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May 2017
Capital Markets Monthly
As the economy awakens to spring, political
risks and side effects loom
Just as the merry month of May is about to start, sentiments on the
markets are mixed. On political soil, growth of a carefree spring mood
is hesitant at best. Although the first major stumbling blocks inherent
in Europe’s 2017 election super-cycle seem to have been overcome,
the surprising move to bring parliamentary elections forward to 8
June in the UK has renewed political uncertainty after England filed for
divorce from the European Union at the end of March, as expected.
It remains to be seen whether the possible strengthening of prime
minister Theresa May’s mandate proves to be a game changer for
what look like being difficult Brexit negotiations. In the US, president
Donald Trump is having to deal with resistance on the domestic policy
front, which is delaying the implementation of his agenda.
By contrast, the global economy at least seems to be following
nature’s example as spring gets underway. The fledgling economy
is sprouting and thriving in nearly all key regions. The “soft” mood
indicators are, however, racing ahead of the “hard” economic data,
a phenomenon that is particularly true in the US. So, while the
strength of the growth signal for the US economy is shrouded in
doubt, our expectation that the global economy will slightly exceed
its growth potential remains supported for the time being. At the
same time, the increasing pace of economic growth is not expected
to be consistent over the coming months.
At least the scenario does not lend itself to renewed expansionary
efforts on the part of the major central banks. The US Federal
Reserve, for example, recently indicated that it was not only planning
further rate hikes but also might start returning the size and
composition of its balance sheet – which is currently worth trillions –
back to normal as the year progresses. It intends to throttle or
desist from reinvesting, both in US Treasuries that are approaching
maturity and in mortgage-backed securities (MBS). Accordingly, the
signs are growing that global central bank liquidity could peak in the
first half of 2018.
The global economy
follows nature’s
example as spring
gets underway.
Ann-Katrin Petersen
Vice President Global Capital Markets &
Thematic Research
As of 27/04/17
Equity Indices
Status
FTSE 100
7,211
DAX12,444
Euro Stoxx 50
3,567
S&P 500
2,389
Nasdaq6,049
Nikkei 225
19,197
Hang Seng
24,615
KOSPI2,205
Bovespa64,677
FXStatus
USD/EUR1.088
Interest Rates %
USA
3 Months
2 Years
10 Years
Euroland 3 Months
2 Years
10 Years
Japan
3 Months
2 Years
10 Years
Raw Materials
Oil (Brent, USD/Barrel)
1.17
1.26
2.31
-0.33
-0.73
0.35
0.06
-0.20
0.02
50.7
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What does this augur for the financial markets?
• T he prevailing “reflation theme” is currently still supporting the
equity markets. However, the boost from oil prices – which are
higher year on year – and surprisingly positive economic data are
set to gradually lose pace.
• A
s inflation rises and the prospect of the central banks gradually
returning their monetary policies to normal (European Central Bank)
or continuing to do so (Federal Reserve), the upward pressure on
yields persists on the bond markets, especially in the US. In these
conditions, keeping an eye on bond duration risks is advisable.
• P olitics remains a key issue for investments. In Europe, the super
election year could produce some surprises and occasional
hefty fluctuations on the financial markets – although
favourable election outcomes might also present opportunities.
Doubts about the effectiveness of – basically dollar-positive –
“Trumponomics” are increasing in the US.
What is more fun in spring than defying unwanted proliferation with
a colourful bed of mixed flowers?
I believe the same holds true for investments.
Ann-Katrin Petersen
Allianz Global Investors: Capital Income: Dividends – May 2017
Markets in Detail
Tactical Allocation, Equities & Bonds
• Equity markets are still being supported by the “reflation theme” – expectations of continued economic revival around the world
coupled with rising inflation rates.
• The boost to inflation from oil prices – which are higher year on year – will, however, gradually dissipate. Equally, the pace of
economic growth cannot be expected to increase consistently over the coming months.
• Given the present valuations of a range of asset classes and in the light of increased political uncertainty, enhanced volatility
remains likely.
• On the bond markets, the upward pressure on yields will continue, especially in the US. Keeping an eye on bond duration risks is
therefore advisable.
German equities US equities • Surveys among companies, such as the ifo and purchasing
managers’ indices, indicate that the German economy will get
off to an energetic start in the second quarter of 2017.
• Export-oriented companies should enjoy a further boost from
the global economy. In contrast, consumer confidence is
expected to suffer somewhat due to higher inflation and the
recovery in the oil price. Nevertheless, given the robust state of
the labour market, there are no grounds for scepticism here.
Within the Eurozone, Germany continues to have the lowest
unemployment rate.
• In terms of their long-term average, German equities appear
to be slightly overvalued according to the Shiller price/earnings
(P/E) ratio.
• Historically low interest rates combined with expansionary
Fed policy has helped lift US equity valuations to high levels.
This creates a drag on return potential in the long run.
• Solid macro data – particularly in the labour market –
supports the all-time highs in US equities – at least for now.
The US business cycle is however maturing, which suggests
approaching headwinds: e.g. lower profit margins due to
higher wages.
• US large caps are more exposed than domestically oriented
small caps to shifts in the value of the US Dollar.
European equities • To date, Eurozone economies have remained stable despite
the political challenges. Sentiment indicators are pointing
towards continued solid economic growth overall with
pace and breadth increasing in the second quarter 2017,
although there is little prospect of any further positive
surprises.
• Domestic demand will probably remain the key driver of
economic growth in the currency union. Although the
gradually rising inflation rate will reduce purchasing power,
the steady increase in employment will support consumer
spending. Added to this, the economy will continue to enjoy
support from extraordinarily low interest rates and the low
value of the Euro versus other currencies.
• Although the UK economy proved to be surprisingly robust
following the shock of the Brexit vote, with gross domestic
product growth actually increasing in the second half of
2016, it should lose momentum noticeably as the year
progresses. Uncertainty surrounding the economic
repercussions of leaving the EU will probably dampen the
propensity to invest.
• Based on the cyclically adjusted Shiller price/earnings
ratios, valuations in the European equity segment are
slightly above their long-term average, with some individual
European countries still appearing more attractive than
other markets.
Japanese equities • Helped by the weaker Yen exchange rate and brighter prospects
for the global economy, export momentum may well be one
of the key reasons for the Japanese economy growing
somewhat faster this year than has recently been the case.
• In February, the Japanese unemployment rate fell
unexpectedly to 2.8%, its lowest level in 22 years. Price trends
also provided positive surprises recently. Overall, however,
“Abenomics” has still not managed to get inflation on a
sustained upward path. As a result, the Bank of Japan will
probably continue its policy of “quantitative and qualitative
monetary easing with yield curve control” for the time being.
• Japanese share prices remain closely tied to the development
of the Yen.
Emerging market equities • In the emerging markets, the signs are pointing to a moderate
acceleration in growth, due mainly to the continued loose
economic and fiscal policy in China and growing stability in
the two heavyweight economies Brazil and Russia, helped
not least by the recent hike in commodity prices.
• Nevertheless, there are still risks. Indeed, in a number of
emerging markets, expansionary economic policy is
accompanied by growing imbalances, in particular a high
and increasing level of private debt and inflationary property
prices. In addition, the stronger US Dollar will have a
temporary negative impact, inasmuch as the cost of
servicing debt will increase in local currency for the large
number of Dollar-denominated loans.
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Allianz Global Investors: Capital Income: Dividends – May 2017
• In terms of the Shiller price/earnings ratio, valuations of
emerging market equities continue to be relatively attractive.
• Tactical overweighting might be advisable although investors
with a longer-term horizon should tend towards neutral.
Sectors
• Given that reflation expectations have already moved upwards,
bond yields remain the key for the recovery in more cyclically
oriented value stocks to continue. We like US banks as a play
on steeper yield curves, at the expense of sectors like
consumer staples or utilities.
• Structurally, we still recommend the dividend style, because in
an environment in which overall long-term growth prospects are
sluggish, dividends remain an important factor for equity returns.
Investment theme: Capital income
restrictive monetary policy, should further encourage the
cyclical increase of US Treasury yields. In fundamental terms,
US Treasuries are still overvalued, despite the recent correction,
although the extent of overvaluation has decreased.
• In the UK, continuing the loose monetary policy following the
Brexit vote should help to support the Gilt markets. At the
same time, though, higher import price inflation due to the
exchange rate should not be ignored.
• There are no signs of pressure on Japan’s government bond
yields, particularly as the Japanese central bank is anchoring
yields on 10-year bonds at 0%.
• Lack of compensation for duration risk highlights the
vulnerability of government bonds. Negative long-end term
premia have regularly been a harbinger of rising interest rates.
Our advice for the bond segment would therefore be to
shorten duration.
• The environment of low/negative interest rates will probably
persist for the time being, especially in the Eurozone and
Japan. After subtracting inflation, US Treasury yields are also
barely adequate, which makes securing regular investment
income more important than ever.
• Asymmetric monetary policy should continue favouring risky
assets in a climate of heightened volatility. Investors should keep
an eye on corporate bond yields and, above all, on corporate
dividends since with equities investors have a share in real assets.
• Dividends have historically dampened the return volatility of
equity portfolios. They look promising this year: we estimate that
MSCI Europe companies, alone, will distribute EUR 315 billion –
a record! Back in 2016, they paid out EUR 302 billion.
Emerging market bonds Euro bonds • Credit risk and liquidity premia of Euro investment grade
corporate bonds reflect broadly fair valuations, while Euro high
yield securities are trading at comparatively expensive levels.
• In the US, re-leveraging in the private sector reflects share
buy-backs financed by cheap debt, a prospective risk in a rising
rate environment.
• In terms of historical default rates, US corporate bonds may be
slightly overvalued.
• Although the arguments for “proper tapering” have
meanwhile become more convincing, the Governing Council
of the European Central Bank (ECB) will probably not start
gradually reducing its asset purchases (“QE”) until 2018
(see also our latest QE Monitor). As such, ECB monetary policy
remains extraordinarily loose for the time being.
• From an investor’s perspective, the power struggle on the
Euro bond markets continues: while the ECB’s negative
interest rate policy is keeping yields on short-term debt
securities anchored at low levels, the ongoing demand for
securities from the Eurosystem continues to exert downward
pressure on yields at the longer end, too. However, investors
should keep an eye on yield drivers such as increasing
inflation expectations, the Fed’s cycle of interest-rate hikes
and the expected cessation of quantitative easing – although
there probably won’t be a sharp upsurge in yields.
• Euro peripheral sovereign markets remain supported by
expansionary ECB monetary policy, but are still prone to
political risks.
International bonds • In March 2017, the US Federal Reserve implemented its third
rate hike. The notion that fiscal policy will probably be more
expansionary under “Trumponomics”, along with a more
• Negative structural factors (e.g. high levels of debt, slower
growth potential in numerous emerging markets and
protectionist trends in the US) have clouded the secular
outlook for EM government bonds.
• Moreover, expectations of less expansionary monetary policy
in the US over the medium term are weighing on this asset
class. In contrast, the economic environment has recently
stabilized, albeit not across all countries.
• In contrast to many developed markets, local emerging
sovereign real yields are on average significantly positive.
Corporate bonds Currencies
• Overall, the international exchange rate system is still under
the influence of diverging monetary policies (e.g. the US rate
hike vs. the continuation of low interest rate policies in Europe
and Japan) and commodity prices.
• The surge in the US Dollar reflects the expectation that the
change in the US Administration will lead to an increase in
cyclical differences and international interest rate differentials.
The prospect of a US economic policy that will focus more on
domestic concerns is also putting pressure on emerging
market currencies, albeit with significant differences from
region to region.
• In terms of interest rate differentials, the GBP looks “fairly”
valued. In light of the UK’s massive current account deficit
and likelihood of dwindling capital inflows, however, Pound
Sterling is in danger of weakening further.
3
Allianz Global Investors: Capital Income: Dividends – May 2017
Do you know the other publications of Allianz GI Global Capital Markets & Thematic Research
Active Management
→→ “It‘s the Economy, Stupid!”
→→ The Changing Nature of Equity Markets
and the Need for More Active Management
→→ Harvesting Risk Premium in Equity Investing
→→ Active Management
Alternatives
→→ Volatility as an Asset Class
Financial Repression
→→ Shrinking Mountains of Debt
→→ QE Monitor
→→ Between a Flood of Liquidity and a Drought
on the Government Bond Markets
→→ Liquidity – The Underestimated Risk
→→ Macroprudential policy – Necessary, but not a Panacea
Strategy and Investment
→→ Equities – The “New Safe Option“ for Portfolios?
→→ Dividends instead of Low Interest Rates
→→ “QE” – A Starting Signal for Euro Area Investments?
Capital Accumulation – Riskmanagement – Multi Asset
→→ Smart Risk with Multi-Asset Solutions
→→ Sustainably Accumulating Wealth and Capital Income
→→ Strategic Asset Allocation in Times
of Financial Repression
Behavioral Finance
→→ Behavioral Risk – Outsmart Yourself!
→→ Reining in Lack of Investor Discipline:
The Ulysses Strategy
→→ Behavioral Finance – Two Minds at Work
→→ Behavioral Finance and the Post-Retirement Crises
All our publications, analysis and studies can be found on the
following webpage:
http://www.allianzglobalinvestors.com
@AllianzGI_VIEW
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Imprint
Allianz Global Investors GmbH
Bockenheimer Landstraße 42-44
60323 Frankfurt/Main
Global Capital Markets & Thematic Research
Hans-Jörg Naumer (hjn), Stefan Scheurer (st),
Ann-Katrin Petersen (akp)
Data origin – if not otherwise noted: Thomson Reuters.
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