. as profit margins are likely to rebound from depressed levels and the benefits
from cheap commodity prices will not be partially offset by a strong currency.
Shifting economic momentum: while the U.S. economy has outperformed over the past few years, the momentum
is shifting towards international economies. So far this year, economic data have come in weaker than expected
in the US and have surprised on the upside in Europe and other large foreign economies. Growth expectations are
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PRIVATE BANKING INSIGHTS – Market Commentary
still downbeat in Europe, Japan, China and
other economies and the impetus from easing
monetary and credit conditions, lower oil prices
and weak currencies is likely to lead to upside
surprises.
Valuations will be another impediment for
a continuation of the past years’ relative US
outperformance. Most equity markets currently
trade on relatively high P/E ratios, or at least
above their long term averages. There is nothing
alarming with the current level of PE ratios,
particularly in a context of extremely depressed
yield on competing assets and valuations are
usually a poor market timing indicator. However,
the fact that valuations are more attractive
outside the U.S. at a time when the earnings,
margins, monetary and economic momentum
is also more attractive overseas should help
support a continuation of the shift in regional
performance we have seen so far this year. In
the case of US equities, high PE ratios are more
worrying since earnings have already rebounded
significantly since the end of the recession and,
as indicated, profit margins are more likely to
roll over rather than expanding further. Looking
at Shiller Price/Earnings ratios (computed by
using a rolling average of earnings over the past
10 years in order to smooth the impact from economic cycles), the S&P500 currently trade at 27.8x cyclically-adjusted
earnings, significantly above the long term average of 17x. By comparison, the Shiller PE stands at only 15x in Europe,
a record discount of nearly 50% (vs an historical average discount of 10-15%). The relative valuation argument of
equities against bonds is even more compelling in Europe and Japan where bond yields are close to zero (and in some
cases negative) and significantly lower than dividend yields.
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PRIVATE BANKING INSIGHTS – Market Commentary
INVESTMENT STRATEGY
• The upcoming Fed tightening cycle will inevitably result in higher market volatility and more frequent corrections,
but the underlying uptrend for global equity markets will be sustained. We are therefore sticking with our strategy
of overweighting global equities in our portfolios.
• Two consecutive months with a Friday 13th (February and March) was maybe all we needed for a reversal in the
relative fortunes of US and International markets. We keep our preference for international equities – we are
overweight Europe, Japan and Emerging Asia at the expense of US, Australia, Canada and Emerging Markets exAsia. We also continue to partially hedge the foreign exchange exposure in Japan and Europe, despite the already
sharp US dollar appreciation in recent months.
• We remain underweight fixed income markets as risk-adjusted returns look more attractive for equity markets,
but we are not overly negative on the outlook for bond markets, at least in the medium term. Indeed, we maintain
a fixed income duration in line with our benchmark, at around 5 years. We do not believe that the 10-year treasury
is overvalued with a 2% yield, although we expect ongoing volatility in the near term given current uncertainties
around the timing, pace and final level for the Fed funds rate in this cycle.
• The 10-year treasury yield should trade at a level consistent with where investors expect short-term rates to be, on
average, over the next 10 years and a term premium. If, as we believe, the Fed funds rate is unlikely to peak much
higher than 2.5% in the current cycle, the average is likely to be below 2% (since the current level is close to zero
and one should expect the Fed to have to cut rates at some point in the next 10 years as the economy faces the
threat of another recession later in the forecasting period). The term premium is likely to be minimal in the current
environment of extremely depressed bond yields and ongoing QE purchases in the Eurozone and Japan.
• We remain overweight corporate bonds, with a particular focus on high yield bonds. The current environment of
decent global growth, strong corporate balance sheets and limited net supply of government bonds will drive asset
allocation flows towards this relatively high-yielding asset class.
• We have been USD bulls for the past 18 months and this view has played out far beyond our wildest expectations,
with the USD index up a staggering 25% since mid-2014. We are getting less comfortable with this view which
has become a massive consensus. The Euro appears to be on a free fall towards parity and negative deposit rates
combined with QE purchases, as well as interest rate hikes in the US, might sustain this momentum for a while.
However, the Euro is already significantly undervalued when looking at the current account and purchasing power
parity. The situation is however different in Japan where the trade surplus has basically disappeared in recent
years and where more pronounced deflationary forces warrant efforts to sustain a much cheaper currency. At
some point, a further appreciation of the dollar will become a bigger problem for the US economy and will likely
limit the Fed’s ability to raise rates, thereby removing one support for the dollar. For now though, we feel that our
strategy to partially hedge our foreign exchange exposure still makes sense as we don’t see yet factors which would
lead to a reversal of the current strong trends supporting the dollar.
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PRIVATE BANKING INSIGHTS – Market Commentary
• Finally, we remain underweight commodities but we are gradually warming up to the sector. Lower oil prices
should eventually boost demand and reduce the current oversupply situation. The futures curve is discounting
higher prices, which gives an incentive for some market players to build up oil stocks but for most investors, this
will limit potential returns (negative “roll yield”). As such, we think it makes sense to wait for the futures curve to
flatten before increasing our investments in oil. Gold has come down substantially in recent weeks, most likely
on the back of dollar strength. While we have no specific allocation to gold today, the likely persistence of very
depressed real interest rates should help lift gold prices later, once the USD rally matures.
FOR MORE INFORMATION CONTACT YOUR WEBSTER PRIVATE BANK PORTFOLIO MANAGER OR
EMAIL US AT [email protected].
Source for charts: FactSet 03/15
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SEI Funds are distributed by SEI Investment Distribution Co. (SIDCO). SIMC and SIDCO are wholly owned subsidiaries of SEI Investments Company.
The Webster Symbol is registered in the U.S. Patent and Trademark Office. FN01453 03/15
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