Investment Outlook First Quarter 2020 · the long lasting hangover of the credit crisis....

Investment Outlook First Quarter 2020 1

A new decade, a new path for investmentsInvestment OutlookFirst Quarter 2020

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Contributors

Regional Chief Market Strategists

Belal Mohammed Khan [email protected] +41 (0)58 705 5273

Cheuk Wan Fan [email protected] +852 2899 8648

Patrick Ho [email protected] +852 8525 8691

Jose Rasco [email protected] +1 (1)212 525 3264

Jonathan Sparks [email protected] +44 (0)20 7860 3248

James Cheo [email protected] +65 6658 3885

Nicoletta Trovisi [email protected] +44 207 005 8569

Global FX Coordinator

Global Market Analyst, Real Estate Investment

Guy Sheppard [email protected] +44 (0)207 024 0522

William Benjamin [email protected] +44 (0)207 024 1546

Head of Alternative Investment Funds

Global Head of Fixed Income

Laurent Lacroix [email protected] +44 (0)207 024 0613

Kevin Lyne Smith [email protected] +44 (0)207 860 6597

Global Head of Equities

Elena Kolchina [email protected] +44 0207 860 3058

Senior Fixed Income Credit Specialist

Global Chief Market Strategist

Willem Sels [email protected] +44 (0)207 860 5258

Head of Asset Allocation

Stanko Milojevic [email protected] +44 (0)20 7024 6577

Neha Sahni [email protected] +44 (0)20 7024 1341

Global Investment Strategist, Managing Editor


ContentsLetter to clients 05

Portfolio Strategy 06

2020s vision – views on the next decade 10

Modern Monetary Theory: 12 unlimited free money?

Expected returns for the 2020s 14

Themes 16• Investing in a low yield world 16 • Sustainable investing 17

• Industrial Revolution 4.0 19 • Seeking EM Structural growth 20

Equities 22

Fixed Income 24

Currencies and commodities 28

Hedge Funds 32

Private Markets 34

Real Estate 35

Disclaimers 36

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Dear client,

The past decade has been kind to investors, with the US economy staying out of recession for a record 10 years (and counting) and unprecedented central bank policies lifting market valuations to new highs. The next decade however will most likely see a recession at some point, or economists will have to throw away their text books. And while central bank policy should remain accommodative, it is starting to test its limits. So while the stroke of midnight on 31 December does not mean that everything changes, it is clear that the new decade will mean a new path for investments.

Investors ideally like their portfolios to give them income, growth and stability. But with cash rates and bond yields in developed markets near record lows, global economic growth below normal, and political uncertainty creating potential volatility, these objectives will not be as easy to achieve as in the past.

Indeed, our 10-year future return expectations have come down, and in coming years, our investment strategy will therefore need to follow new paths to achieve our three objectives. To achieve an adequate level of income, we believe portfolios should avoid excessive cash balances on which rates are just too unattractive. We also avoid the lowest rated end of high yield because valuations are just too tight and the weak economy is a risk to that part of the HY universe. Instead, we favour USD investment grade, emerging markets’ local and hard currency debt, but complement this with dividend stocks, real estate and private debt instruments to generate further income. Where appropriate, some leverage can help boost the net income of portfolios.

The lower than normal economic growth we expect for 2020 and 2021, and the over-optimistic consensus earnings expectations provide a challenge for investors too. To boost the return potential of portfolios, we don’t think the answer lies in taking higher cyclical risk, and instead focus on quality companies with sustained earnings growth. We also look for long term growth in promising sectors, geographies or themes related to the Fourth Industrial Revolution or Sustainability. Hedge funds should be able to capture growth opportunities, while typically being less exposed to market corrections or to the economic cycle. And private equity can help tap into long term themes, reduce the market timing risk, and help look through short term volatility and geo-political uncertainty.

A multi-faceted investment strategy is thus needed to achieve the three objectives of income, growth and stability. But in a low growth and low interest rate environment, returns are unlikely to be as high as they were in the past decade.

What could change this? The ‘Japanification’ of the Western world – low growth and low inflation - is largely the consequence of ageing populations and the long lasting hangover of the credit crisis. Fundamentally, many households, and corporates even more so, are not optimistic enough about the economic outlook to invest and boost economic growth. Progress on a US-China trade deal could help take some uncertainty away. But increased fiscal spending and market friendly reforms are probably needed. If investment in infrastructure, green energy and 5G for example were to kick-start the global economy, both corporates

and households could use some of their significant cash balances and invest, raising productivity and growth. This could ultimately lift interest rates and inflation a bit. It could take time before there is a political consensus to do this though, and so, for the moment, we continue to invest under the assumption of low growth and low inflation.

We are optimists however, and believe that the ageing, urban, digital, mobile, sharing-based, knowledge-based, circular, fast-paced and increasingly Asian global economy provides companies and investors with plenty of opportunities. We think it will be important to constantly keep the three objectives of income, growth and stability in mind, to not leave money on the table, miss opportunities, or take excessive and concentrated risks. Diversifying risk exposures is especially important when broad-based market upside is lower than in the past, and political risks remain high. But sometimes, the new paths lead you to the most interesting sights.

We would like to wish all our clients a happy and prosperous 2020 and a good start to the new decade.

Willem Sels, Global Chief Market Strategist

4th December 2019

WelcomeMessage from our Global Chief Market Strategist

Portfolio StrategyInvestors will need to combine a number of strategies to try to achieve enough income, growth and resilience for their portfolios.

Global economic growth may be bottoming but will still remain lower than normal. Before investors move to a more risk-on stance, geo-political uncertainty will need to decline.

Three challenges for 2020

Investors typically want three things from their portfolio: income, upside to valuations, and low volatility. But as we enter 2020, these objectives are real challenges, because the yield on offer in many bond markets is near historical lows, economic growth is lower than normal, and policy uncertainty is very elevated. So how should a good investment strategy respond?

Challenge 1 - Low income.

As regular readers will know, we believe the low cash and bond yields are largely a structural phenomenon, and here to stay. That is because inflation is capped by consumers who compare prices online, while the Chinese savings surplus and global ageing also keep bond yields low. Cash rates are unlikely to rise any time soon, and investors who are sitting on a lot of cash may therefore be disappointed by returns. Moreover, investors with large cash holdings are often tempted to complement them with high risk assets, such as low-rated high yield, to try to achieve their overall target portfolio return, but holding such assets is not ideal in a low growth environment.

Instead, holding USD investment grade, EM hard currency and local currency bonds achieves a better balance between risk and income.

These assets are our main overweights in fixed income, and form the core of our solution to the income challenge. In addition, part of any cash balance can probably be allocated to cash enhancement strategies, which take some short term credit risk or currency and

volatility views, but have a higher yield than cash. Dividend stocks are another tool in the box, because they now provide income that exceeds investment grade yields in Europe, and Treasury yields in the US. Of course, any investment in dividend stocks needs to be appropriately sized, because their risk profile is closer to that of equities than that of bonds. One also needs to be selective to ensure that the company can continue to pay the dividend in a slow growth environment. Many managed solutions, in fact, combine all of these strategies to address the income challenge, by taking measured credit risk, selling options, and mixing equities and bonds – all under a strict risk approach. Additionally, private debt and real estate can provide a longer term approach to income generation, and provide further diversification. Finally, using some leverage, where appropriate, can help

lift returns and income, and we think the cost of leverage is unlikely to increase, as most central banks are either on hold or in easing mode.

Challenge 2 - Low growth.

In the past 6 months, we have been positioned for slower economic growth, but have remained invested because we do not expect a US recession. A US-China partial trade agreement may signal that we are beyond the weakest point in the global monthly economic data series, but 2020 GDP growth will still remain below normal, at 1.7% in the US, 0.7% in the EU and 5.8% in China. Earnings growth may pick up from the Q3 low, but 2020 consensus expectations are still too high. So while any bottoming of the data could lead to short term outperformance of equities and cyclical assets, the ‘slow for longer’

Source: Bloomberg, HSBC Private Banking as at 4 December 2019. Past performance is not a reliable indicator of future performance.

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Low for longer: cash rates and safe haven bond yields should remain low

-2

-1

0

1

2

3

4

5

6

7

8

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18

%

US Fed funds 10-year US Treasury yield

ECB repo rate 10-year German Bund yield

7Investment Outlook First Quarter 2020

growth environment means that such outperformance would not extend very far.

To address this second challenge, a multi-faceted and balanced approach is again warranted. First, we choose our sector and country exposure to adapt to the slow cycle. Sector-wise, we maintain a defensive approach in Europe, with an underweight in European industrials,

and overweights in European consumer staples and utilities. By comparison, we hold a more neutral cyclical stance in the US and Asia. Geographically, we have closed our underweights in Germany and Taiwan, on signs of progress regarding the US-China trade deal. But in China, we still maintain a focus on domestic themes and areas that benefit from policy stimulus, to limit direct exposure to trade headlines.

We also focus on investment themes which are supported by structural trends, to lower the sensitivity to the short term economic outlook. These include themes such the Fourth Industrial Revolution, EM seeking Structural Growth and the opportunities linked to the move towards a more sustainable world. You can read much more on this in our Themes section.

Challenge 3 - Low visibility

Investors are used to handling uncertainty around the economic, earnings and interest rate outlook. But they are often much less comfortable with taking a view on politics, and so are we. Geo-political tensions are not just present between the US and China, but in other regions of the world as well. Gold tends to be a good hedge against uncertainty, and we maintain our overweight position to hedge the risks that are not cyclical in nature.

And of course, US elections in 2020 will lead to many headlines, which will lead to two-way volatility, and create a risk on / risk off type of environment. Active strategies that buy the dips and sell the rallies should be well suited to this environment, especially if a lack of direction in growth or interest rates keep markets in a range.

Diversifying remains key but is harder to achieve

Low bond yields not only provide investors with an income challenge, but are challenging from a portfolio diversification perspective too. The very low (and sometimes negative) safe haven bond yields mean that some investors don’t hold safe haven bonds anymore, and are less well diversified. And if Treasury yields cannot fall much further from the current level, they may not protect as well against a fall in equities as they did before.


Source: HSBC Global Research as at 4 December 2019. Forecasts are subject to change.

0

2

4

6

8

10

12

Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13 Dec-15 Dec-17

%

US dividend yield EM dividend yield

Europe dividend yield US BBB yield

Slow for longer: global economic growth is unlikely to pick up in 2020

Credit yields have dropped relative to dividend yields

0

1

2

3

4

5

6

7

8

US Eurozone UK China India Latin America

Rea

l GD

P gr

owth

and

fore

cast

s (%

)

2017 2018 2019 2020 (F) 2021 (F)

8

So, investors will have to look for additional diversification strategies. By definition, exposure to any asset that is not perfectly correlated to the core equity position you hold, will help diversify the portfolio. So, firstly, geographical diversification helps, and with an increasing number of markets facing geo-political risks, it is prudent to avoid excessive concentration in any market.

We also like to take advantage of the opportunities in equity markets while limiting directional exposure, to protect against potential temporary downside, and recognising that aggregate market upside may be muted. Active managers and equity market neutral hedge funds should be well placed to do this, and can try to generate excess returns (alpha) by picking the winners and avoiding the losers from disruption (see our hedge fund section). And for those investors who can take a longer term view, private equity can help look through the cycle, and help avoid behavioural biases that often lead investors to buy and sell at the wrong moment.

What lies ahead?

Many factors can drive up asset prices, but among them, we believe that three are crucial (see table). Which one of the three is dominant, can determine the kind of assets that should outperform.

First, global liquidity and ‘cheap money’ can create very broad-based asset price inflation, boosting bonds, equities, real estate and commodities at the same time. This factor has been supportive for

markets for several years, and remains in place, as global liquidity remains ample. Under this ‘cheap money’ regime, the main message for investors is to be invested, and not to be in cash.

But where investors choose to put their money to work largely depends on their risk appetite, and therefore on the economic cycle. For much of 2019, the cyclical outlook has been too weak and uncertain for us – and for global investors - to jump into the most cyclically sensitive areas of the market or support value stocks. Instead, investors have been willing to pay a premium for quality stocks with stable earnings growth, and have favoured investment grade when capturing carry in fixed income (high yield is more cyclical).

Not all riskier assets need a strong economic cycle, however. Some companies and geographies can outperform because they benefit from structural growth. We have been seeking out these areas, principally through our thematic investment ideas, which focused on these sustainable trends. We have also been overweight technology, which performed well for most of 2019, and which fits with this desire to look for long term growth, that is not too sensitive to the current economic cycle.

For 2020, our core macro-economic scenario of low rates and low growth, argues in favour of remaining invested, while managing cyclicality and focusing on companies and themes with structural growth.

But what could change this strategy? For now, it seems premature to take a much more positive stance on the global economy, but we recognise that a broader than expected US-China trade agreement could boost global growth and optimism. Some business sentiment surveys have started to bottom out, and investor sentiment often improves when this is the case. But we wouldn’t get too carried away. Risk assets sold off less when business sentiment declined

recently than they did in the past on such occasions, and hence should rally less from here as well. In addition, even if business sentiment improves somewhat, economic growth should still remain below normal, and political uncertainty remains elevated.

Fiscal spending could be another game changer, but this again depends on politics, and may take time to materialise. Advocates of Modern Monetary Theory (MMT) believe that governments can spend more without any negative side effects. After a decade of austerity in Europe, governments may be ready to loosen the belt a bit, but are unlikely to move to the other extreme very quickly. We see some potential for investments in infrastructure and green energy, benefiting our ‘All electric’ investment theme. But the fiscal spending we foresee is unlikely to drive up inflation and government bond yields. Still, market’s inflation expectations are too low, and if CPI were to rise (for example, because of tariffs, obstacles to global competition in the labour market, oil price base effects or global warming causing food prices to rise) it could hurt both equities and bonds. This is why holding some gold and US inflation-linked Treasuries (TIPS) makes sense, in our view.

The pickup in the economic cycle thus depends either on a US-China trade agreement, or on fiscal spending. Markets may be willing to anticipate some of the good potential news, but should not fully price in such scenarios before they materialise. Until our ‘low for longer’ rates trend, and ‘slow for longer’ growth trend are challenged, we remain invested, with a highly selective and diversified approach, selling the rallies and buying the dips.

Drivers 2019 2020 outlook

Global liquidity

Very supportive

Supportive

Economic cycle

Negative Neutral

Structural themes

Supportive Supportive

10

2020s vision – views on the next decadeAt the dawn of a new decade, we examine which trends of the 2010s will continue or fade, and which new trends may develop in the 2020s.

We have written a lot about the weakness in manufacturing data, and linked this to the trade tensions between the US and China. But this decline is also structural in nature, especially in the developed markets. Manufacturing has been shifting to the East and the South for decades. And as the sharing economy allows people to use cars without owning them, and stream music without the need for CDs, we need to produce fewer ‘things’.

Consumers put less emphasis on buying items to stuff into their small urban flats, and instead prefer spending their money on interesting experiences, supporting the leisure, travel and entertainment industries. The transition from a manufacturing-heavy economy to a knowledge economy dominated by services is a painful one and has left many people behind. Wages have grown more slowly than usual, in part because unionisation tends to be lower in the services sector than in manufacturing. And of course, economic growth has slowed as countries go through this transition.

The policy mix used during the 2010s to address some of these challenges has not been very effective, but was dictated by the credit crisis. Fiscal austerity was needed to cap debt growth in Europe, but severely cut government infrastructure and other spending. And while central bank rate cuts and quantitative easing were intended to make borrowing cheap and available, many companies and households have not felt optimistic enough to borrow to build a new factory or a new house. QE has managed to create asset price inflation, but has not managed to kick-start growth.

In the 2020s, the recipe is likely to change, and fiscal spending should gradually pick up. In the UK, both the Conservatives and Labour have promised to increase spending, while in Europe, the typically frugal Germany is now growing so slowly that spending may need to increase. We think there could be increased spending in green energy, given the clear need, and the commitment of governments around the world to the climate goals. This would clearly benefit our All Electric theme. We also believe that 5G investment will pick up, as countries do not want to be left behind in the trend to make everything ‘smart’, from ‘smart cities’ to ‘smart factories’ and ‘smart government’. The risk to this view is that governments’ room for investment may be limited by the need to spend more on pensions and social security. In the Eurozone in particular, it may also take more time, or more economic weakness, before governments decide to act.

And if fiscal spending leads to a somewhat better outlook for growth, companies may again feel optimistic enough to start to invest more and use their rich cash balances. They need to, because productivity growth has been very weak. Profit margins have so far been supported by falling interest costs, but that tailwind is now largely behind us, and if wage inflation starts to rise because of full employment and global ageing, this could hurt margins. Global warming may also put some upward pressure on food price inflation. Inflation should not rapidly accelerate, but it is more likely to rise somewhat than fall in coming years. There are many innovations, including automation, robotics and AI, which will help companies raise productivity and protect their margins, and ultimately lead to a pickup in growth.

As countries formulate their answers to slow growth and to the decline of manufacturing, they are likely to work with their neighbours, and create further regionalisation. It’s clear that globalisation has stalled, and regionalisation is gaining traction as a way to secure resource and markets, limit the impact of tariffs, and be able to compete with other economic blocks. China has a clear and explicit strategy of regionalisation, and we believe it will help it to become the number 1 economy by the end of the 2020s. India will become the number 3 economy, in our view, though more because of organic growth than through trade links.

Not every country will manage this transition well, and political decision making will remain important for investors to consider. In the age of fast news, political headlines will continue to create a lot of volatility. We think in such an environment, hedge funds and active managers are well placed to take advantage of the volatility, while investments in private markets allow investors to look through the noise.


From monetary accommodation to fiscal stimulus?

From globalisation to regionalisation?

From corporate cash to business investment?

From disinflation to price stability?

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Modern Monetary Theory: unlimited free money? Interest rates are on a downtrend around the world, prompting many observers to wonder if governments should use this ‘cheap money’ to boost fiscal spending to lift economic growth. A body of research by economic institutions argues that when interest rates reach the ‘zero bound’, as they have in the Eurozone and Japan, a combination of monetary and fiscal policy is required. Former ECB President Mario Draghi has repeatedly stressed the benefits of well-targeted structural reforms and fiscal policy as a complement to his accommodative monetary policy. And towards the end of his tenure he became even more direct, saying “if there were to be a significant worsening in the Eurozone economy, it’s unquestionable that fiscal policy […] at the euro area level becomes of the essence”. This view is backed up by an OECD simulation where euro area public investment was raised by 0.75% of GDP for five years, alongside structural reforms to boost productivity. It resulted in a 0.8% boost to GDP after the first year, compared to just 0.3% for Quantitative Easing alone, with strong results for long-term growth too. Furthermore, their modelling produced less asset-price inflation because fiscal support is typically more targeted than monetary support.

As our chart illustrates, the room for fiscal easing varies greatly from country to country. Within Europe, Germany has ample fiscal room while Spain and Italy risk facing EU penalties for breaking the

‘fiscal compact’. The world’s two largest economies both have similarly large fiscal deficits but China arguably has more room to ease given its lower central government debt. In the US, there was an initial boost to growth following the tax reforms, but more recent sluggish growth has led to calls from more innovative policy action.

Modern Monetary Theory (MMT) is at the heart of this soul-searching and has become a new buzz-word. MMT argues that a sovereign nation that prints its own currency and has a floating exchange rate typically only defaults if it chooses to do so. For example, MMT proponents consider the US Treasury and Federal Reserve as one consolidated sovereign entity, as all profits of the Fed are remitted back to the Treasury. And many of the bonds issued by the Treasury have been bought by the Federal Reserve in a process called quantitative easing (QE). The sovereign effectively has a monopoly on money and can therefore ‘print’ as much as it likes without recourse, because money is a liability that cannot be exchanged at the Fed for any commodity or other asset of the state, since the US left the gold standard.

MMT therefore argues that the sovereign can finance spending, and this point is widely accepted. But MMT goes one step further by arguing that there are no limits to this process, and that it will not lead to inflation. This is where MMT conflicts

with traditional economic models, and we believe that there is an upper limit to government spending because eventually the markets would start to price in an inflation risk premium. Markets may also fear that a government may choose to default, perhaps because previous fiscal spending did not yield the expected gains to economic growth. It seems hard to imagine that persistent government over-spending, financed by the central bank, would not eventually be seen as a giant Ponzi scheme, even with the “exorbitant privilege” the US commands by being the dominant currency of the world. In our view, the scope for countries to ‘print and spend’ depends on the credibility of the central bank, the government’s default track record, its current deficit and debt level, and whether or not a large part of the debt is held by foreigners.

This is not to say that targeted amounts of central bank financed investment could not yield positive results, especially when rates are at the ‘zero bound’, when risks of an inflation spike are low. But MMT is unlikely to become the norm in monetary policy any time soon. We thus foresee only a measured pickup in fiscal spending, which may take some time to materialise. And ideally, as Mr. Draghi argued, this would go hand in hand with productivity boosting reforms.


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cal b

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China

JapanGermany

UK

France

Australia

Brazil

RussiaFiscal tightening

Fiscal loosening

Canada

Italy

Source: Bloomberg, HSBC Private Banking as at 4 December 2019.

Room for fiscal spending is not limitless

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Expected returns for the 2020sForming expectations

All humans are susceptible to various psychological biases, and this also happens when we form our expectations around market returns. Investors often anchor to recent experiences and over-extrapolate recent returns into the future. But the decade behind us was pretty strong for equities, with the S&P 500 returning 12.7% p.a in nominal terms. Although economic growth was slow, none of the major economic blocks went into recession for more than 10 years. But as the cycle matures, we should not base our expectations solely on recent trends, and instead focus longer term potential growth.

On the other hand, people sometimes overestimate the probability of disastrous events. The 2000s were the worst decade in the century for stock market investors, marked by the dot-com crash in

2000-2003 and the 2008 market collapse triggered by the worst financial crisis since the 1930s. This decade is still fresh in many investors’ minds, rendering them too fearful as a result. But a look at our table below shows that the events of the 2000s were indeed very unusual. We believe that a repeat of such events in the coming decade is far less probable than some investors perceive them to be.

So, how does our outlook for the 2020s compare to history? As shown in the table below, our expectation is that the US Stock market would return 6.1%. At first glance, 6.1% may come across as pessimistic, but inflation expectations are relatively low as well. In fact, a 4.1% real return (i.e. net of inflation) over a ten-year period is not unusual, and four out of ten decades saw real equity market returns below this figure. As such, we would label our forecasts as realistic, rather than pessimistic.

Decade Stocks Bonds 60/40 Inflation

1920s

1930s

1940s

1950s

1960s

1970s

1980s

1990s

2000s

2010s

15.2%

0.2%

9.0%

19.2%

7.7%

5.7%

17.4%

18.1%

-1.0%

12.7%

6.0%

4.9%

3.2%

-0.1%

1.4%

5.5%

12.6%

8.8%

7.6%

6.1%

11.8%

3.7%

7.0%

11.4%

5.4%

5.9%

15.9%

14.5%

3.0%

10.5%

-0.9%

-2.0%

5.4%

2.2%

2.5%

7.4%

5.1%

2.9%

2.5%

1.8%

2020s (expected)

6.1% 1.5% 4.6% 2.0%

Historical US market returns and expected returns for 2020-2030 (annualised)

Source: HSBC Global Asset Management, HSBC Private Banking, Refinitiv Datastream, University of Lausanne, as at 4 December 2019.


Equity markets

We expect equities to outperform fixed income, and to a greater degree than when we calculated our forecasts in the past two years. In 2019, equities experienced a brief melt-up in January and rebounded from the sharp correction in May, but have remained fairly volatile and directionless since, amid escalation of the US-China trade tensions and deteriorating manufacturing activity across the globe. Meanwhile, bonds saw an impressive rally, as central banks around the world delivered a number of unexpected interest rate cuts, but equities’ price / earnings ratios remained relatively constant. We thus foresee some further upside for

price / earnings ratios in coming years if rates remain low. And if inflation were to increase somewhat because of higher fiscal spending and tight labour markets, nominal equity returns are likely to benefit relative to bond returns.

We continue to consider emerging market equities as more attractive than their developed market counterparts, with an expected return of 8.7% p.a, largely due to greater economic and earnings growth potential. We also see opportunities in Private Equity, where the ability to access a broader opportunity set and use capital more efficiently leads us to expect returns of 9.1% p.a. for the median manager.

Fixed income

Following substantial rate cuts and repricing over the last twelve months, fixed income investing is becoming particularly challenging. Low yields and tight credit spreads form an unfavourable starting point for future returns. Markets may be overly pessimistic on future growth and may be overextending the period of inflation below central banks’ targets. As a result, any pickup in bond yields or inflation later in the decade may lead to negative real returns for government bonds. This is something that investors have not seen over the last fourty years, but was not unusual in the preceding fourty-year period from 1940 until 1980. In fact, it can be argued that the recent experience has been anomalous and not repeatable in coming decades.

Government bonds have been the best diversifying asset class in recent history, with substantially negative correlations with equities and respectable overall returns. However, due to our very low expected returns, we now increasingly seek diversification through private markets, un-correlated hedge fund strategies and gold.

In investment grade, the credit quality deteriorated somewhat over past years as issuers took advantage of very low yields, while they also borrowed at longer term than previously, extending the overall duration of the market. With lower yields and higher intrinsic risks, investing for income is particularly challenging, as we discuss in our portfolio strategy section. For the long run, we still see a reasonable amount of yield pickup in selective high yield, and especially in EM local currency debt market, where our expected returns are 3.6% p.a. and 6.9% p.a., respectively. A selective and tactical approach to fixed income is needed to find the best risk/return trade-off, and it is clear that a simplistic 60% equities / 40% governments portfolio composition is not appropriate for the decade ahead.

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10

15

20

2004 2006 2008 2010 2012 2014 2016 2018 2020

pric

e / e

arni

ngs

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4%

6%

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10%

12%

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16%

18%

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1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Long-dated bond yield Cash rate

Government bond yields are low on an absolute basis, and relative to cash rates

Source: HSBC Private Banking, Refinitiv Datastream, University of Lausanne, as at 4 December 2019. Past performance is not a reliable indicator of future performance.

Equity market valuations are not yet at record levels

Source: HSBC Private Banking, Refinitiv Datastream, as at 4 December 2019.

16

1. Investing in a low yield worldLow bond yields are often seen as the market’s way of expressing its dissatisfaction with the economic outlook. But even negative safe haven yields do not necessarily imply a recession. The low bond yields that many investors are struggling with, are more structural than cyclical in nature.

Bond yields have been on a declining path for decades, suggesting that much of the moves are structural. Inflation is structurally low, allowing central banks to keep interest rates low. At the same time, global ageing and the Chinese savings surplus create demand for global bonds, and we find it hard to see how these trends can reverse any time soon. Of course, quantitative easing (QE) has played a role in bringing yields down since the financial crisis. But the trend of lower bond yields had started well before the crisis hit. And while QE was scaled back in recent years, Japan continues with it, the ECB has restarted it and the Fed is expanding its balance sheet for liquidity reasons. The risk that central banks sell safe haven bonds and cause corporate and EM markets to significantly re-price, thus seems low. Of course, there could be

a small pickup in yields if a trade deal or a pickup in fiscal spending in Europe were to lift global economic growth somewhat, but any such pickup should be small. We also acknowledge that globalisation has probably passed its peak, and protectionism could lift inflation a bit, but the impact on bonds should be small.

In this low rate and low yield environment, the risk is that investors opt for cash holdings or very low rated high yield bonds. We think either would be a mistake, as cash in developed markets is bound to generate low returns, while low rated high yield spreads are too tight, in our view. Moreover, it would be overly prudent to sit on cash if, as we believe, the US is not going into recession.

Instead of holding cash or low rated high yield (the two extremes of the risk spectrum), we continue to see a better risk / return trade-off in USD investment grade credit. We also prefer it over EUR or GBP credit given the yield differential. Emerging markets hard currency and local currency bonds provide an attractive pickup in our view, and we believe that EM local currency bonds will benefit from

central bank cuts (see our EM theme for more details). We also see opportunities in developed market financial bonds, across the capital structure, in spite of relatively full valuations.

Dividend stocks are attractive in a low yield world, with dividends exceeding Treasury yields in the US and exceeding IG bond yields in Europe. When economic growth is slow, it is important to select companies that can sustain or grow their dividends. For example, financials often pay high dividends, but have a cyclical business model. Most often, though, companies paying high dividends have a relatively a-cyclical business model, with utilities being a good example.

Looking for companies with sustainable dividends is just one way to increase portfolio income and resilience. We also believe that looking for ‘quality stocks’ more generally can be a good idea in this low growth and low yield world. The quality label can be defined in many ways but we specifically like companies with high and stable profitability, and manageable leverage.

Finally, low yields should help gold, which typically rallies if real bond yields fall. We sympathise with investors who find it hard to buy safe haven bonds with negative yields, and we believe that many will find that gold can be an attractive alternative diversifier.

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Amount of outstanding bonds with negative yields

Source: Bloomberg, HSBC Private Banking as at 4 December 2019. Past performance is not a reliable indicator of future performance

Themes


A lot has been written about sustainability. Many articles focus on the obvious positives of the sustainability story, including the clear need for the world to be more sustainable and the role investors can play to incentivise companies to clean up their act. In addition, there is the possibility of attractive returns for shareholders in companies that develop new services or products that help address the sustainability challenge. The World Economic Forum has decided to make “Stakeholders for a Cohesive and Sustainable World” its theme for the 2020 Davos meeting.

Other articles take a more cautious approach, pointing out the relative infancy of sustainable and ESG (Environment, Social, Governance) investing. For example, fund houses have different ways of scoring companies on their ESG scale and their processes are still evolving. This makes it hard to have enough reliable data to prove that investment returns using an ESG approach would have generated similar, or better returns than a standard benchmark index. Clearly, selecting companies with good

ESG scores may result in a quality bias, and (depending on the approach) in lower energy and mining holdings. And this will of course lead to temporary underperformance or outperformance, as any style bias would also do. Becoming a more sustainable business also involves costs and investment.

But rather than looking back to try to calculate historical performance, we believe it is important to look ahead. In fact, looking at the fundamental drivers and their outlook is exactly what any investor would need to do with a new trend that is so far untested. In our view, if companies benefit from behaving in a sustainable way, then investors in those companies should benefit as well, in the long run. And this is what we explore in our graphic.

It is clear that more and more consumers want less packaging and fairer working practices, and that they are willing to take their business elsewhere if needed. And if clients put pressure on a company to behave sustainably, that company will often put pressure on its own suppliers to be more sustainable as well. Employees,

too, increasingly want their employer to have strong diversity rules, fair promotion practices and sustainable production processes. So it’s important for businesses to take this into account if they want to attract and retain talent.

Thinking about sustainability can help businesses to anticipate changes in consumption patterns or regulatory changes, and this should allow them to develop new products and services. Those that are ahead of their competition will benefit, while those who fail to foresee the changes may be slow to innovate, miss opportunities, or even become irrelevant and fail.

Therefore, sustainability matters for investors too. As one fund manager told us, “if you don’t incorporate environmental, social and governance aspects in your stock selection, you will miss very important issues”, regarding the potential opportunities or the risks to that company’s business. Therefore, incorporating sustainability in one’s investment strategy is not just about trying to do good: it is a necessary part of the company analysis and investment process.

2. Sustainable investing

Be sustainable to

Lower risks and create new opportunities

Consumers & supply chain: create loyalty, avoid bad publicity

Employees & community: attract talent

Products & services: new opportunities

Regulators: changes to operating environment

Investors: their willingness or ability to invest

Equity analysts: earnings forecasts

Rating agencies: rating and cost of funding

18

Among the three aspects of ESG, many articles find that good governance is the most important driver, with many examples of improved governance boosting corporate performance and investor returns. And an important aspect within governance is the presence of diverse management teams, which tend to perform better. Diversity of thought tends to help generate more ideas, and helps challenge and avoid really bad decisions, which could have been harmful to the business.

Another thematic focus for us is our ‘All Electric’ theme, which looks at opportunities related to electrification, including electric vehicles, the related need for batteries, and a flexible electric grid. Renewable energy is now cheaper than conventional energy production, leading to a quick pick-up in solar and wind installations. But as solar power production picks up when it is hot, and falls during winter or at night, the grid needs to be able to quickly redirect the flow of electricity. All of this creates opportunities for the firms involved. And if governments decide to invest more in green energy to boost their economies or to reach the Paris Climate goals, this investment theme could benefit from another strong tailwind.

Finally, our Clean Living theme focuses on the investment opportunities in pollution treatment and reduction, water treatment and sanitation, and recycling. The public is increasing galvanised by a combination of social media coverage and personal experience that something needs to change. And technological progress allows companies to develop profitable products and services to tackle this challenge.


After a volatile Q2 and Q3 in 2019, the tech sector has fared somewhat better lately. Semiconductor and biotechnology indices have started to improve in early October and made new year-to-date highs in Q4. Some of the cyclical headwinds we highlighted three months ago may be easing. The China-US trade talks seem to be making some progress, and the smartphone sales outlook is improving somewhat due to 5G. In the longer term, we continue to expect a whole range of innovations and new disruptive technologies, which provide investors with a wide scope of new investment opportunities, which we group under ‘Industrial Revolution 4.0’. This is in spite of some issues such as anti-competitive practices, personal data protection, and the challenge of controlling the spread of misinformation (i.e. ‘fake news’).

While Fintech has already taken off in China, parts of Europe and in the US, strong potential in mobile wallets and payments can also be found in Southeast Asia. In a report by Google, Temasek & Bain, out of around 400 million adults in Southeast Asia, only 104 million are enjoying full access to basic financial services (i.e. bank account, bank credit, and insurance). One reason for the low banking penetration is cost, because physical bank branches are expensive. Other challenges include the lack of identification systems and credit information. Fintech has the potential to solve many of these challenges, thanks to widespread access to smartphones, and Fintech firms being able to make better credit assessments. Digital

payments adoption has surged, driven by the activities such as ride hailing and e-commerce, and mobile wallets are poised to grow even faster. From USD22 billion in 2019, they will likely quintuple to over USD114 billion by 2025.

Oncology remains a hot topic in biotechnology, and our ‘Future Health’ theme. An active research topic concerns the question why the immune system that helps the body fight foreign “non-self” cells and pathogens, does not work on cancer cells. Harnessing the immune system’s ability to detect and destroy cancer cells is the basis of a rapidly growing stream in oncology known as immuno-oncology (I-O), which has more than 1,600 clinical trials currently registered at the US Food and Drug Administration. Most tumors arise from transformed normal cells that have undergone genetic changes so that they become carcinogenic but can escape being seen as harmful by the immune system. I-O is about identifying ways to make the immune system “see” and eliminate these transformed cells at an early stage. Together with the progress in next generation sequencing we mentioned in our Q4 edition of the Investment Outlook, immunotherapies offer a means to personalize cancer treatment that is also more durable and prone to fewer side effects than traditional cancer therapies. The search for a cure has already spurred new diagnostics that can detect cancers earlier, monitor the patient during treatment, and look for disease reoccurrence.

5G-related opportunities are the key source of our more upbeat outlook for the biggest integrated circuit makers going into 2020. A large Asian semiconductor company for wireless communications will offer several 5G system-on-a-chip (SoCs) in 2020 and hopes their gross margins will be better than its overall average. In the US, with 5G network launches set to take center stage, we believe 2020 could see a steady rise in competition, a rebound in smartphone upgrade rates off record lows, increased switching activity, and a wider availability of 5G handsets.

In the US, we continue to think patterns of consumption will move from physical shops to online, supporting our ‘Digital Consumer’ theme, in spite of the slowdown in the economy in 2020. This change will continue to bring a new set of digital opportunities not just in technology companies, but also in traditional sectors like logistics, supply-chains and distribution which are now readying for a future using robots, drones, virtual reality and much more. Companies have been reluctant to invest much in operations or additional capacity in recent months, as trade tensions have reduced visibility for their business. But we think any improvement in the US-China tensions, or a stabilization of manufacturing sentiment, could encourage companies to invest some of their considerable cash piles. In the medium term, they need to, in order to increase productivity from current low levels, and to keep pace with their competitors that are at the forefront of technological innovation.

3. Industrial Revolution 4.0

20

Emerging market (EM) assets have encountered macro challenges in 2019 due to protracted US-China trade tensions, the global synchronised slowdown and geopolitical conflicts. Even if there is a phase-one trade deal, there is unlikely to be a complete removal of all tariffs in 2020. Hence our investment strategy focuses on selective areas of resilience in EM and Asia and on long-term structural growth opportunities.

The secular drivers of strong personal income growth, digitalisation of retailing and premiumisation of consumer demand continue to support healthy consumer spending growth across Asia, which forms the basis of our Power of Asian Consumer investment theme. Within the region, we favour the domestic consumption story of China, India and the ASEAN countries, and the attractive opportunities in personal services, e-commerce, high-end consumer goods, entertainment, travel, education, healthcare and financial services.

Bucking the downturn in global trade and the manufacturing cycle, Asian consumer spending has been performing much better than the industrial sector over the past year. Asia’s massive affluent middle class stands out as an important growth engine. And the Asian consumer continues to rapidly accumulate wealth. According to Boston Consulting Group’s Global Wealth report, private wealth across Asia will rise at an annual pace of 9.4% to reach USD58.2 trillion over the next five years. This is the fastest rate of

all regions and compares to 5.7% globally. We forecast actual consumer spending in Asia ex-Japan to grow by 5.8% in 2020 and 5.9% in 2021, well above the average global rate of 2.5% in 2020 and 2.6% in 2021.

Asian technology companies should benefit, as the region remains at the forefront of technological innovation reshaping consumer behaviour amid rising penetration of e-commerce. As China spearheads disruptive technological changes across 5G, artificial intelligence, e-payment, health technologies and Internet of Things, it has become the world’s largest e-commerce market and the number one consumer of smartphones and electronics products. And it is on track to overtake the US to become the world’s number one consumption market in 2020.

In China, the rise of the empty-nesters, who account for 53% of urban consumption, is driving strong growth in travel, entertainment, sportswear, home refurbishing and footwear. And in 2019, China released a policy aimed at improving fitness, enhancing sports-related consumption. Asia’s travel and hospitality industry is another growth sector and has remained resilient amid global uncertainty. It benefits from robust outbound tourism across the region, particularly from China. Outbound trips made by Chinese tourists increased by 14.7% to 150 million in 2018 and up 14% to 81.3 million in H1 2019, making the country the world’s largest outbound travel market and

contributing 10% of global outbound travel expenditures. And with just 120 million Chinese citizens (i.e. 8.7%) holding a passport, there is significant upside ahead for China’s outbound travel.

Education is another bright spot of Asia’s consumption story. India has the world’s largest population of about 500 million in the age bracket of 5-24 years, which presents promising opportunities in the education space. India’s education market size was worth USD101 billion in 2019 and it has become the second largest market for e-learning after the US. In China, 61 million school children already attend extra lessons at after-school tutoring institutions, and this is growing at an annual pace of 10%.

In India, reform initiatives such as financial inclusion and digitalization are creating a wide range of financial services and new consumption patterns. Modern retailers benefit from a rising preference for modern grocery shopping. Healthcare services see structural demand growth as a result of ageing populations in North Asia and Singapore. And in emerging ASEAN markets, healthcare spending should rise, as it is still low compared to the developed world at around 5% of GDP, well below 10% in Japan and 17% in the US. In India, Indonesia and Vietnam, the young demographics and rising urbanization rate will boost spending on digital retail, housing, healthcare and communication services.

4. Seeking EM Structural Growth


To help manage the challenges from the trade conflicts, we have launched a new High Conviction Theme, Shaping a New China, which captures structural growth opportunities from China’s economic transformation and beneficiaries of policy stimulus. The US tariffs and sanctions have led Beijing to rethink its strategic positioning in the global technology supply chain. We note that the technology sector is the single largest part of China’s imports (21% of total imports in 2018), with semiconductors accounting for 70% of this.

With national security, supply chain stability and intellectual property in mind, China is investing heavily in R&D to strive for more independence in critical technologies and upstream components. In particular, China’s semiconductor companies are racing to make chips at home. They are also rapidly adapting to accommodate the rollout of 5G, slimmer smartphones, and burgeoning chip demand for autonomous driving. We don’t think the trade tensions will stop China from investing heavily in technological innovation and R&D, as it is determined to reduce its reliance on foreign technology. We find attractive opportunities in China’s newly emerging technology companies which will benefit from the more proactive monetary and credit policies to support technological innovation and industrial upgrading.

We expect the Chinese government to further step up monetary and fiscal stimulus through Loan Prime Rate cuts,

reserve requirement ratio reductions and corporate tax cuts. We forecast reserve requirement ratio cuts of 150bp and a 30bp reduction in Loan Prime Rate before the end of 2020. The government will likely double down on its support for the private sector to stabilise domestic growth. Hence, we continue to seek opportunities in selective Chinese financial and domestic consumption stocks exposed to policy easing, increased infrastructure spending, 5G and technological upgrading.

There are rapid structural reforms taking place. China is committed to opening its financial markets to foreign institutions in 2020, in part as a response to trade conflicts, but also for its own development needs. Foreign ownership limits on banks have been removed, and those for insurers and asset management companies will be removed in phases in 2020. Through a local acquisition, a US firm this year became licensed to provide digital payment services in China. Beijing is also improving the funding environment through the launch of a new Science and Technology Innovation (STAR) Board and is planning another new Technology Board in Shenzhen. We favour companies which will benefit from the government’s preferential policies to support the development of the Greater Bay Area and Shenzhen under its new role as the nation’s “pilot demonstration area for socialism with Chinese characteristics”.

Amid low global cash rates and bond yields, EM and Asian central banks are expected to stay dovish and offer further

monetary easing, supporting our bullish view on the High Conviction Themes of Asian Credit Opportunities and EM Debt with Focus on Carry. Generally resilient domestic fundamentals, structural growth potential and central bank easing are all supportive drivers for EM and Asian hard currency and local currency bonds. We favour local currency bonds in China, Indonesia, Brazil, Mexico and Russia and hard currency credit in China, Indonesia, South Korea, Brazil and GCC due to their attractive yield pick-up relative to DM credits, and supportive central banks’ policies. Technically, we expect EM and Asian corporate bonds to attract inflows from yield seeking investors around the world as they reallocate from their negative yielding debt markets into higher yielding assets.

Many EM and Asian central banks are expected to ease monetary policy further in 2020, helping to stretch out the current economic cycle, and thus limiting default risks. Some Asian credits often offer higher yields than their developed market counterparts with similar credit metrics, suggesting that there are still compelling relative value opportunities in Asian credit. Taking into account latest accelerated rate cuts by the People’s Bank of China, we stay bullish on Chinese hard currency and local currency bonds, and selective Chinese bonds issued by quality SOEs and high yield bonds issued by selective Chinese property developers.

22

We hold a neutral allocation to equities amid supportive central bank policies, but challenges to corporate margins and geo-political headline risks remain.

We favour the US over Europe, and focus on quality and dividend stocks in the current low growth and low yield environment. We hold a neutral view on China and focus on areas with structural support.

The year 2020 on the Chinese calendar is the year of the metal rat. It is supposed to be a year of new beginnings, new opportunities, love, and money. After a year filled with uncertainty and volatility, many global investors would no doubt welcome a new year filled with new beginnings. But it seems that the one factor that should continue to test equity markets is the political calendar. The year begins with the possibility of a Brexit deal, followed by elections in Taiwan, Korea, Hong Kong and possibly also in Singapore, and ends with the US Presidential election. While it is true that historically equities have performed well during US Presidential election years, any changes in

the polls could lead to two-way volatility. In addition, global economic growth and trade flows are weaker than normal and corporate margins are under some pressure. The policy response continues to be dependent on just one engine (central bank accommodation) while markets are still waiting for any tangible signs of broad-based fiscal support.

But while it may be difficult to match the 2019 performance, global equities should still be up in 2020, as monetary policy support remains in place and should limit any material sell-off. Price/earnings ratios are not overly stretched, and risk premia could come down somewhat when trade negotiations advance further. With organic growth weak and interest rates low, corporate M&A should remain a positive factor. And high corporate cash balances should allow for corporate stock buyback programs to continue to be a tailwind for stock markets throughout the year.

But the upside is unlikely to be uniform, with the US better placed than Europe, and cyclical sectors likely to underperform until there is better news on trade or increased fiscal spending. In the

meantime, we position in quality stocks with sustainable earnings, to weather any volatility in the macro data, and in dividend stocks, to generate some income in a low bond yield environment. We also worry that consensus expectations of continued margin growth are overly optimistic, as, in fact, margins are already declining, as shown in our graph. Companies with strong brand names, and effective operations, logistics and marketing should be more resilient to any margin pressure. Often, these are the companies that make the most of the technological innovations.

It is likely that tech will remain responsible for much of the long term growth and efficiency gains. Investors who get caught up too much in the vicissitudes of the business cycle run the risk of forgetting some of the secular themes that may propel productivity and equity market performance in 2020 and beyond. Deployment of 5G, for example, will expand connectivity across the globe, and enable other technologies like the driverless car, and an explosion of interactive content and media. We continue to see opportunities in digital consumption around the world, and in other structural growth themes (see themes section).

The US Hopefuls

The US equity outperformed most other markets in 2019, especially when performance is measured in a common currency. And while the trade dispute has slowed trade flows, manufacturing and investment spending, US economic and equity market fundamentals still look resilient. This is largely because of a strong consumer outlook, with the unemployment rate near 50-year lows, wages rising at more than a 3.0% annualized rate, interest rates to be on hold, and inflation in check. All those factors point to continued solid growth in consumer spending in 2020. We believe the Fed will remain on hold throughout 2020, and this should provide some stimulus to the interest rate sensitive sectors of the US economy, especially housing and autos.


Equities

95

100

105

110

115

120

125

130Cash US Europe ex UK UK

EM Asia EM Latam EM EMEA

Dec-18 Feb-19 Apr-18 Jun-19 Aug-19 Oct-19

The US has been the strongest equity market, but all equity markets outperformed cash in the year to date


2020 is a Presidential election year and historically US equity markets have performed quite well in the run-up. Volatility is likely, as the identity and policies of the democratic challenger are still unknown, and polls may vary during the year. The current administration seems determined to reach an agreement with Canada and Mexico on trade. They have also suggested they will introduce new proposals on topics as varied as healthcare reform and another round of tax reform aimed at the middle class. We believe the market would react positively to progress on any of these measures, as they could boost business optimism.

EM Asia: is the future here now?

A key part of the global growth and wealth creation story in 2020 and beyond will come from the emerging market countries in Asia, led by China and India. However, in the short-term the region may continue to feel the pressure of slower trade flows, elevated levels of debt, and the strength of the US dollar. Any substantial progress with the US-China trade negotiations could lead to better market sentiment, especially if the deal includes tariff reductions. While there has already been some anticipation of such a deal, Asian stocks remain cheap when compared to the US.

In the meantime, we continue to manage the challenges of slower global trade, and weaker economic growth in China and India by focusing on domestic themes and by limiting cyclicality. In China, the government is likely to continue to provide stimulus through reserve requirement cuts, lending policy reforms favouring the small private sector stocks, and continued investment into infrastructure. The introduction of 5G is a major government-led initiative and should help boost economic growth beginning in 2020, as digital consumerism and key business productivity-enhancing technologies will continue to drive future growth. We continue to focus on secular themes such as the expansion of the middle class, and the related demand for healthcare, education and entertainment.

European Opportunities

One of the surprises of 2019 was the strong performance of European stocks, amid falling economic growth. Hopes of a bottoming of economic data, and of US automotive tariffs potentially being avoided helped. The ECB’s decision not to charge banks negative rates on part of their reserves was a positive too.

Germany’s GDP growth is particularly challenged and it is likely that it may barely reach 0.3% in 2020, due to its dependence on manufacturing and, therefore, on exports. We upgraded German stocks to neutral as we think economists’ expectations are now very low. But we would need more definitive progress on a US-China trade deal, the potential automotive tariffs, and on Brexit, to become more optimistic. We maintain an underweight on Europe, as we view the US and Asia more favourable. We do not think that European valuations are as attractive as we often hear, once one takes into account that Europe has a much smaller technology sector than the US does. European companies do offer an attractive dividend yield for global investors, however, and compare quite favourably to the negative interest rates offered in bond markets.

We have been holding a neutral view on UK stocks due to the uncertainty around the Brexit process and continue to do so. The election outcome of 12 December could shed more light, and could cause us to change our view. But following the divorce, the negotiations on a future relationship with the EU will start, and uncertainty is therefore unlikely to disappear completely. We note, however, that the UK stock market is relatively cheap, with global companies trading at a discount. The evolution of GBP is important to watch, however. If improved risk sentiment pushes up GBP, this traditionally makes it difficult for UK multi-nationals to advance. Small cap domestic companies may fare better in this scenario.

Source: Refinitiv, Bloomberg, HSBC Private Banking as at 4 December 2019. Past performance is not a reliable indicator of future performance.

A weak economic outlook tends to lead to weaker margins, and they have already started to decline.

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Fixed income The ‘low for longer’ environment favours continued investment in bonds, but the ‘slow for longer’ economic environment means it is important to be selective.

We favour USD Investment grade, EM hard currency and local currency bonds.

2019 will be a year for bond investors to remember. The slowdown in economic activity due to trade tensions, coupled with subdued inflation forced Developed Market (DM) and Emerging Market (EM) central banks to ease monetary policy. Falling rates, low inflation and substantial risk premia in EM debt led to strong performance across bond markets. Our investment strategy focused on selective EM debt and US Investment Grade (IG) bonds at the detriment of DM sovereign and European corporate credit securities, and bore its fruits.

While we start 2020 on less appealing valuations relative to 2019, we largely carry on with the same strategy and remain invested. Our low for longer thematic in DM rates provides structural support for riskier assets, albeit with some limits because of below-normal

economic growth. In DM, we continue to have a defensive stance on European corporate credit due to deteriorating fundamentals and the fading effects of the ECB’s Asset Purchase Programme. We do not expect the ECB to cut interest rates further in negative territory. The slowing economy and poor state of manufacturing in Europe will continue to weigh on Cyclical and Industrial sectors. In addition, we anticipate the default rate among EUR High Yield (HY) companies to increase to 1.8% from 1.1% in 2019. On the flip side, we favour bonds issued by financial institutions on generally strong capitalisation and Non-Performing Loans (NPL) provisions and remain neutral on GBP credits which could enjoy tailwinds from any BoE’s easing. We have a mild preference for non-core sovereign bonds in the Eurozone relative to core countries due to a higher carry, but note that political risks in Italy and Spain could bring some rate volatility in the short term.

In the US, we remain constructive on investment grade (IG) corporates and have a neutral stance on high yield (HY) bonds. While we acknowledge credit spreads have substantially tightened over the year and the economic cycle

is mature, we believe recession risk is still distant despite the slowdown in activity. The Federal Reserve delivered three “insurance” cuts in 2019 which should keep financial conditions accommodative for some time. While we do not expect rate cuts in 2020, any substantial economic deterioration would be met with strong actions from the Fed. US corporate earnings growth may disappoint somewhat, but some large companies are starting to cut dividends and favour balance sheet deleveraging instead, benefiting bond holders. It is generally a strategic decision to maintain an IG rating for most BBB-rated companies. We also believe that fund flows towards US IG bonds should carry on in 2020 as there is still a relative opportunity for European and Japanese investors looking for positive yielding securities. This improved technical backdrop was seen in 3Q19, when heavy supply of new issues was easily absorbed, without harming secondary market credit spreads. In terms of sectors, we favour Financials. Their better capitalisation on the back of stricter regulation post global financial crisis has made this industry more resistant to any sell off and turned it into a lower beta investment. On the sovereign side, we have a tactical preference for index-linked bonds (TIPS) relative to conventional US Treasuries but remain largely underweight the overall DM sovereign spectrum.

Our low for longer thematic in DM rates also provides a positive backdrop for EM bonds. As such, we continue to have an overweight allocation towards EM bonds, in both Hard (HC) and Local (LC) Currencies. We focus our HC investments in selective markets where we see progress on economic reforms in countries like China, Indonesia, Brazil and to a certain extent in the GCC countries. Although growth has slowed down quite significantly in EM, central banks were able to cut interest rates and significantly reduce term premia. On balance, many of the leading EM economies are now quite

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Source: JPM CEMBI Index, ICE BofAML Index, Bloomberg as of 4 December 2019.Past performance is not a reliable indicator of future performance.

EM and US HY default rates remain low


resilient thanks to reduced structural imbalances with floating currency regimes, high FX reserves, benign inflation and better economic policies. In addition, many corporates have focused on deleveraging their balance sheets to reduce vulnerability to external factors over the recent years. The EM HY default rate continued to decline on average in 2019, falling from 1.6% to 1.1% (as of the end of October 2019). This is in stark contrast to US HY, where default rate increased from 1.9% to 2.8% over the same period. Many EM corporate issuers provide best in class credit fundamentals with lower leverage ratios compared to DM (i.e. Net Debt to EBITDA at 1.6x for EM HY compared to 3.6x in US HY and 4.2x in European HY). In our view, this means that although valuations on EM HC bonds might look stretched, they are justified by credit fundamentals. In the low growth environment of 2020, however, we expect credit spreads to remain broadly unchanged and yield to come mainly from coupon income, but still see potential for further spread compression in Asian HY companies. Outside of Asia, we prefer Brazil and GCC external debt, where structural reforms are taking place.

As for LC bonds, the continuing monetary policy easing from most EM central banks, coupled with the low economic growth and inflation provides a supportive backdrop to local rates. The expected ‘Phase 1’ of a US-China trade agreement may include guidelines on how to manage the Renminbi, and this should provide some comfort to investors by supporting to the overall EM currency complex. In addition, technicals are turning more supportive. Fund inflows have been strong lately driven by bond index inclusions and real-money investors continue to remain under-invested in this sub-asset class. Our focus in local rate markets is on China, Indonesia, Russia and Brazil. We recently upgraded Mexico, following a more dovish stance from Banco de Mexico which acknowledged below-target inflation and slowing economic growth. We recently downgraded our exposure to India to a neutral stance given rising fiscal risks this year and in 2020, following an unexpected fiscal stimulus for the corporate sector.

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is p

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s

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HY Asia US HY Euro HY

We believe there is still value in selective EM spreads


26

In terms of yield curve positioning, we reiterate our Buy and Hold strategy for USD bonds but move slightly further up the yield curve to focus on 3-5 year maturities. This maturity bucket allows us to capture more yield while still keeping any credit spread volatility in check. We favour BB to mid-IG rated USD-denominated corporate bonds with solid credit quality, from both DM and EM, to fulfil this approach.

Our ‘buy the dips’ and ‘sell the rallies’ approach can also be applied to bonds. Within our ‘low for longer’ yield view, we think it can make sense to tactically increase duration after episodes where bonds sell-off materially. Of course, such a tactical approach requires a high-risk profile and an awareness of the duration risks involved.

Source: JPM CEMBI Index, ICE BofAML Index, Bloomberg as of 4 December 2019.Past performance is not a reliable indicator of future performance.

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With the notable exception of Argentina, 10-year bond yields have come down considerably in 2019

28

We foresee further mild strength for the US dollar, but think that a number of EM currencies with yield and relative economic strength should be resilient. Political uncertainty should lead to a risk on / risk off environment for FX.

Currencies

FX markets are traditionally driven by cyclical, structural and political factors. But in the current environment of low rates, narrowing interesting rate differentials, and low volatility, some of these factors are having less of an impact, and this makes it harder to predict currencies’ behaviour. Also, continued geopolitical uncertainty can make it difficult for investors to anticipate the next move.

For a large part of 2019, FX was in a risk on / risk off mode, with currencies mainly moving up and down on the markets’

assessment of the overall level of risk. But lately, currency markets have been taking a more hopeful stance on geo-political issues and global growth. Cyclical currencies with supportive economic figures should perform well, especially if they also have positive real rates, and this points to support for the US dollar among G-10, and IDR or PHP among EM. USD should continue to trade with a positive tone, in spite of the two rate cuts delivered by the Federal Reserve in 2019. We believe that the Fed will not cut the policy rate any further in 2020, and the yield advantage of USD compared to other G-10 currencies remains a clear USD-positive. By comparison, currencies such as EUR, AUD or NZD with low (or even negative) rates and relatively weak economic drivers will struggle to perform, in our view, as investors look for yield and are likely to view the US economy as more resilient by comparison.

In the UK, the situation remains uncertain, with Brexit remaining the main driver of risk appetite, and setting the direction of sterling. The Brexit deadline was only pushed back by 3 months and a general election will be held on 12 December. We think that the market would see either a Conservative majority or a ‘remain’ coalition as positive for sterling, and a hung parliament as a negative for the currency. Following the elections, markets will try to assess whether the withdrawal agreement will be approved. If approved, the attention would then switch to the nature of the new trade relationship with the EU, and the timing of a vote on that new deal. We continue to see three possible scenarios, with the UK leaving the EU with a deal, the UK leaving the EU with no deal, or the UK not leaving the EU at all. Consequently, markets are unlikely to jump to conclusions until there is more clarity, and this explains why GBP has been trading in a range lately. Still, considering all the different case scenarios and their impact on the currency, we see, on average, slightly more upward potential than downward risk in the coming months. Given the number of critical steps, we do not think that it is prudent to bet on any political outcome, and instead adopt a sequential and event-linked approach.

Brexit is important for the Eurozone as well, and we think EUR could follow the same path as sterling in the short term. Indeed, EUR has been closely linked to GBP since the emergence of Brexit. Consequently, we think EUR will move sideways until there is a Brexit resolution, and we hold a neutral view on EUR in the short term. Still, we continue to see more downside risk over the longer term coming from current economic

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EUR and GBP have generally followed the same path, with mild weakness against USD throughout 2019


Currencies and Commodities


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The Chinese currency has recovered from recent lows, on hopes of progress on a US-China trade deal



challenges, because of limited room for the European Central Bank, and because of the unattractive bond yields in EUR when compared to USD.

In Emerging Markets, the risk-on mood has lately been supportive for select EM currencies. But we believe the outlook is mixed, and we therefore remain neutral and selective among EM currencies. Global uncertainties combined with a resilient USD could weigh on EM FX performance. However, some EM currencies should manage to remain robust and partly offset some negative forces with their appealing yield/risk ratio. We think countries with positive economic growth data and below-target inflation such as IDR and PHP in Asia, and RUB in EMEA could see more resilient currencies. In such cases, even if their central banks reduce the policy rate, this would not be seen as negative, but supportive for the domestic economy given a robust domestic situation and healthy external balances.

RMB has been appreciating in the lead-up to the signing of a “Phase 1” trade deal. However we still remain prudent as a ‘Phase 1’ agreement has not been signed yet, at the time of writing, the content is not fully known, and news reports highlight that the agreement could be postponed to the next year. The RMB’s outlook in 2020 will also depend on the likelihood of any further improvement in US-China trade relations (e.g. the likelihood of a “Phase 2” deal) and on China’s growth recovery. We think growth may slow somewhat further in 2020 and we keep our neutral stance on RMB, forecasting 7.15 by Q4 2020.

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Gold prices have benefited from the fall in bond markets’ real yields

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Commodities

We believe the gold price will edge higher in the coming months, supported by a mix of easier global monetary policies, economic uncertainty, and trade and geopolitical risks. In a low yield environment, gold’s lack of a coupon or dividend is less of a disadvantage than usual, and as the graph on the previous page shows, gold has benefited from falling real yields in the bond market. In addition, we think gold will be less exposed to downward pressures coming from the improvement in equity market sentiment as the market is already pricing in some of the positive news that could come from a US-China trade deal. A possible failure or delay in reaching a deal, uncertainties in the Eurozone created by Brexit and the coming general elections in the UK, the US and other countries should prop up the gold price. And while physical demand for the yellow metal is eroding due to the reduction in Chinese and Indian imports, investors’ demand looks resilient. The important gold-backed ETF holdings and the significant long positions on the Comex exchange are supportive for gold, and look strong enough to offset downward pressures from that softer physical demand. The further strengthening of USD we foresee is an obstacle for gold prices, but should be dwarfed by its safe-haven characteristics.

As for the oil market, we think prices will remain broadly steady in the coming months. Global uncertainties are negative for prices as the demand for the commodity usually falls in that kind of environment. High oil inventories in the US are a negative as well. However, our anticipation for further OPEC supply cuts through 2020 should limit any potential downside for crude oil prices. In addition, US oil supply is quite sensitive to the oil prices, and thus can help rebalance the market. We expect US supply growth to slow materially in 2020, which could act as a tailwind for prices. All in all, however, we still see supply growth exceeding demand growth, limiting the potential upside for oil prices.

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For investors who find safe haven bonds unattractive, hedge funds can be an alternative way of portfolio diversification and give some downside protection.

Hedge funds should also benefit from creative disruption and market volatility, which should provide good managers with opportunities to exceed the muted equity market returns we expect.

In the current low yield environment, where safe haven bonds often trade at negative yields, many investors are looking for alternative ways to diversify their portfolio. In this quest, we believe that hedge funds can play an important role. The flexibility of hedge funds’ investment mandates allows managers to invest capital free from most of the constraints faced by benchmark-oriented managers. Moreover, they also have the ability to sell securities short, which can prove valuable as a hedging and risk management tool. And lastly, different hedge fund strategies have low correlations between them. The average cross-correlations between strategies ranges from a very low 0.05 for market neutral and volatility arbitrage strategies to 0.40 for equity long-short strategies.

Beyond diversification, hedge funds often provide a good degree of downside protection. Hedge fund drawdowns have often been shorter and shallower than comparable drawdowns experienced by equity markets. We believe this can provide some comfort in the current uncertain macro environment, where investors are worried about potential corrections triggered by economic weakness, geo-political tensions or high market valuations. And if inflation were to rise or central banks were to become more hawkish (against our view), this could hurt both equities and bonds, and hedge fund strategies’ low correlations with both asset classes would be very valuable. And as our graph shows, where we are in the economic cycle tends to have little bearing on hedge fund returns.

The lack of a market benchmark in hedge fund mandates doesn’t only have diversification benefits, but also allows hedge funds to add to returns. Given our view that economic growth will be slow, and analyst earnings expectations are too high, equity returns may be muted, and any alpha generation will be welcome. Hedge funds try to identify securities they believe to be undervalued or overvalued on an absolute or relative basis, and selling short thus allows them to access

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Historical performance ahead of, and after, the bottom of US business sentiment.

Source: Bloomberg, HSBC Private Banking as at 4 December 2019. Past performance is not a reliable indicator of future performance. Data since 1980, including 9 instances of ISM bottoming.


drivers of return not present in traditional investment strategies.

As the world continues to change, the fourth industrial revolution, the rapid move towards sustainability, and the regionalisation of the global economy will all create disruption. Companies will have to adapt, and the winners of today could become the losers of tomorrow. Disruption naturally offers opportunities to hedge funds as positive and negative views can be expressed with long and shorts exposures. That said, hefty valuations somewhat limits the opportunity set. Hence, we favour managers who are sufficiently hedged and invest in sectors that continue to require domain expertise, grow secularly and undergo rapid change.

Political risks are difficult to handle for any investor, but they create both volatility as well as opportunities for managers. Capital preservation is embedded into the HF model, so risk has to be trimmed down during risk-off periods. It is true that during subsequent and sudden risk-on periods, hedge funds sometimes struggle to ramp up risk again, but volatility also creates opportunities, both from a directional and relative value perspective.

And lastly, the cash rate matters for returns. A low cash rate tends to have a slight negative impact as hedge funds usually hold cash due to their use of derivatives. But within the broader context of the current compressed bond yields, we believe that hedge funds can offer attractive relative returns since the profitability of their investment strategies is not necessarily directly linked to the level of yields, or the market direction.

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Amid lower than normal economic growth and the potential for short term volatility, the longer term approach of private assets can be valuable, if investors can live with lower liquidity for part of their portfolio. And as private markets have grown, they often offer opportunities that are not readily available in public markets.

The development of private markets is probably one of the most significant investment trends of the last 20 years. Over time, they have become capable of funding firms to a much larger size, and a number of young, fast-growing companies now choose to remain private. While the number of listed companies in the US has declined by 45% since 1997, the number of PE-backed companies has risen to about 8,000, broadening the opportunity set for investors. A growing availability of funding has delayed the need for initial public offerings (IPO) until company operations are more established. In fact, the pace of IPOs has nearly halved in the last 20 years. With companies choosing to remain private for longer in order to focus on their long-term development plans, as opposed to near-term revenue and profitability, much of the initial entrepreneurship value is being captured by private market investors, long before the IPO stage.

In fact, almost entire sectors of the economy are now absent from the public markets, for example software, where 98% of all companies are private. Software is appealing because of its high levels of recurring revenue and renewal rates, which should be robust through economic cycles. Amid the uncertainty around the economic cycle, such companies can be an attractive diversifier in portfolios.

Private markets can thus provide exposure to high growth sectors of the economy, which we continue to favour relative to cyclical sectors. Moreover, PE managers have the luxury of long time horizons

to create value, and this longer term PE holding period aligns well with growth companies’ business model, where the best opportunities can occur three or five years from now.

PE and Private debt firms are also sheltered from the day to day volatility of public markets, which is valuable, as we foresee the potential for volatility in public markets next year. Moreover, in volatile markets, investors can fall victim to behavioural biases or bad timing decisions, and a professional PE manager with the luxury of a long term approach can help avoid this.

In Private Credit, regulatory developments have led to a continued movement of lending activity away from bank balance sheets to direct lending. This provides multiple opportunities for investors to participate in bilaterally negotiated direct loans. These private loans often benefit from stronger investor protections (covenants and documentation) than public markets, and have benefited from both a complexity and illiquidity premium. In a world focused on yield, their high single digit return can be an important addition to fixed income portfolios. To build in downside protection, we currently favour funds lending to the upper middle market, where borrowers tend to be larger and more resilient companies, backed by private equity sponsors. If default rates were to pick up, managers with

the resources and skills to work through turnaround situations may outperform others. Generally speaking, though, private debt firms should be able to negotiate a better outcome than individual bond holders in the public markets.

Many commentators worry about the high amounts of fund raising and the run-up in valuations, and worry that managers may not find enough attractive opportunities to put their ‘dry powder’ to work. PE fundraising has indeed risen, but it is below the long term average when compared to the PE industry’s outstanding assets under management. Moreover, managers in the Buyout, credit and real assets space are still investing their funds within an average of 2.8 years, which is about the same pace as in the past 20 years. It is true that valuations have risen, but so have they in public markets. Still, managers who can source the best opportunities will likely outperform others, and we expect to continue to see a much wider dispersion of returns in private markets than in public markets because of this.

While PE investors wait for capital calls, the low cash rate can weigh on returns. To address this, secondary investments or staggered PE portfolios can be part of the answer.

Private markets

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Real estate provides an income stream which should compare favourably to low sovereign bond yields. Supply / demand dynamics and technological change are critical drivers of the choice of location and asset selection.

Global drivers of occupational real estate demand are mixed. Whilst employment growth is positive in most markets, pushing up wages, geopolitical events have shaken business sentiment. In light of this uncertainty, central banks have become more accommodative and governments have indicated a greater willingness to increase spending, which may, with time, bolster business investment and domestic demand. Longer term, occupier markets are being shaped by shifting demographics and disruptive technology.

The impact of new technologies is being most keenly felt in how consumers shop. The growing acceptance of shopping online, the improvement of the commerce platforms and the speed of delivery has hit traditional retailers such as department stores and mid-priced apparel. With profitability declining, landlords are having to offer significant discounts in many markets to maintain occupancy. Downward pressure on rents is greatest where ecommerce’s share of retail has grown fastest and furthest (including the UK, Germany, and some parts of the USA).

The reciprocal trend of faltering physical retail has been robust appetite for industrial (logistics) space as retailers reorganise supply chains to minimise both the cost and time of delivery. The importance of rapid delivery has fuelled strong competition for scarce urban logistics locations, driving rental growth. Again, the disruption has been greatest in those markets with higher ecommerce penetration.

Whilst technology allows for the transformation of consumer behaviour, it is being driven forward by younger generations. Millennials (born 1981-1996) and Generation Z’ers (born 1996-2010) are largely digitally native and take ubiquitous superfast connectivity and next-day delivery for granted. As their relative spending power grows, the shopping that older generations still tend to do in-store (such as grocery shopping) is expected to shift online, further supporting logistics at the expense of physical retail. Retail with a greater focus on convenience (groceries), services (dry-cleaning and restaurants) or with a strong experiential component is proving more resilient.

The rapid expansion of ecommerce has been mirrored by appetite for office space by the major internet platforms (such as Facebook, Amazon, Netflix, and Google). Along with many other companies hoping to become future platforms, demand for office space is fuelled by the appetite for graduates of STEM (science, technology, engineering, and mathematics) disciplines. As a result, markets such as San Francisco, Boston, London, Berlin, and Singapore in particular have benefited from these trends.

Despite the recent negative news surrounding WeWork’s failed IPO, the co-working sector remains a key source of new demand for many of the world’s gateway markets. In addition to freelancers and early stage start-ups, corporates are becoming increasingly important sources of demand as they use co-working space for short-term projects, as contingency space (e.g. a large investment bank recently set up an emergency trading floor in co-working accommodation in the City of London) and as a means of attracting younger talent who often prefer the more relaxed environment over traditional corporate offices.

Supply matters too. And given the late stage in the cycle, the pipeline of developments is moderate relative to previous cycles. Moreover, where the pipeline is elevated, it is usually a reflection of deep underlying demand. The shift to online retail precipitated the dramatic decline in new retail development and the reciprocal growth of industrial space. The scale of industrial construction has picked up in the US and UK, leading it to get closer to underlying demand, but it still allows rental growth to remain positive.

With the exception of a few markets, including Washington and New York in the US, office construction is still modest. Even in these markets, competition for new high quality space is high as, in a tight labour market, a firm’s office offering is central to attracting and retaining the best talent. And in many European and Asian office markets, where development has been limited and employment growth steady, vacancy rates in core locations are very low, supporting rental growth.

Property yields, having compressed across all sectors and geographies over the last decade, have started to differentiate as underlying prospects have diverged. For example, retail yields are now rising as rental rebasing and higher capex requirements depress values, whilst industrial yields continue to trend downwards as investor appetite builds.

In general, low property yields and moderating rental growth point to a period of lower absolute total returns. However, amid the loose monetary policy environment, future performance is expected to imply a reasonable premium over developed market government bonds. With greater diversity of both occupier performance and yield movement, property selection and asset management are becoming increasingly important to deliver performance.

Real Estate

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DisclaimerRisk Disclosures

Risks of investment in fixed income

There are several key issues that one should consider before making an investment into fixed income. The risk specific to this type of investment may include, but are not limited to:

Credit risk

Investor is subject to the credit risk of the issuer. Investor is also subject to the credit risk of the government and/or the appointed trustee for debts that are guaranteed by the government.

Risks associated with high yield fixed income instruments

High yield fixed income instruments are typically rated below investment grade or are unrated and as such are often subject to a higher risk of issuer default. The net asset value of a high-yield bond fund may decline or be negatively affected if there is a default of any of the high yield bonds that it invests in or if interest rates change. The special features and risks of high-yield bond funds may also include the following:

• Capital growth risk - some high-yield bond funds may have fees and/ or dividends paid out of capital. As a result, the capital that the fund has available for investment in the future and capital growth may be reduced; and

• Dividend distributions - some high-yield bond funds may not distribute dividends, but instead reinvest the dividends into the fund or alternatively, the investment manager may have discretion on whether or not to make any distribution out of income and/ or capital of the fund. Also, a high distribution yield does not imply a positive or high return on the total investment.

• Vulnerability to economic cycles - during economic downturns such instruments may typically fall more in value than investment grade bonds as (i) investors become more risk averse and (ii) default risk rises.

Risks associated with subordinated debentures, perpetual debentures, and contingent convertible or bail-in debentures

• Subordinated debentures - subordinated debentures will bear higher risks than holders of senior debentures of the issuer due to a lower priority of claim in the event of the issuer’s liquidation.

• Perpetual debentures - perpetual debentures often are callable, do not have maturity dates and are subordinated. Investors may incur reinvestment and subordination risks. Investors may lose all their invested principal in certain circumstances. Interest payments may be variable, deferred or canceled. Investors may face uncertainties over when and how much they can receive such payments.

• Contingent convertible or bail-in debentures - Contingent convertible and bail-in debentures are hybrid debt-equity instruments that may be written off or converted to common stock on the occurrence of a trigger event. Contingent convertible debentures refer to debentures that contain a clause requiring them to be written off or converted to common stock on the occurrence of a trigger event. These debentures generally absorb losses while the issuer remains a going concern (i.e. in advance of the point of non-viability). “Bail-in”

generally refers to (a) contractual mechanisms (i.e. contractual bail-in) under which debentures contain a clause requiring them to be written off or converted to common stock on the occurrence of a trigger event, or (b) statutory mechanisms (i.e. statutory bail-in) whereby a national resolution authority writes down or converts debentures under specified conditions to common stock. Bail-in debentures generally absorb losses at the point of non-viability. These features can introduce notable risks to investors who may lose all their invested principal.

Changes in legislation and/or regulation

Changes in legislation and/or regulation could affect the performance, prices and mark-to-market valuation on the investment.

Nationalization risk

The uncertainty as to the coupons and principal will be paid on schedule and/or that the risk on the ranking of the bond seniority would be compromised following nationalization.

Reinvestment risk

A decline in interest rate would affect investors as coupons received and any return of principal may be reinvested at a lower rate.

Changes in interest rate, volatility, credit spread, rating agencies actions, liquidity and market conditions may significantly affect the prices and mark-to-market valuation.

Risk disclosure on Dim Sum Bonds

Although sovereign bonds may be guaranteed by the China Central Government, investors should note that unless otherwise specified, other renminbi bonds will not be guaranteed by the China Central Government.

Renminbi bonds are settled in renminbi, changes in exchange rates may have an adverse effect on the value of that investment. You may not get back the same amount of Hong Kong Dollars upon maturity of the bond.

There may not be active secondary market available even if a renminbi bond is listed. Therefore, you need to face a certain degree of liquidity risk.

Renminbi is subject to foreign exchange control. Renminbi is not freely convertible in Hong Kong. Should the China Central Government tighten the control, the liquidity of renminbi or even renminbi bonds in Hong Kong will be affected and you may be exposed to higher liquidity risks. Investors should be prepared that you may need to hold a renminbi bond until maturity.

Risk disclosure on Emerging Markets

Investment in emerging markets may involve certain, additional risks which may not be typically associated with investing in more established economies and/or securities markets. Such risks include (a) the risk of nationalization or expropriation of assets; (b) economic and political uncertainty; (c) less liquidity in so far of securities markets; (d) fluctuations in currency exchange rate; (c) higher rates of inflation; (f) less oversight by a regulator of local securities market; (g) longer settlement periods in so far as securities transactions and (h) less stringent laws in so far the duties of company officers and protection of Investors.

Risk disclosure on FX Margin

The price fluctuation of FX could be substantial under certain market conditions and/or occurrence of certain events, news or developments and this could pose significant risk to the Customer. Leveraged FX trading carry a high degree of risk and the Customer may suffer losses exceeding their initial margin funds. Market conditions may make it impossible to square/close-out FX contracts/options. Customers could face substantial margin calls and therefore liquidity problems if the relevant price of the currency goes against them.

Currency risk – where product relates to other currencies

When an investment is denominated in a currency other than your local or reporting currency, changes in exchange rates may have a negative effect on your investment.

Chinese Yuan (“CNY”) risks

There is a liquidity risk associated with CNY products, especially if such investments do not have an active secondary market and their prices have large bid/offer spreads.

CNY is currently not freely convertible and conversion of CNY through banks in Hong Kong and Singapore is subject to certain restrictions. CNY products are denominated and settled in CNY deliverable in Hong Kong and Singapore, which represents a market which is different from that of CNY deliverable in Mainland China.

There is a possibility of not receiving the full amount in CNY upon settlement, if the Bank is not able to obtain sufficient amount of CNY in a timely manner due to the exchange controls and restrictions applicable to the currency.

Illiquid markets/products

In the case of investments for which there is no recognised market, it may be difficult for investors to sell their investments or to obtain reliable information about their value or the extent of the risk to which they are exposed.

Alternative Investments

Investors in Hedge Funds and Private Equity should bear in mind that these products can be highly speculative and may not be suitable for all clients. Investors should ensure they understand the features of the products and fund strategies and the risks involved before deciding whether or not to invest in such products. Such investments are generally intended for experienced and financially sophisticated investors who are willing to bear the risks associated with such investments, which can include: loss of all or a substantial portion of the investment, increased risk of loss due to leveraging, short-selling, or other speculative investment practices; lack of liquidity in that there may be no secondary market for the fund and none expected to develop; volatility of returns; prohibitions and/or material restrictions on transferring interests in the fund; absence of information regarding valuations and pricing; delays in tax reporting; - key man and adviser risk; limited or no transparency to underlying investments; limited or no regulatory oversight and less regulation and higher fees than mutual funds.


Investments in Commodities

Investments in commodities may involve substantial risk, as the price of the commodity may fluctuate significantly.

Important notice

The following may be subject to local requirements

This is a marketing communication issued by HSBC Private Bank (UK) Limited (see note 1) on behalf of HSBC Private Banking. This document does not constitute independent investment research under the European Markets in Financial Instruments Directive (‘MiFID’), or other relevant law or regulation, and is not subject to any prohibition on dealing ahead of its distribution. HSBC Private Banking is the principal private banking business of the HSBC Group. Private Banking may be carried out internationally by different HSBC legal entities according to local regulatory requirements. Different companies within HSBC Private Banking or the HSBC Group may provide the services listed in this document. Some services are not available in certain locations. Members of the HSBC Group may trade in products mentioned in this publication.

This document is provided to you for information purposes and general market commentary only and should not be relied upon as investment advice. This document is not offering securities and is not a prospectus. The information contained within this document is intended for general circulation to HSBC Private Banking clients and it has not been prepared in light of your personal circumstances (including your specific investment objectives, financial situation or particular needs) and does not constitute a personal recommendation, nor should it be relied upon as a substitute for the exercise of independent judgement. This document does not constitute and should not be construed as legal, tax or investment advice or a solicitation and/or recommendation of any kind from the Bank to you, nor as an offer or invitation from the Bank to you to subscribe to, purchase, redeem or sell any financial instruments, or to enter into any transaction with respect to such instruments. The content of this document may not be suitable for your financial situation, investment experience and investment objectives, and the Bank does not make any representation with respect to the suitability or appropriateness to you of any financial instrument or investment strategy presented in this document.

If you have concerns about any investment or are uncertain about the suitability of an investment decision, you should contact your Relationship Manager or seek such financial, legal or tax advice from your professional advisers as appropriate.

Market data in this document is sourced from Bloomberg unless otherwise stated. While this information has been prepared in good faith including information from sources believed to be reliable, no representation or warranty, expressed or implied, is or will be made by HSBC Private Bank (UK) Limited (see note 1) or any part of the HSBC Group or by any of their respective officers, employees or agents as to or in relation to the accuracy or completeness of this document.

The information stated, forward-looking statements, views and opinions expressed and estimates given constitute HSBC Private Banking’s best judgement at the time of publication, are solely expressed as general commentary and do

not constitute investment advice or guarantee of returns and do not necessarily reflect the views and opinions of other market participants and are subject to change without notice. Actual results may differ materially from the forecasts/estimates. It is important to note that the capital value of, and income from, any investment may go down as well as up and you may not get back the original amount invested. Past performance is not a guide to future performance. When an investment is denominated in a currency other than your local or reporting currency, changes in exchange rates may have an adverse effect on the value of that investment. There is no guarantee of positive trading performance.

Foreign securities carry particular risks, such as exposure to currency fluctuations, less developed or less efficient trading markets, political instability, a lack of company information, differing auditing and legal standards, volatility and, potentially, less liquidity.

Investment in emerging markets may involve certain, additional risks which may not be typically associated with investing in more established economies and/or securities markets. Such risks include (a) the risk of nationalization or expropriation of assets; (b) economic and political uncertainty; (c) less liquidity in so far of securities markets; (d) fluctuations in currency exchange rate; (e) higher rates of inflation; (f) less oversight by a regulator of local securities market; (g) longer settlement periods in so far as securities transactions and (h) less stringent laws in so far the duties of company officers and protection of Investors.

You should contact your Relationship Manager if you wish to enter into a transaction for an investment product. You should not make any investment decision based solely on the content of any document.

Some HSBC Offices listed may act only as representatives of HSBC Private Banking, and are therefore not permitted to sell products and services, or offer advice to customers. They serve as points of contact only. Further details are available on request.

In the United Kingdom, this document has been approved for distribution by HSBC Private Bank (UK) Limited (see note 1) whose office is located at 8 Cork Street, London W1S 3LJ. Clients should be aware that the rules and regulations made under the Financial Services and Markets Act 2000 for the protection of investors, including the protection of the Financial Services Compensation Scheme, do not apply to investment business undertaken with the non-UK offices of the HSBC Group. This publication is a Financial Promotion for the purposes of Section 21 of the Financial Services & Markets Act 2000 and has been approved for distribution in the United Kingdom (UK) in accordance with the Financial Promotion Rules by HSBC Private Bank (UK) Limited (see note 1) who is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

In Guernsey, this material is distributed by HSBC Private Banking (C.I.) a division of HSBC Bank plc, Guernsey Branch which is licensed by the Guernsey Financial Services Commission for Banking, Insurance and Investment Business. HSBC Bank plc is registered in England and Wales, number 14259.

Registered office 8 Canada Square, London, E14 5HQ. HSBC Bank plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority (UK FCA reference number: 114216).

In Jersey: Issued by HSBC Private Banking (Jersey) which is a division of HSBC Bank plc, Jersey Branch: HSBC House, Esplanade, St. Helier, Jersey, JE1 1HS. HSBC Bank plc, Jersey Branch is regulated by the Jersey Financial Services Commission for Banking, General Insurance Mediation, Fund Services and Investment Business.

In Switzerland, this material is distributed by HSBC Private Bank (Suisse) SA, a bank regulated by the Swiss Financial Market Supervisory Authority FINMA, whose office is located at Quai des Bergues 9-17, 1201 Genève, Switzerland. This document does not constitute independent financial research, and has not been prepared in accordance with the Swiss Bankers Association’s “Directive on the Independence of Financial Research”, or any other relevant body of law.

In Dubai International Financial Center (DIFC) by HSBC Private Bank (Suisse) S.A., DIFC Branch, P.O. Box 506553 Dubai, United Arab Emirates, which is regulated by the Dubai Financial Services Authority (DFSA) and is permitted to only deal with Professional Clients as defined by the DFSA.

In South Africa

In South Africa, this material is distributed by HSBC Private Bank (Suisse) SA’s Representative Office approved by the South African Reserve Board (SARB) under registration no. 00252 and authorized as a financial services provider (FSP) for the provision of Advice and Intermediary Services by the Financial Sector Conduct Authority of South Africa (FSCA) under registration no. 49434. The Representative Office has its registered address at 2 Exchange Square, 85 Maude Street, Sandown, Sandton.

In Bahrain and Qatar by the respective branches of HSBC Bank Middle East Limited, which is locally regulated by the respective local country Central Banks and lead regulated by the Dubai Financial Services Authority. In Bahrain, this communication is sent to the addressee for his/her information only and is not intended to be distributed to the general public in the addressee’s country of residence. The addressee notes, acknowledges and understands that the addresser established in the addresser’s country of residence is not licensed under the laws of the addressee’s county of residence and is, therefore, not subject to supervision or regulation by the local regulator at the addressee’s country of residence. None of the products and services of the addresser have been approved or registered with the local regulator.

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Disclaimer continuedIn Lebanon, this material is distributed by HSBC Financial Services (Lebanon) S.A.L., licensed by the Capital Markets Authority as a financial intermediation company Sub N°12/8/18 to carry out Advising and Arranging activities, having its registered address at Centre Ville 1341 Building, 4th floor, Patriarche Howayek Street, Beirut, Lebanon, P.O.Box Riad El Solh 9597.

In Hong Kong and Singapore, THE CONTENTS OF THIS DOCUMENT HAVE NOT BEEN REVIEWED OR ENDORSED BY ANY REGULATORY AUTHORITY IN HONG KONG OR SINGAPORE. HSBC Private Banking is a division of Hongkong and Shanghai Banking Corporation Limited. In Hong Kong, this document has been distributed by The Hongkong and Shanghai Banking Corporation Limited in the conduct of its Hong Kong regulated business. In Singapore, the document is distributed by the Singapore Branch of The Hongkong and Shanghai Banking Corporation Limited. Both Hongkong and Shanghai Banking Corporation Limited and Singapore Branch of Hongkong and Shanghai Banking Corporation Limited are part of the HSBC Group. This document is not intended for and must not be distributed to retail investors in Hong Kong and Singapore. The recipient(s) should qualify as professional investor(s) as defined under the Securities and Futures Ordinance in Hong Kong or accredited investor(s) or institutional investor(s) or other relevant person(s) as defined under the Securities and Futures Act in Singapore. Please contact a representative of The Hong Kong and Shanghai Banking Corporation Limited or the Singapore Branch of The Hong Kong and Shanghai Banking Corporation Limited respectively in respect of any matters arising from, or in connection with this report. Some of the products are only available to professional investors as defined under the Securities and Futures Ordinance in Hong Kong / accredited investor(s), institutional investor(s) or other relevant person(s) as defined under the Securities and Futures Act in Singapore. Please contact your Relationship Manager for more details.

Where we make any solicitation and/or recommendation in Hong Kong to you for a Financial Product (as defined in HSBC’s Standard Terms and Conditions) where this is permitted by cross border rules depending on your place of domicile or incorporation, we will take reasonable steps to ensure the suitability of the solicitation and/or recommendation. In all other cases, you are responsible for assessing and satisfying yourself that any investment or other dealing to be entered into is in your best interest and is suitable for you.

In all cases, we recommend that you make investment decisions only after having carefully reviewed the relevant investment product and offering documentation, HSBC’s Standard Terms and Conditions, the “Risk Disclosure Statement” detailed in the Account Opening Booklet, and all notices, risk warnings and disclaimers contained in or accompanying such documents and having understood and accepted the nature, risks of and the terms and conditions governing the relevant transaction and any associated margin requirements. In addition to reliance on a solicitation and/or recommendation made in Hong Kong by HSBC (if any), you should exercise your own judgment in deciding whether or not a particular product is appropriate for you, taking into account your own circumstances (including, without limitation, the possible tax consequences, legal requirements and any foreign exchange

restrictions or exchange control requirements which you may encounter under the laws of the countries of your citizenship, residence or domicile and which may be relevant to the subscription, holding or disposal of any investment) and, where appropriate, you should consider taking professional advice including as to your legal, tax or accounting position. Please note that this information is neither intended to aid in decision making for legal or other consulting questions, nor should it be the basis of any such decision. If you require further information on any product or product class or the definition of Financial Products, please contact your Relationship Manager.

In Luxembourg, this material is distributed by HSBC Private Banking (Luxembourg) SA, which is located at 16, boulevard d’Avranches PO BOX 733, L-2017 Luxembourg and is regulated by the Commission de Surveillance du Secteur Financier.

In the United States, HSBC Private Banking offers banking services through HSBC Bank USA, N.A. – Member FDIC and HSBC Private Bank International, and provides securities and brokerage services through HSBC Securities (USA) Inc., member NYSE/ FINRA/SIPC, and an affiliate of HSBC Bank USA, N.A.

Investment products are: Not a deposit or other obligation of the bank or any affiliates; Not FDIC insured or insured by any federal government agency of the United States; Not guaranteed by the bank or any of its affiliates; and are subject to investment risk, including possible loss of principal invested.

Australia

If you are receiving this document in Australia, the products and services are provided by The Hongkong and Shanghai Banking Corporation Limited (ABN 65 117 925 970, AFSL 301737) for “wholesale” customers (as defined in the Corporations Act 2001). Any information provided is general in nature only and does not take into account your personal needs and objectives nor whether any investment is appropriate. The Hongkong and Shanghai Banking Corporation Limited is not a registered tax agent. It does not purport to, nor does it, give or provide any taxation advice or services whatsoever. You should not rely on the information provided in the documents for ascertaining your tax liabilities, obligations or entitlements and should consult with a registered tax agent to determine your personal tax obligations.

Where your location of residence differs from that of the HSBC subsidiary where your account is held, please refer to the Disclaimer at http://www.hsbcprivatebank.com/en/utilities/cross-border-disclosure for disclosure of cross-border considerations regarding your location of residence.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of HSBC Private Bank (UK) Limited (see note 1).

A complete list of private banking entities is available on our website, www.hsbcprivatebank.com.

Note 1

On 1 January 2020, the business of HSBC Private Bank (UK) Limited will transfer, or as the case may be, will have transferred to HSBC UK Bank plc, conducted through its Private Banking Office at 8 Cork Street, London, W1S 3LJ. In this document, on and from 1 January 2020, please read references to HSBC Private Bank (UK) Limited as references to HSBC UK Bank plc.

©Copyright HSBC 2019

ALL RIGHTS RESERVED

Investment Outlook First Quarter 2020 · the long lasting hangover of the credit crisis....

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