Domino effects - Nordea Asset Allocation... · • For now, upside in risk assets seems capped by...

Domino effectsGlobal Asset Allocation StrategyFebruary 2019

Investments │ Wealth Management

This material was prepared by Investments |

EQUITY STRATEGY: Take profits in EM

FIXED INCOME STRATEGY: Underweight HY bonds

• Equity markets are currently rebounding, after the major

correction we saw in December. Policies, most importantly the

U-turn from Fed, has been very helpful and might break the

negative domino effects from the correction in Q4.

• Markets are already pricing in a lot of bad news after the sell-off,

which is why we continue to see strong performance at the same

time as almost all key data keeps disappointing.

• Global growth still seems decent and earnings are still growing,

but the negative trend in both needs to stop for this to become a

sustainable rally. We keep neutral weight in equities.

KEEP EQUITIES NEUTRAL

February 2019

• We take profit from our EM overweight and Europe underweight,

which has done quite well, bringing our regional allocation to

neutral.

• The valuation and earnings advantage of Emerging Markets has

waned, while we see risks tilted to the upside in Europe.

• We stay conservative within the bond portfolio and keep HY

bonds in underweight and government bonds in overweight.

• We expect modest returns from bonds in 2019, even though

more cautious central banks are currently supportive for bond

markets.

Domino effects


Market performance & recommendations

Equity markets are rebounding after the selloff in December

Current allocation Previous allocation

ASSET ALLOCATION - N + Comments

Equities

Fixed Income

EQUITY REGIONS - N +

North America

Europe

Japan

Asia excl. Japan

Latin America

Eastern Europe

Denmark

Finland

Norway

Sweden

EQUITY SECTORS - N +

Industrials

Cons Discretionary

Cons Staples

Health Care

Financials

IT

Comm. Services

Utilities

Energy

Materials

Real Estate

BOND SEGMENTS - N +

Government

Investment Grade

High Yield

Emerging MarketsSource: Thomson Reuters / Nordea


But the pace is likely to remain decent on aggregate

Growth outlook facing headwinds

Source: Thomson Reuters / Nordea

DM growth slowing down vs. EM


• The global economic growth is facing headwinds. However, the pace is likely to remain decent and the markets have already priced in notable weakness.

• Estimates now point to above-potential expansion, but they normally fall further during the year. Overall, risks are tilted to the downside.

• We do not expect a global recession, meaning sub-2.5% growth. However, we are in a downturn, which makes navigating the financial markets harder.

Estimated earnings are downgraded with speed

Earnings on the path to normalization, and with speed


Earnings growth normalizing


• 2018 earnings will be approx. 15%, but the more important question is if earnings will continue to grow in 2019. We think so, but at a much lower rate.

• Top-line growth will continue to get some support from consumption and investments, although margin pressure might start to take its toll on earnings.

• Worryingly, estimated earnings are falling rapidly. If the speed of downgrades continues, we will soon be in a earnings recession (if analysts are correct).

Wage growth and financing cost should take its toll

Wages, financing cost and slower economic growth could weigh on margins


Margins normally correct in recessions, or due to external shocks


• Earnings are revised down by the minute. One reason is the potential margin pressure, though we seldom see margins fall rapidly outside recessions.

• Higher wage growth, financing costs, and the strengthening of the USD last year are the most important factors that has potential to pressure margins.

• However, top line growth and pricing power should keep margins high, ergo our main scenario is low single digit earnings growth, but no recession.

The stellar earnings growth is not only due to tax cuts

The last strong US earnings season for now


Impressive US earnings


• Q4 earnings are on the path to grow over 14% y/y in the US. Fundamentals are solid, however tax cuts are still boosting earnings with ca. 8-10%-pts.

• Negative effects from the tariff dispute or dollar strengthening are unlikely to affect Q4 earnings in a material way, though there will be some drag.

• The sales growth rate is so far 5,6%, meaning the contribution from organic growth is considerable. All in all, so far a mixed earnings season in the US.

…but China is leaning against the wind latelyDriven by Fed, major balance sheets are contracting Y/Y…

• Policy rates: Fed pushed the pause button, fuelling a come-back for risk appetite YTD. ECB hikes are still a long shot, and PBoC is easing.

• Balance sheet: With max quantitative tightening in the US and balance sheet expansion in China, major balance sheet growth is getting less negative.

• Bottom line: Monetary headwinds could be peaking, but we don’t expect it will be the main driver for the next 6m.

Monetary headwinds are moving closer to a peak

Source: Thomson Reuters / Nordea Source: Thomson Reuters / Nordea

…but recession risks have already risen substantiallyLast call? Fed pausing to prevent recession risks…

• Where 2018’s market focus was about monetary tightening per se, 2019 might be about its lagged effects and, hence, center around real growth concerns.

• Is the Fed’s U-turn timely enough to prevent a more severe downturn? We know that monetary policy affects the real economy with a significant time lag.

• The rate hikes already seen are pointing towards an inverted curve, normally a necessary but not necessarily sufficient condition for a US recession.

The key question is, whether damage already is done


…with tighter credit conditions a potential catalyst worth monitoringFinancial conditions could mean further downside risk for growth...

• For now, upside in risk assets seems capped by slowing economic momentum and therefore the lagged effect of last year’s monetary tightening.

• The downside, on the other hand, seems capped by Fed’s renewed dovishness.

• Domino effect is key: Tighter financial conditions could mean tighter credit conditions, higher funding cost, lower growth, putting more pressure on markets.

Watch out for domino effects


Latest observation

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ISM Manu. New orders, USA (rhs) US financial conditions (GS Index), Y/Y


Brexit has so far not affected UK equities more than rest of EuropePolitical noise in US hurt consumer confidence

Politics is adding to the noise


• Even though government is (temporary) reopened, the political noise in the US is weighing on consumer confidence, which could start weigh on economy.

• The trade spat between US and China is on idle for the moment, but the deadline of March 1st is approaching. We think some kind of deal will be struck.

• In Europe, Brexit is in focus. So far, UK assets have done OK, but if the outcome becomes a hard Brexit that will probably change.



Equities are far from expensive

Global equities are already pricing in slower growth


Equities are priced below long-term average

• Global equities has derated close to 20% since January 2018, due to extremely strong earnings growth and negative equity price development.

• Weaker cyclical outlook, higher bond yields and outright recession fears are among the reasons for the derating.

• The derating can continue, but then equites would start to price in an economic recession, and we do not think a recession is likely in 2019.


USD get medium term support from US macro supremacy… …but stretched positioning will dampen the appreciation pressure

Economic divergence continues to set the scene for USD


• Despite slower US growth, macro divergence between US and the rest of the world is still overall supportive for the US Dollar…

• …trumping Fed’s newfound patience. On the other hand, still stretched positioning will dampen the appreciation pressure.

• This should lead to weaker EUR, supporting European exporters. EM liquidity, on the other hand, continues to be an issue despite PBoC easing.


As the markets, sentiment has bounced backVolatility lower, but at a (permanently?) higher level

Sentiment neutral with downside risks


• Along with markets, sentiment followed the bounce and is now around neutral levels. But as always, the devil is in the details.

• As the technical side was deeply oversold at the end of December, it’s now approaching overbought territory, meaning short term pull-back risk is higher.

• Volatility has also subsided, but at a high level, indicating that the market worries hardly are over. We expect sentiment to be jittery going forward.

Massive growth in IG debt, and worryingly in the lower rating classes

• The size of the US IG market has grown massively since the financial crisis, as the expansion and easy money have incentivized companies to lever up.

• The growth has been heavily skewed to the lower quality in IG, and the share of BBB is now 50% of total IG market, which increases the risk to investors.

• Not all drivers behind this are bad ones, but if the growth environment worsen and we enter a new downgrade cycle it will be more negative than normal.

US corporate debt growing fast


Corporate debt almost on pre financial crisis level


Fed ignited a rally in spreads

Spread tightening in risky bonds after Fed ignited a rally


Big differences in yield levels

• January has delivered a great rally in risky bonds, as sentiment improved when Fed eased their communication concerning coming rate hikes.

• However, global growth outlook remains murky, and tightening financial conditions weigh on outlook for HY. Hence we keep the defensive tilt in bonds.

• We expect modest returns from bond markets going forward, although more cautious central banks are currently supportive of bond markets.


…but their earnings outlook is deteriorating

Take profits on a winning EM equity bet


EM equities have outperformed clearly since October…


• We take profits from our EM overweight and Europe underweight, which has done quite well, bringing our regional allocation to neutral.

• Both the valuation and earnings advantages of Emerging Markets have waned while the region has continued to outperform Europe.

• Europe, for its part, is a heavy underweight among investors and much political noise is already priced in. Hence, risks are tilted to the upside.


Neutralize the cyclical tilt

Neutralize the cyclical tilt – increase Health Care

Defensives in the lead during the selloff


• Without going outright defensive in the sector strategy, we take a relative bet within the defensive sectors by reducing IT and raising Health Care.

• We reduce the weight in IT-sector to neutral, given the weaker earnings outlook and weaker guidance from leading companies like Apple and Samsung.

• Among the defensive sectors Health Care looks fundamentally most attractive and is typically a good late-cycle performer.

Sector Recommendation Relative weight

Industrials Neutral -

Consumer Discretionary Neutral -

Consumer Staples Underweight -2%

Health Care Overweight +2%

Financials Neutral -

IT Neutral -

Communication Services Neutral -

Utilities Neutral -

Energy Neutral -

Materials Neutral -

Real Estate Neutral -


February 2019

EQUITIESNEUTRAL

• We take profits from our EM overweight and Europe underweight,

which has done quite well, bringing our regional allocation to neutral.

• Both the valuation and earnings advantage of Emerging Markets has

waned while the region has continued to outperform Europe.

• Europe is a heavy underweight among investors and much political

noise is already priced in. Hence, risks are tilted to the upside.

• .

NEUTRAL ACROSS THE BOARD

The long rally has been particularly strong in North America



Equity regions │ Returns (in SEK)

Total return 115% 97,8% 17,2%

Ann. Return 8,0% 7,1% 0,9%

SAA EXCESSTAA


Equity regions │ February 2019

USA Neutral

- Earnings outlook is deteriorating rapidly

- Valuation is the least attractive among

equity regions

- Extended dollar positioning is the key

near-term risk

Recommended weight 40%

Neutral weight 40%

Europe Neutral

- Economic growth waning and earnings

likely to follow

- Too much political noise and economic

weakness already priced in, and valuation

is the most attractive among regions

- Monetary conditions remain supportive


Neutral weight 25%

Sweden Neutral

- Industrial sector facing some headwinds

from the slump outside the US

- Earnings still healthy, no signs (yet) of

trade-related issues

- Economy doing fine but could be

negatively impacted by higher rates


Neutral weight 15%

Japan Neutral

- Earnings outlook worse than elsewhere

but not deteriorating as rapidly

- Valuation is attractive and monetary policy

supportive

- The link between yen and equity markets

means more muted return prospects


Neutral weight 5%

Emerging Markets Neutral

- Earnings outlook is weakening together

with the rest of the world

- Slower economic and trade growth are

concerning, but supporting policies from

China will help

- Valuation no longer a clear support


Neutral weight 15%

Asia excl. Japan – Neutral


Neutral weight 10%

Eastern Europe – Neutral


Neutral weight 2%

Latin America – Neutral


Neutral weight 3%


USA │ Clouds gathering around the outlook

…and valuation is extended in comparison


US earnings outlook deteriorating rapidly…


• Last year’s support from strong earnings and economic growth is fading rapidly. A particular concern is the deterioration in the heavyweight sector, IT.

• Valuation remains stretched compared to peers, putting added pressure on the US in a wobbly market.

• Trade war will weigh on all equity regions, but the US is likely to lose the least if things deteriorate. Put together, we prefer a neutral weight.


Europe │ Raise to neutral on very sceptical positioning

PMI’s have continued to weaken and signal significantly lower growth


Lower political risk, but equities are still pricing in bad news


• Despite leading indicators signalling further disorientation of the growth picture, and earnings estimates seem to high, we raise Europe to neutral .

• ECB members have now changed their language accordingly and political risks have eased. Brexit will still take headlines, but not likely affect EU equities.

• With investors being very sceptical on European assets, we start to see performance risk and therefore raise European equities to neutral.


Finland │ Good value and earnings mean great prospects

…and the usual valuation premium is goneFinnish earnings set to outpace peers…

• We upgrade Finnish stocks to overweight on the back of a strong earnings outlook, great dividends and attractive relative valuations.

• Finnish stocks got more than their share in the Q4 sell-off, priming them for a rebound. However, some of this has already taken place.

• Although there is a risk that analysts have not fully appreciated the impact of the global slowdown, this risk is no more pronounced than in Europe.



Denmark│ Tactical outlook balanced, but more positive given the sector composition

Despite fluctuations the relationship holds up well


A stronger dollar tends to support Danish companies earnings


• Danish stocks have underperformed global stocks during the January risk-on move despite earnings revisions being in favor of Danish stocks.

• Valuation remains a headwind but given shifts in FX and earnings momentum is a positive. We await the earnings season to confirm a possible trend shift.

• We stick to a neutral position for Danish stocks, though we are slightly more positive on the sector level given large share of in Health Care in the index.


Norway │ Valuation is back to neutral, and outlook is balanced

Norwegian equites are no longer expensive


Violent turn from support to headwind from oil prices


• Oil prices has been a tailwind so far this year, but as the outlook is mixed, the support could fade.

• The outlook for the Norwegian economy is solid and will support earnings growth, however we don’t expect positive effects from weaker NOK this year.

• Valuation has turned from very stretched to fair. The outlook for Oslo Børs is balanced, and we remain a neutral weight.


Sweden │Still a challenging environment for industrials

Swedish equities lagging behind global


Industrial-heavy Sweden is dependent on the global momentum


• As previously flagged for, the EZ manufacturing slump and weaker Chinese data has weighed on Swedish industrials

• The recent bounce in Swedish industrials appears premature given the worsening Chinese industrial cycle, stay Neutral

• The Swedish economy is doing well, but the housing sector remains a risk, and could continue to weigh on the large banking sector


Emerging Markets │ Downgrade to neutral – weaker Chinese cycle will weigh on EM earnings

Brazilian equities are pricing in too much economic improvement


Chinese slowdown add pressure on already weakening EM exports


• EM earnings are highly correlated with EM exports. Both should come under increased pressure as the Chinese import cycle deteriorates further.

• US-China trade deal remains an upside risk, but any sentiment boost should be short-lived. The global trade slowdown is not caused by the trade conflict.

• Driven by Bolsonaro optimism, Brazilian equities have made a classic overshoot relative to economic fundamentals. Downgrade EM to neutral.


Japan │ Uninspiring story, triggers needed (and few are on the horizon)

Earnings are also sluggish, a weaker yen could help


Growth had a terrible Q3 and prospects for 2019 are bland


• Growth is trailing off to some extent with pressure form both investments, consumption and exports. Short term, it’s hard to see positive triggers.

• Earnings is facing a similar story, with estimates following global earnings down, but from a lower starting level. Valuation is OK, but hinges on earnings.

• Foreign investors have pulled large amounts YTD and buyer of last resort is BoJ. Positioning is thus another headwind for Japanese equities.


Sectors│ Returns (in SEK)

EXCESS


Industrials│ Stuck between trade and Capex

Capex plans should provide a boost


Trade worries weigh on Industrials


• Industrials have underperformed since early 2018, with mostly trade worries weighing on the sector.

• As industrials are sensitive to the economic cycle we still remain cautious on the fundamental side. Sceptical positioning poses an upside risk.

• Upside risks to this sector includes capex, potential infrastructure package in US and a trade deal with China. We remain positively biased but still neutral.


Consumer Discretionary │ A tale of two sectors

But valuation is stretched


Consumer Discretionary has done ok in 2018


• Consumer Discretionary is torn between the waning brick-and-mortar business and the booming online retail business, making the outlook hard to assess.

• The sector usually performs well in an early-cycle environment which was distorted by the US tax-reform in 2018 – but effects are waning.

• As the cycle matures the labour-intensive part of the sector will struggle. While online retailers will continue benefit from higher sales - we remain neutral.


Consumer Staples │ Macro headwinds and fundamental problems

Consumer Staples are very much yield sensitive


Valuations remain elevated in the sector


• Consumer Staples experienced relatively flat performance in 2018, as earnings got hurt by higher raw material prices and higher freight costs.

• Competition in the sector is increasing as consumer preferences are changing, where especially E-commerce is changing the landscape.

• Earnings are lackluster, valuations are stretched and the sector faces major headwinds from increasing rates. Underweight.


Healthcare │ M&A activity in big pharma is accelerating

High drug prices has lead to pollical pressure


Healhcare typically performs well in late cycles


• Major M&A activity in the sector, as a series of deals involving big pharma acquiring cheap biotech companies sparked off over the Christmas

• Renewed focus from Trump on curbing prices could weigh, but so far the pressure is on the middlemen instead of big pharma companies.

• Healthcare is typically a good late cycle sector. We have turned more constructive on Healthcare, and recommend overweight.


Financials │ Cheap, for a reason

Italian politics are weighing on EU banks


Growth outlook can drag financials further


• As financials have underperformed, they are now very cheap versus history, and the banking sector is split between US and EU banks.

• European banks also struggle with several other things among the weak macro momentum and political uncertainty in Europe.

• European risks and regulation are a headwind, while US deregulation provides a tailwind. Put together, we believe neutral is the best position.


IT │ Earnings outlook is weak

Extremely strong global earnings growth


US companies expect strong growth in investments


• IT has been sold off, led by higher rates and skepticism for future earnings growth, fueled by profit warnings from both Apple and Samsung.

• The cyclical outlook has deteriorated, though both consumption, capex and the structural outlook (digitalization) still support the sector.

• Protectionism and trade war are obvious risks, and the risk/reward is no longer supportive of an overweight. We cut to a neutral weight.


Communications Services│ Estimated earnings are holding up

Biggest names in the new sector


Stocks moved from IT & Consumer Discretionary into Telecom


• Earnings estimates has fared much better for the communication sector than for the rest of the cyclicals, and that is a support.

• The new sector includes companies that facilitate “communication & offer related” content and information through media.

• It still hard to judge this new sector, due to the lack of historical data, and we continue with an neutral weight.


Utilities │Improved earnings outlook

Better earnings outlook for Utilities


Less pressure from higher yields


• There is signs of overcapacity in the USA, which is not good for pricing power in the sector. We are also running at low levels of capacity utilization.

• Earnings revisions has however turned positive, and the growth outlook for 2019 is improving.

• Utilities are highly levered and pay high dividends. If rates go higher it could hurt Utilities through higher costs, but this pressure has recently dropped.


Energy │ Bear market for oil

Booming US shale production


The falling oil price is taking its toll on earnings


• Positive output surprise from both US and OPEC, US waivers for the main Iranian oil importers and technical headwind led to a bear market in oil.

• Structurally, the outlook is mixed due to the battle between the rise in shale production vs. underinvestment in traditional oil (depletion of traditional wells).

• Earnings estimates has been slashed, despite the recent uptick in oil prices, the risk is high and we stick to a neutral weight on the sector.


Materials │ Higher risk from Chinese steel production weigh

Earnings tend to outperform towards the end of the cycle


Metals prices have weighed on the sector’s performance


• Materials tend to perform well towards the end of the cycle, but risks have risen from Chinese steel production, and we keep our neutral weight.

• Despite recent rebound, China-worries continues to haunt the sector. Going forward, Chinese easing could provide a boost, but we wait for the evidence.

• Valuation is relatively attractive, but estimated earnings are being slashed, so we do not think valuation will be in the driving seat for now.


Tight labour markets supports earnings in the sectorTight relationship with rates

• The real estate sector experienced strong performance towards the end of 2018, in the backdrop of the correction and risk off moves.

• Whereas strong economic momentum in the US and tight labour markets support the sector, the strong relationship with rates are expected to hold.

• We don’t see significant evidence for significant lower rates from here, but fundamentals are strong, and the combination warrants a neutral position.

Real Estate │Strong fundamentals but limited upside from yield



• We recommend to underweight high-yield bonds and overweight

government bonds in the bond portfolio.

• Government bonds offer low yield, but they provide stability for the

portfolio.

• Moderating global growth has made central banks to take a more

cautious approach to monetary tightening. This supports bonds.

Central banks take a step back

February 2019

FIXED INCOMEUNDERWEIGHT

Growth concerns have pushed yields lower



Fixed income markets │ February 2019

Corporate bonds Neutral

- Decent economic growth, good level of

earnings and solid balance sheets still

support corporate bonds.

- Increasing government bond yields were a

headwind for corporate bonds last year.

We expect government yields to increase

in a gradual manner and there’s less

headwind in 2019.

- Returns from corporate bonds will remain

low, but they offer stability to the portfolio

High-yield bonds Underweight

- Spread for high-yield bonds widened

forcefully at the end of 2018. Moderating

growth and tighter financial conditions in

the global economy could cause

continued challenges for high-yield.

- High-yield bonds are still supported by

solid corporate earnings and low expected

defaults.

- Cautious comments from Federal Reserve

helped spreads to compress in January.

Government bonds Overweight

- Return prospect is modest due to low yield

- Government bonds provide diversification

and stability to the overall portfolio

- Euro zone inflation outlook is still modest

and central bank does not want to

jeopardize economic growth, which has

moderated. Investor expectations

regarding ECB rate hikes are pushed

further into the future.

Emerging market bonds Neutral

- A dovish turn from the Fed and better FX

performance has been supportive for EM

bonds this year

- Global growth indicators have been falling,

but technical factors provide support to

EM bonds.

- We estimate risks regarding EM bonds as

balanced. High yield appears attractive,

but tighter USD financial conditions could

cause volatility.

Cash Overweight

- Negative euribor rates mean that return is

still basically zero for cash

- Cash provides liquidity to the overall

portfolio and it also has an opportunistic

role if attractive investment opportunities

open up in the markets


EUR IG │ Continued low yields

Resolution on Italian budget provides support for financial corporates


Yield has increased from the lows due to spread widening


• Decent economic growth, good earnings and solid balance sheets all support European investment grade corporate bonds.

• Corporate bond credit spreads widened considerably last year as euro zone economic growth moderated and ECB bond buying was terminated.

• Returns from investment grade credits will remain low, but within the low risk investment universe, European corporate bonds offer stability.


US IG │More cautious Fed gives some relief

Investment grade yield increased considerably in 2018


Currency-hedge eats most of the yield in US IG


• Corporate credit fundamentals are still acceptable in the US along solid corporate earnings and robust economic growth

• Increase in government bond yields has been a great headwind for IG. Fed indicating pause in monetary tightening supports IG performance prospects.

• We favour European investment grade credits compared to US ones due to the hedging cost and a shorter duration in European bonds


High-Yield │ 2019 started with a rally, but more challenging times ahead

Forecasts point towards a very low default rate


Yields and spreads increased sharply at the end of last year


• We recommend to keep high-yield bonds underweight in the bond portfolio. Moderating global growth and tighter financial conditions weigh on outlook.

• High-yield spreads tightened forcefully in January after cautious comments from the Fed and helped capital market to reopen for bond issuance.

• High-yield bond issuer credit metrics are still supported by solid corporate earnings. Also default estimates point towards below historic default ratios.


Positive effect from FX fading, and growth indicators not supportive Valuation remain attractive, even after spread tightening

• A dovish turn from the Fed and better FX performance has been supportive for EM bonds this year, after showing resilience through end of last

year.

• But, global growth indicators have been falling, and as US rate markets have already priced out rate hikes in 2019, the positive effect on FX will

likely fade.

• The environment is not very bullish for EM bonds, although we see some positive conditions like valuation and technical factors, hence we

keep neutral.

EM bonds │Attractive yield, but the environment is challenging for EM assets



Nordea Global Asset Allocation Strategy Contributors

Strategists

Andreas Østerheden

Senior Strategist

[email protected]

Denmark

Sebastian Källman

Strategist

[email protected]

Sweden

Ville Korhonen

Fixed Income Strategist

[email protected]

Finland

Espen R. Werenskjold

Senior Strategist

[email protected]

Norway

Assistants

Victor Karlshoj Julegaard

Assistant/Student

[email protected]

Denmark

Mick Biehl

Assistant/Student

[email protected]

Denmark

Amelia Marie Asp

Assistant/Student

[email protected]

Denmark

Frederik Saul

Assistant/Student

[email protected]

Denmark

Global Investment Strategy

Committee (GISC)

Leif-Rune Husebye Rein

Chief Investment Strategist

[email protected]

Norway

Michael Livijn


[email protected] Sweden

Antti Saari


[email protected]

Finland

Witold Bahrke


[email protected]

Denmark

Sigrid Wilter Slørstad

Senior Strategist

[email protected]

Norway

mailto:[email protected]


DISCLAIMER

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