L’outlook 2018 di Syz Asset Management
A cura di Fabrizio Quirighetti, CIO and Co-Head of Multi-Asset Team, Hartwig Kos, Vice-CIO and Co-Head of Multi-Asset Team e di Adrien Pichoud, Chief Economist, SYZ Asset Management
2017 has on one hand been an uneventful year, with equity and bond markets maintaining their upward trend. On the other hand, there have been several macro and market events that could have derailed the near-decades long bull market, such as the ever-challenging Brexit negotiations, Presidential elections in France, political uncertainly in Germany, unrest in Spain’s Catalonia region, rates hikes in the U.S. and of course North Korea. In the end, it seems that financial markets will finish the year on a strong note with risk-inclined investors rewarded yet again.
How will markets fare in 2018 and what does the global economy have in store for investors? Positive growth, accommodative financial conditions and supportive sentiment point towards a second year of synchronized above –trend global growth in 2018, while inflation will remain a focus point as it will shape monetary policy normalisation speed and magnitude going forward.
MACROECONOMICS (Pichoud). While there are many factors that could impact the global economy from a macro-perspective, we believe that inflation and geopolitics are the greatest threats to risk assets in 2018.
- Inflation has remained stubbornly low in the last decade, despite exceptionally accommodative monetary polices. In large part, this is due to structural factors such as demographic changes, globalisation or technological innovations. Moreover, the legacy of the Financial Crisis on growth has persisted for long and began to dissipate only recently in Europe.
In the current more favourable economic backdrop, central banks are now hinting toward normalizing their policies, with the Fed leading the way. Given the support risk assets have derived from those accommodative policies in the past years, markets will be highly sensitive to any news that could encourage central banks to move faster than expected. Therefore, even just modestly higher inflation could spark sudden repricing of equity and credit markets. Investors should be warry of this risk and protect their portfolios accordingly.
- Geopolitics is the other area of concern. By mid-2018, the terms of any Brexit agreement (or lack of) will be clear. Should the ultimate divorce be a messy one, this would certainly be risk-off for the UK and could have broader regional implications. The Italian elections also loom on the calendar of risk-events in 2018. At this point, the election could really go in any number of directions. This degree of uncertainty – out of the worlds 3rd most indebted economy – may not bode well for risky assets. Finally, any conflict on the Korean Peninsula would most certainly be a negative event. Our base case is that none of these situations is likely, but the lack of clear visibility and greater-than-limited chance of a miscalculation should be factors in investors’ asset allocation decisions.
ASSET VALUATIONS (Kos). It goes without saying that fears about Inflation and Geopolitics will dominate the media coverage over 2018, but they are not the only risk factors that we face in 2018 and beyond.
The biggest risks in our view besides that are asset valuations. What makes valuations such a dangerous risk factor is the fact that it is a latent risk factor. This means that as long as the macroeconomic environment is good, investors don’t pay too much attention. But if there are only mild changes to the overall backdrop, investors will all of a sudden start paying a lot of attention to valuations and the fact that almost everything is expensive.
Looking at Bond markets, everyone knows that western government yields are low. But it is not the government bond segment where the frothiness in fixed income valuations transpires. It is corporate credit. After years of loose monetary policy and investor’s desperate hunt for yield, corporate credit in general but high yield markets in particular, have become the single most expensive asset class in the world.
Here we see that the yield of European junk bonds in blue is below the dividend yield on the Stoxx 600 in orange. In an environment where inflationary pressures are mounting and question marks over the ECB’s monetary stance are increasing, European high yield at these valuations is clearly vulnerable.
In investors mind’s equities are at the moment the asset class of choice. And indeed while bonds are expensive, equities are in comparison fair value. This is obviously a relative argument, but when looking at equity valuations in absolute terms the picture looks very different.
Taking the S&P 500 as an example, Robert J Shiller a Yale professor and Nobel laureate has created a time series of what he calls the Cyclically Adjusted Price Earnings ratio (CAPE). The aim of this CAPE measure is to provide an objective framework to compare equity valuations over the long term
This measure shown in blue is currently 31.3 the only time when this measure was that high was in 1929 shortly before the stock market crash and in 1999 during the dot-com Bubble. It is true that valuations can stay elevated and even stretched for a long time. But the important point here is that if sentiment towards equities turns more negative, valuation will clearly not provide a cushion to soften the impact.
Within equity markets there is also significant dispersion of style and sector preferences. A few areas are in vogue, while other areas are completely neglected by investors. A very good example of this is the relative performance of US Growth versus US Value stocks
Here you can see US growth stocks in orange and value stocks in blue. Since the early 90’ies growth has outperformed value. However this out performance has been patchy over time. In the late 90’ies growth outperformed value, after the burst of the dot.com bubble this reversed completely. However, since the GFC growth has persistently outperformed value. The overall outperformance stands currently at 250% which equals a 3 standard deviation over the observation time period. To put this in perspective, this a one in 370 year event, and we are in the middle of it.
One also has to bear in mind that the stark outperformance of growth over value has coincides with a time period of very loose monetary policy, where access to credit to fund further growth was cheap and easy. Going forward the path of monetary policy looks clearly different which could trigger shifts in investor preferences. Given the extremes that we are at the risks of sudden style or sector rotations in different segments of the market, not only growth and value is very high.
RISK & CORRELATIONS (Bolliger). From a purely quant perspective and risk standpoint, markets seem to be behaving too well despite, in many cases, very stretched valuations, which indicates very little buffer and places to hide in the event of market dislocations.
A casual look at the VIX Index, which has reached all time low, would give investors the false impression that there are no storm clouds or virtually any clouds on the horizon. Like if risks would have been suppressed from financial markets
A key milestone for investors in 2018 is to reconcile the inherent underlying risks to financial markets against the fact that market indicators appear to show they have disappeared.
Our base case is that we expect there will be at least one healthy market ‘correction’ in 2018. The concern would be to what extent such a market correction spreads. Leverage in the market will become clear as will the degree of confidence in the bull market. A risk-centred approach would be well warranted at this stage in the cycle. Markets may indeed continue to move higher, but the asymmetry is turning increasingly unfavourable at each new market high.
2018… ONE MONTH AT A TIME (Quirighetti). Plans are nothing. Planning is everything. And so we have quite clear views of what could positively or negatively impact market returns in 2018. Much like in 2017 or 2016, our longer views as well as our tactical positioning will be shaped by our in-depth monitoring of the economic backdrop, the valuations assessment of a large range of asset classes and a close attention to the various form of risks (intrinsic, across assets or within a balanced portfolio). With so many key events and outcomes still unclear at this stage, one cannot take a high conviction/ or any directional view without an exposure to risk.
Our approach will continue to find the best risk-adjusted positioning as well as instruments or creative ideas exhibiting favourable asymmetry – where our potential upside is far more attractive that any potential losses.
There are very likely to be interesting entry-points in the year, with some of the currently more expensive assets experiencing an overdue correction. In this way, 2018 may be somewhat different than 2017. As usual, we will be looking to deploy capital not following the market, but by identifying mispriced assets.
In this sense, whether inflation does spike, credit spreads widen, technology companies experience a re-pricing or any other unknown macro or market risks appear, our positioning will be one that allow for a close look at the dislocation and potentially find value that can be realised. This is what investing is all about and what we have been doing for the last 20 years and will do in 2018 and beyond.