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UBS House View
Monthly Base August 2017
Chief Investment Office WM
Published
Jul 20 2017
This report was prepared by UBS AG.
Please see the important disclaimer at the end of the document.
This document is a snapshot view. We update the tactical asset allocation
as changes occur and resend it to subscribers. For all other forecasts and
information, we advise you to check the Investment Views section in your EBanking or in Quotes.
1
Financial Market Outlook – short term (6 months)
Global Tactical Asset Allocation
Global earnings recovery supports
equities
Level in USD
•
500
28
450
27
400
26
350
25
300
24
250
23
Asset allocation
Global government bond yields rose after central bank statements appeared to become more hawkish, but ultimately most yields remained within
their respective ranges for the year. Our view is that central banks will tighten policy only very gradually. We expect the ECB to announce in
September an exit from its quantitative easing program next year, and the Fed to raise rates once more later this year. We maintain our risk-on
stance, with an overweight position on global equities against high grade (HG) bonds, and an overweight on Eurozone stocks against UK equities.
Global economic growth remains on a solid path, earnings trends are positive in all regions, while financial conditions remain easy and valuations
are not yet overly expensive.
•
Equities
We maintain our overweight position on Eurozone equities against UK stocks. We believe consensus expectations for UK corporate earnings growth
of about 20% this year are too high. The benefit from a weak pound should disappear by 4Q17, while the UK equity market is less sensitive to
global economic growth. We expect earnings growth of Eurozone companies to catch up with UK peers, supporting stock prices in the region. We
maintain an overweight position on global equities (and US high grade bonds) against euro high yield bonds (see below).
200
22
Jan-12 Sep-12 May-13 Jan-14 Sep-14 May-15 Jan-16 Sep-16 May-17
MSCI AC World (in USD, lhs)
MSCI AC World, 12m trailing EPS (rhs)
Source: Thomson Reuters, UBS, as of July 2017
•
We are closing our overweight on USD high yield (HY) bonds against HG bonds, as valuations have tightened and the upside for HY is limited
after the strong rally since early 2016. We think equities provide better risk-adjusted returns than credit at this stage of the business cycle. Euro
HY spreads remain at tight levels, and the yield-to-maturity is unappealing at 3.4%. We think the asset class is expensive, with an average price
of EUR 105 limiting price upside, and we see better value in a mix of global equities and HG bonds.
Real EUR index rate is still very
subdued
BIS trade-weighted exchange rate indices,
Eurozone, rebased (Jan-1999=100)
•
120
115
110
105
100
95
90
85
80
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Nominal Effective Exchange Rate Index, Broad
Real Effective Exchange Rate Index, Broad
Bonds
Foreign exchange
We are opening an overweight on the euro against the Swiss franc (CHF). The CHF is overvalued considering deeply negative interest rates and
rising expectations of ECB normalizing monetary policy. We are overweight on the Swedish krona (SEK) against the CHF; the euro against the
US dollar; and the Canadian dollar against the Australian dollar. Sweden's Riksbank should become more hawkish due to strong growth and
firming inflation. The euro's appreciation against the USD has further room to go, given the euro's undervaluation and the "catch up" potential
of Eurozone economic growth and monetary policy. The Bank of Canada is likely to become more hawkish this year, while the Reserve Bank of
Australia should remain on hold given the ongoing rebalancing of the economy.
Source: Macrobond, UBS, as of July 2017
Head CIO Global Asset Allocation Andreas J Koester, [email protected] or CIO asset class specialist Philipp Schöttler, [email protected] 2
Cross-asset preferences
Most preferred
Equities
Bonds
Foreign exchange
Hedge Funds
•
•
•
•
•
Global equities
•
•
Corporate hybrids
•
•
•
•
Model portfolios (EUR & USD)
Least preferred
•
Risk Parity Liquidity
2%
5%
UK equities
Eurozone equities
High grade
bonds
13%
Hedge Funds
18%
Eurozone value opportunities
US TIPS 2%
US share buybacks and dividends
US smart beta
US leveraged loans
SEK
EUR (
CAD
•
•
•
•
•
•
•
)
Developed market high grade bonds (
Replacing "well-worn" bonds
)
EUR
Equities US
12%
High yield
bonds
3%
EM bonds 4%
Euro high yield
CHF (
USD
AUD
The peak of the USD cycle
Equities others
5%
Equities EM
4%
Equities Europe
24%
)
Hedge Funds
18%
Risk Parity Liquidity
2%
5% High grade
bonds
11%
Navigating rising US rates with hedge
funds
US TIPS
4%
Precious Metals
& Commodities
USD
Equities US
21%
Recent upgrades
Inv. grade
corporate
bonds 8%
Recent downgrades
Equities Europe
13%
Inv. grade
corporate
bonds
8%
High yield
bonds
3%
EM bonds
4%
Equities others
6%
Equities EM
5%
As of 20 July 2017
Note: Portfolio weightings are for a EUR and a USD model
portfolio, with a balanced risk profile (including TAA). We expect
the EUR balanced portfolio (excluding TAA) to have an average
total return of 3.8% p.a. and a volatility of 8.2% p.a. over the
next seven years. We expect the USD balanced portfolio (excl.
TAA) to have an average total return of 5.4% p.a. and a volatility
of 8.1% p.a. over the next seven years.
3
Global tactical asset allocation
Tactical asset allocation deviations from benchmark*
underweight
neutral
Currency allocation
overweight
underweight
Liquidity
Equities total
neutral
overweight
USD
Global
US
EUR
Eurozone
UK
GBP
Switzerland
JPY
Japan
EM
CHF
Others
Bonds total
SEK
High grade bonds
Corporate bonds (IG)
NOK
High yield bonds**
EM sovereign bonds (USD)
CAD
EM corporate bonds (USD)
NZD
US TIPS
Duration overlay (USD)
AUD
Precious Metals & Commodities
new
old
Source: UBS, as of 20 July 2017
new
old
*Please note that the bar charts show total portfolio preferences, which can be interpreted as the
recommended deviation from the relevant portfolio benchmark for any given asset class and sub-asset class.
**Position includes an underweight in EUR HY.
4
CIO themes in focus
Equities
• Eurozone in style – Value opportunities
Solid economic growth and a moderate rise in inflation provide a suitable background for Eurozone "value" stocks to outperform the wider market, in our view. This is because value has a
cyclical sector bias, with a heavy weighting in financials. The relative performance of value tends to move in tandem with bond yields. We expect bond yields to move higher, driven by rising
US interest rates and the prospect of the European Central Bank tapering its bond purchases early next year.
• Profit from US share buybacks and dividends
US companies are generally in good shape: they generate high free cash flow, have plenty of cash on their balance sheets and enjoy low financing costs. The stock market should reward
investors in companies that return capital through dividends and share buybacks. These companies offer attractive yields in the current low-interest-rate environment. On average, S&P 500
companies returning cash to shareholders via dividends and/or share repurchases offer investors a total yield of about 5% (share buybacks plus dividend yields). Around two-thirds of this
yield come from share buybacks. Good free cash flow generation is a key factor for this theme, and more favorable corporate tax and cash repatriation rules under US President Trump may
boost cash returns to shareholders this year. As buybacks depend on management's discretion, we recommend investing in a diversified basket of stocks.
• US smart beta
Certain stock characteristics (momentum, quality, small capitalization, risk-weighting, value, and yield) have been shown to deliver long-term investment outperformance relative to a market
capitalization-weighted index. Combining these characteristics, known in the industry as smart beta, makes the investment less cyclical and creates a "passive-plus" solution. Smart beta's
compelling value proposition has resulted in a phenomenal growth in assets. Smart beta ETF assets have increased to over half a trillion USD and are growing at more than 25% a year.
Bonds
• Replacing well-worn bonds
Risk-free yields in many major developed markets are near or below zero. Even if rates remain unchanged, many short- to medium-term bonds would deliver negative total returns. Investors
who avoid negative yields and instead add longer-dated paper at a slightly positive yield often take an even greater risk, as seen in the recent correction. We think investors can preserve
wealth by taking profits on assets that will deliver negative total returns (exceeding the costs of switching out) in most likely scenarios. More attractive alternatives can be found on CIO's
bond recommendation lists.
• US loans – Attractive floating yield
US senior loans are an attractive alternative to more traditional fixed income segments, in our view. Loans provide exposure to the most senior part of a company's capital structure and are
often secured by the company's assets, leading to higher recovery rates than for bonds. Also, loans offer a floating coupon rate, which benefits from an increase in US short-term interest
rates. The current yield (to a three-year takeout) of roughly 5.5% is attractive. The 12-month trailing default rate is 1.5%, which we expect to trend sideways over the next 12 months. We
think US loans present an attractive investment opportunity for qualified investors who are comfortable holding less liquid asset classes.
• Yield pickup with corporate hybrids
Corporate hybrids are a niche segment in the corporate bond market. At current spread levels, they compensate investors with a suitable reward for assuming the risks associated with
them. We expect mid-single-digit percentage returns on selected instruments over 12 months.
5
CIO themes in focus
Liquidity & Foreign exchange
• The peak of the USD cycle
In recent years, the USD has been highly overvalued. US monetary policy was normalizing while ultra-expansionary measures in many other countries were still being introduced. The tide
is about to turn, in our view, as the laggard countries pick up the economic pace and close the gap with the US. A re-thinking and eventual tapering of ultra-loose policies in the Eurozone,
Sweden, Switzerland and the UK should help their currencies regain lost ground against the USD. Oil-producing nations' currencies depreciated markedly in 2014 and 2015, but with the
Canadian and the Norwegian economies reviving, we expect the CAD and the NOK to rise against the USD.
Alternative investments
• Navigating rising US rates with hedge funds
The US Federal Reserve has started to hike interest rates. Based on historical data, we find that most hedge fund strategies are resilient to rising interest rates, while high grade bonds have
performed poorly. Investors looking for an alternative to their high grade bond exposure should consider a diversified hedge fund portfolio characterized by low directional exposure to both
fixed income and equities.
This selection of themes is a subset of a larger theme universe. It represents the highest conviction themes of the UBS Chief Investment Office WM, taking into account the current market environment and risk-return
characteristics.
6
CIO longer term investment themes in focus
Equities
• Automation and robotics
Smart automation is powering the ongoing industrial revolution, combining the innovation capabilities of industrial and IT processes to fuel global manufacturing productivity gains. Rising
wages and challenging demographic developments will push up the costs of emerging market manufacturing companies, driving automation investment, in our view. Artificial intelligence
employed in machines should take automation to the next level. The smart automation industry's total annual revenue stands around USD 156bn today. We believe that over the cycle, the
sector can grow by mid-to-high single digits, with industrial software, robots and new trends – 3D printing market, artificial intelligence and drones – the clear outperformers.
• Digital data
Due to increased urbanization, the global digital universe is expected to expand 50-fold between 2010 and 2020. Rising global internet penetration from 44% in 2015 to around 66% in
2025 and strong data growth in emerging markets are key drivers. From an investment perspective, the theme offers solid long-term growth opportunities, as significant investment will be
required to manage and take advantage of the surge in data. Investors can participate by investing in either data enablers or data infrastructure companies.
• Energy efficiency
Energy efficiency covers wide-ranging issues with numerous characteristics and starting points for promising investment opportunities. Energy efficiency is gaining in importance around
the world thanks to government initiatives, while rising environmental pollution has led to greater worldwide awareness. The International Energy Agency expects the demand for energyefficient products to grow by 7–8% annually. Investment could reach USD 530bn in 20 years, up from USD 130bn in 2013.
• Security and safety
Security and safety touch lives everywhere, from governments securing infrastructure to enterprises protecting data and consumers trusting products as varied as baby food and fire alarms.
Several long-term drivers support the theme, such as urbanization, tighter regulation and growing consumer awareness about product quality, data security, environmental protection and
social responsibility. We think the addressable market is a defensive one that offers attractive growth rates in the mid- to high-single-digits over the next 5–10 years. We estimate its overall
size at around USD 560bn in 2016, and think it will exceed USD 700bn by 2020.
• Emerging market infrastructure
Spending on emerging market infrastructure will likely grow to USD 5.5trn by 2025 from USD 3trn today, bringing its share of global spending to two-thirds from half currently. Inadequate
urban and nationwide infrastructure acts as a bottleneck to economic growth, making infrastructure investment a national priority. A benign macroeconomic outlook for emerging
markets and stable to higher commodity prices will likely further support this spending. In the longer term, income growth driven by urbanization should raise demand for transportation
infrastructure through the consumption of goods (e.g. cars) and services (e.g. aviation) and the expansion of megacities.
This selection of themes is a subset of a larger theme universe. It represents the highest conviction themes of the UBS Chief Investment Office WM, taking into account the current market environment and risk-return
characteristics. The Longer Term Investment (LTI) theme series focuses on inevitable global trends, such as population growth, aging and urbanization, that create a variety of opportunities, with certain companies and
sub-sectors experiencing a higher-than-GDP rate of revenue growth. Here, we include a subset of a larger universe of LTI themes expected to offer good entry points for theme-oriented investors in the coming months
and highlight our preference for a diversified approach to themes.
UBS Chief Investment Office WM considers the highlighted themes as fitting the sustainability framework.
7
Key financial market driver 1 - Central bank policy
Key points
• Coordinated comments from members of the US Federal Reserve suggest that there is a very strong likelihood that the Fed will start
to reduce the size of its balance sheet (passive quantitative tightening) and increase interest rates once more before the end of 2017.
• The European Central Bank is expected to signal (cautiously) a desire to scale back its bond buying program, with incremental
changes in language hinting at that policy shift.
• The Bank of Canada has joined the list of central banks that are tightening policy. The Bank of England has been divided over
whether or not to raise interest rates this year. Within the G7, the Bank of Japan remains the sole voice of unambiguous policy
accommodation.
Policies tighten gradually
CIO view (Probability: 75%*)
• Members of the Federal Reserve have been relatively "on message" about near-term tightening. A further rate increase seems
likely in 2H17. The Fed has set out its intention to reduce the size of its balance sheet by not reinvesting all of the proceeds of
maturing bond holdings. This should begin in 2H17. Comments by Fed Chair Yellen have raised questions over the longer term
course of monetary policy (where the "neutral" interest rate lies), and this may be more of a focus for policy debate.
• The ECB continues to pursue its predetermined quantitative policy path, with bond buying staying at EUR 60bn. There has been
a subtle shift in the language of the ECB statement, and an announcement at the September ECB meeting that bond purchases
will taper in 2018 seems likely.
• The BoE is expected to leave policy unchanged, although disagreements within the monetary policy committee are likely to
continue. Other central banks have been more inclined to discuss policy with a bias to tightening rather than easing; this
coincidence of views more likely reflects the general improvement in global growth data rather than any overt coordination.
Real policy interest rates
Central bank policy rates less headline CPI measures
Source: Haver, UBS, as of 13 July 2017
The Fed prepares markets for further quantitative
tightening
Federal Reserve balance sheet, as % US GDP
Worsening macro backdrop
Positive scenario (Probability: 10%*)
• The Fed falls further behind the curve as inflation surprises higher, with real interest rates slipping more rapidly. The ECB launches
additional policy easing, reversing the language of recent public announcements and signaling a stronger emphasis on the
potential to ease policy further. The BoJ comes under pressure to engineer currency depreciation.
Macro risks fade
Negative scenario (Probability: 15%*)
• The inflation effect of a tighter US labor market leads to a stronger Fed response and a combination of tight monetary policy and
loose fiscal policy. Increased labor market costs and some commodity price pressures lead to higher European inflation, generating
early signs of a more rapid tapering of ECB quantitative easing.
*Scenario probabilities are based on qualitative assessment.
Key dates
Jul 26
Aug 3
Aug 18
US Federal Reserve policy meeting
Bank of England meeting and inflation report
US Federal Reserve meeting minutes
Source: Haver, UBS, as of 13 July 2017
US economist Brian Rose, [email protected], European economist Ricardo Garcia, [email protected] or UBS WM Global Chief Economist Paul Donovan, [email protected] 8
Key financial market driver 2 - Political risks
Key points
• Political uncertainty continues to be a feature in the media, with the focus on the US administration (and its legislative agenda) and
the stability of the British minority government as it negotiates with the European Union. Declining approval rates for the Japanese
government and the prospect of Italian elections in the coming months also attract interest.
• International politics is adding to the uncertainty, with Syria (and its broader implications) and North Korea both focal points. The
situation with Qatar is also of interest given its importance in energy markets. Markets are not especially focused on any of these
risks at the moment, however.
• Domestic investors tend to understand local politics better than foreign investors. Market reactions to political risk will therefore
depend on the domestic-foreign mix of investors. The higher the foreign ownership, the greater the risk of overreaction to political
noise. The dollar's reaction to US political risk is an example of this.
CIO view (Probability: 70%*)
• Political uncertainty still has a high profile in the media, but still has relatively limited impact on financial markets. Only very
significant events with the potential to change the medium term outlook are likely to impact asset prices in a meaningful way.
• Investor focus in the US is less on legal debate about the Russian question, and more on the potential for legislation to
be delayed by the political distraction that the issue creates. President Trump's political capital (and ability to pursue the
administration's legislative agenda) is also in focus.
• The economic causes of anti-establishment politics remain. The market may turn complacent about the economic drivers of
inequality. Local elections in Tokyo reminded investors that anti-establishment politics remains a feature of the global political
scene.
• Syria, Qatar and North Korea remain the key international political risks for the near term. North Korea has assumed greater
prominence, but markets are unlikely to attribute any meaningful probability to disaster scenarios.
Interest in political events
Google Trends, index of global search request for three
key political issues
Source: Google Trends, UBS, as of 17 July 2017
Markets tend not to react too much to political
noise
North Korea and the South Korean KOSPI equity index
Positive scenario (Probability: 10%*)
• The sharp improvement in labor market conditions for low-skilled workers leads to wage increases that either are accompanied
by better credit access or compensate for the loss of credit access since 2008; this eases income and consumption inequality.
Governments and economists successfully communicate the net economic benefits of global trade and diversity.
Negative scenario (Probability: 20%*)
• Nationalist tendencies are encouraged by single-issue politics and social media. Traditional party structures fail to address the
demands of large sections of the electorate, encouraging populism. Political outcomes are increasingly unpredictable as opinion
polls offer less and less guidance. Established parties adopt populist policies, raising uncertainty about mainstream policy programs.
Lower income groups' standards of living are hurt by populist policies and rising food and energy prices, fueling further demands
for radical and unpredictable change.
*Scenario probabilities are based on qualitative assessment.
Key dates
Sep 24
Oct 1
German federal election
Proposed Catalan independence vote
Source: Bloomberg, press reports, UBS, as of April 2017
Global Chief Economist, UBS WM Paul Donovan, [email protected] 9
Key financial market driver 3 - Solid US earnings growth
Key points
• US earnings growth remains solid
• The Trump administration's policies may boost EPS further.
• High profit margins are likely to be sustained.
15%
0%
-5%
S&P 500
*Scenario probabilities are based on qualitative assessment.
Key dates
Jul 26
2Q17E
S&P 500 ex energy
Source: FactSet, UBS, as of 13 July 2017
Easier lending standards point to continued
earnings growth
S&P 500 EPS growth vs. bank lending standards for
commercial & industrial loans (advanced 9 months)
60%
-90
Credit standards easing
40%
-60
20%
Trump's policies boost earnings more than expected
Positive scenario (Probability: 20%*)
• The Trump administration's policies, especially corporate tax reform, generate faster profit growth. Higher interest rates and
deregulation further boost financial sector earnings. Investment spending picks up.
Downturn in sentiment
Negative scenario (Probability: 20%*)
• Trade and geopolitical tensions flare up as a result of the Trump administration's policy priorities, depressing business and
consumer sentiment. Wage pressures, without improving consumer and business demand, may hurt profit margins and earnings
growth rates. Persistently low short-term interest rates and renewed declines in long-term interest rates may pressure financial
sector earnings.
1Q17
4Q16
3Q16
2Q16
1Q16
4Q15
3Q15
-10%
2Q15
slower pace for the rest of the year. For 2Q17, we expect growth of 9–10%. The healthy profit environment is underpinned
by solid US consumer spending, a rebound in US manufacturing activity as energy investment spending and emerging market
demand bottom out, and a more favorable environment for financials. Leading indicators of profit growth, such as bank lending
standards, remain supportive.
• The Trump administration's policies may further boost earnings growth through lower taxes (corporate, individual, and the
repatriation of overseas cash), infrastructure spending, less regulation, and a steeper yield curve (which benefits banks).
However, many details have yet to be worked out, and we do not expect any tax reform legislation until 4Q, at the earliest.
Overall, these policies could boost earnings by 5–15% over the next few years, with the bulk of the benefits stemming from
corporate tax reform (~10%).
• We estimate S&P 500 EPS of USD 132.50 (11% growth) for 2017, and USD 145 (9% growth) for 2018. These estimates include
USD 2.50 (for 2017) and USD 5 (for 2018) in tax reform benefits. The prospects for tax reform remain uncertain. Therefore, our
estimates include roughly half of the expected benefits from tax reform. If tax reform succeeds, EPS should reach USD 150 by
2018.
• Fears that high profit margins will decline in the near term appear overblown. Margins are not higher than normal, excluding
the tech sector. Also, margins typically only decline when the economy enters a recession. Finally, the recent pickup in wages is
unlikely to crimp profitability. Labor costs do not have a strong correlation with profit margins.
5%
1Q15
• After rising at the fastest pace in six years in 1Q17 (+15%), earnings growth should remain strong, although at a slightly
10%
4Q14
Earnings growth reaches "cruising altitude"; Trump policies
may provide a further boost
3Q14
CIO view (Probability: 60%*)
Earnings growth remains healthy, but is
moderating from 1Q17
S&P 500 earnings per share growth
-30
0%
0
-20%
-40%
30
60
Credit standards tightening
-60%
1990
1995
2000
2005
2010
2015
90
2020
S&P 500 EPS y/y (left)
Senior loan officer survey (right, inverted)
Source: Bloomberg, UBS, as of 13 July 2017
peak of 2Q17 earnings season
CIO strategists Jeremy Zirin, [email protected], David Lefkowitz, [email protected] or Edmund Tran, [email protected]. 10
Global economic outlook - Summary
Key points
• Global growth remains around trend, with data generally being revised higher after initial release. Sentiment is more positive than
economic reality would warrant, in our view, but we see evidence of sentiment data starting to converge with reality.
• Inflation data has largely completed the oil-induced reversion to long-term trends. Movements in inflation around these long-term
norms now tend to reflect local, technical factors.
• The Fed will likely raise interest rates once more this year following the two earlier rate increases, and start to reduce its balance
sheet in the second half. We expect the ECB to announce it will taper its balance sheet in 2018.
Global growth remains around trend
CIO view (Probability: 70%*)
• The global economic cycle remains around trend. Strong labor markets support household incomes and spending, although the
data must be interpreted with care. (Because of how they are calculated, average earnings could fall even if everyone employed
had a pay increase.)
• Improving global trade signals broad-based growth in demand, and we would view any moderation in sentiment as a
normalization from excessive levels, not a sign of economic deterioration.
• Inflation rates are now more visibly being influenced by local, largely technical factors. Central banks are likely to look through
this noise to focus on medium-term inflation trends, hence the more hawkish language from the Fed and the Bank of England,
and the increase in interest rates in Canada.
• We expect the Fed to raise interest rates once more this year. Real rates, adjusted for consumer price inflation, are unchanged
from early 2016. We also expect the Fed to begin to reduce its balance sheet. The ECB is likely to continue its current pace of
asset-buying (EUR 60bn a month) and negative interest rate policy, though it may use its September policy meeting to signal that
further quantitative tightening will start next year.
Positive scenario (Probability: 20%*)
Trend-like growth, normal inflation
Source: UBS, as of 13 July 2017
Forecasts and estimates are current only as of the date of this
publication, and may change without notice.
Global trade – another all time high
Real global trade as % of real global GDP
Growth exceeds expectations
• European growth surprises positively, with better labor markets and a more stable banking system that is more willing to lend. Initial
US economic growth data continue to be revised higher, and labor market shortages increase household incomes and consumer
demand at a faster pace than expected.
• Emerging markets see stable domestic demand, and higher commodity prices coupled with consumer demand in developed
economies support export sectors. Protectionist threats from the US are narrowly focused as political reality overcomes campaign
rhetoric.
Political damage to growth
Negative scenario (Probability: 10%*)
• US consumers suffer lower real disposable incomes as domestic inflation pressures increase via the tax effect of trade protection.
Eurozone growth weakens as bank lending reverses.
• Credit growth suffers as capital flows are disrupted and uncertainty undermines normal bank lending.
Source: UBS, as of 13 July 2017
*Scenario probabilities are based on qualitative assessment.
Key dates
Jul 26
Aug 4
Federal Open Market Committee meeting
US employment report
UBS WM Global Chief Economist Paul Donovan, [email protected] 11
US economy - Moderate growth in the US
Key points
• We expect the US economy to grow at a moderate pace over the next 12 months.
• Inflation should gradually trend higher as the recovery continues.
• We expect the Fed to gradually raise rates and to begin shrinking its balance sheet.
PMIs consistent with moderate growth
Purchasing managers' indices (PMIs)
60
50
Moderate expansion
CIO view (Probability: 70%*)
• We expect the US economy to grow at a moderate pace over the next 12 months. The labor market is still improving, with the
unemployment rate at 4.4% and signs that labor shortages are becoming more widespread. Rising household income should
enable robust consumer spending.
• Housing starts and home prices should remain on an upward trend, contributing modestly to overall economic growth.
• Energy sector fixed investment has bottomed and the manufacturing sector has shown improvement in recent months. Overall
investment should grow at a moderate pace.
• The most recent data shows inflation slowing, but we expect a gradual upward trend in the quarters ahead. A tight labor market
and rising producer prices will eventually feed through into consumer price inflation.
• Political uncertainty is high and is threatening to become a drag on growth. We expect a fierce fight over the FY18 budget
this fall. Deregulation should provide some benefit over time. We do not expect the Trump administration to cause any severe
disruptions to trade.
• The Fed hiked by 25 basis points on 14 June and we expect another 25bps of tightening by the end of this year. The Fed will
also begin gradually shrinking its balance sheet.
Strong expansion
Positive scenario (Probability: 15%*)
• US real GDP growth moves above 2.5%, propelled by accommodative monetary policy, looser fiscal policy, strong household
spending, and subsiding risks overseas. Inflation hits the Fed's 2% target earlier than expected, leading the central bank to raise
rates at a faster pace.
Growth recession
Negative scenario (Probability: 15%*)
• US growth stumbles. Political uncertainty and tighter financial conditions weigh on business investment and consumer spending.
The Fed stays on hold.
*Scenario probabilities are based on qualitative assessment.
Key dates
Jul 26
Jul 28
Jul 28
Aug 4
40
30
2007
2009
Manufacturing
2011
2013
Non-manufacturing
2015
2017
Source: Bloomberg, UBS, as of 13 July 2017
Inflation slowdown should be temporary
US headline and core PCE price index, year-on-year in %
5
4
3
2
1
0
(1)
(2)
2007
2009
2011
PCE price index y/y
2013
2015
2017
Core PCE price index y/y
Source: Bloomberg, UBS, as of 13 July 2017
PCE = personal consumption expenditures
FOMC rate decision
GDP for 2Q17
Employment Cost Index for 2Q17
Labor report for July
US economist Brian Rose, [email protected] 12
Eurozone economy - Short-term tailwinds to abate
Key points
• We expect economic growth to remain resilient, but to lose momentum during the year.
• Inflation should consolidate for the remainder of the year.
• The ECB is expected to reduce QE bond purchases from January 2018 onwards.
Eurozone growth expected to top out
Better-than-expected growth
Positive scenario (Probability: 25%*)
• The global economy reaccelerates and the euro weakens more than expected. Eurozone loan demand and the economy recover
faster than envisaged. Political risks fade.
Disinflationary setback
Negative scenario (Probability: 15%*)
• The Eurozone suffers a disinflationary setback as Greece leaves the Eurozone, Brexit talks fail, markets fear a Five Star Movementled government in Italy, the Ukraine conflict escalates, or the Chinese economy suffers a severe downturn.
*Scenario probabilities are based on qualitative assessment.
Key dates
Jul 24
Jul 27
Jul 31
Jul 31
PMI for July
M3 money supply for June
Unemployment rate for June
CPI for July
5
110
3
100
1
90
-1
80
-3
70
-5
60
-7
97 99 01 03 05 07 09 11 13 15 17
Consumer Confidence index (lhs, re-scaled)
Economic Confidence index (lhs)
Real GDP (rhs, y/y growth in %)
Source: Haver Analytics, UBS, as of June 2017
ECB balance sheet boosted by QE and TLTROs
Total assets in national currency (index: 2007=100)
800
Index (Jan 2007=100)
Short-term tailwinds to abate
CIO view (Probability: 60%*)
• We expect economic growth of close to 2%, and inflation to consolidate and average at 1.5% for 2017. However, the economy
is likely to lose some steam over the course of the year as the euro strengthens, the anticipated rise in oil prices bites into
consumption, and the effectiveness of monetary policy diminishes. We expect the ECB to announce in September its intention to
wind down the QE program over 6–9 months starting January 2018.
• In Germany, fundamentals such as consumer confidence, construction, and capital-expenditure planning remain robust, but the
anticipated rise of the euro should limit this year's economic growth potential. We see a 60% chance for a grand coalition, and
a 75% chance of Merkel retaining the Chancellery. In France, a healthier construction sector and more corporate investment,
given a business-friendly government, should help accelerate economic growth this year.
• Italian economic growth should consolidate at low rates, supported by a stabilizing construction sector. We expect a general
election in early 2018. Spain is still posting strong growth, but the momentum is likely to moderate.
120
600
400
200
0
07
09
ECB
11
Fed
13
BoJ
15
SNB
17
Source: Haver Analytics, UBS, as of June 2017 (SNB as of May 2017)
CIO European economist Ricardo Garcia, [email protected] 13
Chinese economy - The balancing act continues
Key points
• China continues to strike a balance between stability and deleveraging.
• Monetary policy is more flexible than claimed, in our view, and fiscal policy remains supportive.
• CPI inflation is likely to stay below 2%, and PPI inflation should moderate further in 2H17.
June new loans rebounded as tightening policy
moderated
3,500
3,000
Smooth 1H but challenging 2H
CIO view (Probability: 90%*)
• Growth momentum moderated in 2Q after peaking in 1Q. The economy will likely face more challenges in 2H17 as the property
market cools and infrastructure investment moderates.
• Regulatory tightening has eased since the central bank increased liquidity via open market operations and the lending facility
in May, and after the banking regulator granted banks a longer period for self-check and improvement. As a result, liquidity
stabilized, market rates moderated, and credit recovered. We expect tightening to continue but at a milder pace, and policy
coordination to be emphasized.
• Fiscal policy is likely to remain supportive this year. Local government infrastructure spending remains an important buffer to
maintain economic stability, and public-private partnerships are likely to remain an important investment vehicle in 2017, but at
a slower pace.
• We expect consumer price inflation to remain below 2% and producer price inflation to moderate further in 2H17. Consumer
inflation stayed subdued at 1.5% in June, while PPI inflation stood at 5.5% as commodity prices fell and manufacturing activity
moderated.
• Fixed-asset investment growth in the January–May period slipped to 8.6% year-on-year from 8.9% in January–April, dragged by
slowing property and infrastructure investment. Retail sales growth remained resilient at 10.7% year-on-year in May.
• We expect Chinese exports to rebound to a single-digit growth rate this year as global growth recovers. Exports rose 8.5% in
1H17 after falling 7.7% in 2016.
• China's international reserves are likely to end the year around USD 3trn. Concerns about large capital outflows have eased as
reserves have risen every month since February.
Growth acceleration
Positive scenario (Probability: 5%*)
• Chinese GDP growth exceeds 7% this year thanks to government stimulus packages and/or a major pick-up in external demand.
Marked growth downturn
Negative scenario (Probability: 5%*)
• A marked growth downturn, defined as sub-6% real GDP growth for more than two quarters, stems from plunging investment
accompanied by widespread credit defaults.
* Scenario probabilities are based on qualitative assessments.
Key dates
Jul 27
Jul 31
2,500
2,000
1,500
1,000
500
0
03/15
06/15
09/15
12/15
03/16
New household loans (CNY bn)
06/16
09/16
12/16
03/17
06/17
New non-financial corporation (CNY bn)
New social financing (CNY bn)
Source: CEIC, UBS, as of 13 July 2017
Market rates stabilized after liquidity injection by
PBoC
5.0
3.7
4.5
3.6
4.0
3.5
3.5
3.4
3.0
3.3
2.5
3.2
2.0
01/17
3.1
02/17
03/17
04/17
05/17
06/17
7-day repo rate (%, LHS)
10-year government bond yield (%, RHS)
07/17
Source: Bloomberg, UBS, as of 13 July 2017
Industrial profits for June
Manufacturing and non-manufacturing PMIs for July
CIO China economist Yifan Hu, [email protected] or CIO analyst Kathy Li, [email protected] 14
Swiss economy - Hard data does not (yet) live up to soft data
Key points
• Swiss GDP growth may accelerate slightly this year compared to 2016. A more broad-based growth across sectors will help the
labor market recover. We expect GDP to return to trend growth in 2018.
• Uncertainty stemming from US politics and Italian elections remain a risk, but overall risks have clearly diminished after the election
of Emmanuel Macron as the new French president.
• After the French elections, pressure on the Swiss franc eased significantly, and the SNB was able to reduce its FX interventions.
Nonetheless, a rate hike is not in the cards until mid-2018, in our view.
Soft data outpacing hard data
Swiss manufacturing PMI and GDP growth y/y (in %)
6%
5%
4%
3%
2%
1%
Moderate recovery
CIO view (Probability: 60%*)
• The manufacturing PMI jumped above 60 in June, pointing to a healthy pick-up in economic activity.
• However, Swiss hard data does not (yet) live up to the strong soft data from sentiment indicators or to the upbeat European data
points. GDP grew only 0.3% in 1Q17.
• We foresee GDP growth of 1.4% in 2017. The recovery may broaden, but it is not likely to accelerate strongly. We expect GDP
growth to return to trend (1.6%) only in 2018.
• Employment grew slightly in 1Q17 and unemployment fell further in May. As the recovery broadens in the coming quarters, the
unemployment rate is likely to fall to 3.2% in 2017 from 3.3% last year.
• CPI inflation rose by 0.2% year-on-year in June as the base effect from oil prices fades out. However, we expect inflation to
average 0.4% in 2017, supported by a weaker franc in the second half of the year.
• Before the French presidential elections, the Swiss National Bank (SNB) intervened heavily in currency markets to prevent a strong
appreciation of the CHF. It has since reduced its interventions as Emmanuel Macron's victory tempered risk aversion and in turn
stopped further inflows into Switzerland. Nonetheless, a rate hike is not in the cards until mid-2018, in our view. We think the
SNB will not raise rates before the ECB slows down its bond purchases.
0%
-1%
-2%
-3%
-4%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Real GDP growth y/y
Forecast for real growth y/y based on 3m average of Swiss PMI
Source: procure.ch, UBS, as of 13 July 2017
SNB FX interventions eased after Macron's election
Weekly change in sight deposits of banks at the SNB in
CHF m
7
6
Eurozone growth boosts Swiss growth
Positive scenario (Probability: 25%*)
• A further drop in Eurozone unemployment fuels positive sentiment in the region, in turn supporting Swiss exports. Compared with
upbeat European growth, Switzerland exhibits some catch-up potential.
Downturn of Swiss economy
Negative scenario (Probability: 15%*)
• Protectionist measures from the new US administration trigger a slowing of global trade, hurting Swiss exports. Political risks in
Italy, where elections are pending, remain in place.
* Scenario probabilities are based on qualitative assessment.
Key dates
Aug 1
Aug 2
Aug 7
Aug 8
5
4
3
2
1
0
-1
-2
PMI manufacturing for July
SECO consumer confidence for 3Q
CPI for July
Unemployment for July
-3
Jan-16
Brexit
Apr-16
Jul-16
US elections
Oct-16
Jan-17
French
elections
Apr-17
Jul-17
Source: SNB, UBS, as of 13 July 2017
CIO Swiss economists Alessandro Bee, [email protected] or Sibille Duss, [email protected]. 15
Contact List
Global Chief Investment Officer WM
Mark Haefele
[email protected]
UBS CIO WM Global Investment Office
Global Asset Allocation
Andreas Koester
[email protected]
UHNW & Alternatives IO
Simon Smiles
[email protected]
Investment Themes
Philippe G. Müller
[email protected]
UBS CIO WM Regional Chief Investment Offices
US
Mike Ryan
[email protected]
APAC
Min Lan Tan
[email protected]
Europe
Switzerland
Themis Themistocleous
Daniel Kalt
[email protected] [email protected]
Emerging Markets
Jorge Mariscal
[email protected]
16
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