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For professional investors
Asset Allocation Monthly
November 2014
MARKET REVIEW
Joost van Leenders, CFA
Chief Economist, Multi Asset Solutions
joost.vanleenders@bnpparibas.com
Economy
The US economy stayed more or less on the trend it has
followed since the end of the recession in mid-2009, i.e.,
weaker growth than during previous expansions but still
relatively solid. The first estimate of third-quarter GDP (+3.5%)
came in above forecasts. Domestic private demand exinventories was a little less solid, with an annualised increase
of 2.3% after 3.8% in the previous quarter, as growth slowed in
private consumption (+1.8%) and investment (+1.0%).
+31 20 527 5126
● Central banks moving in opposite directions
● Equity markets bounce from the dip
● Asset allocation: overweight equities and investment-
US real GDP
grade
Multi-asset
Active weights
Oct-14
Equities
Duration
Investment grade
Nov-14
∆ active
weight
7.5
5.0
2.5
0.0
-2.5
-5.0
-7.5
-10.0
(%-point contribution to growth)
08
09
Consumption
Net export
10
11
12
Government
Inventories
13
14
Investment
GDP (% yoy)
Source: Datastream, BNPP IP
High yield
Emerging market debt
Real estate
Commodities
In flagging the end of its asset purchases, the Fed began the
process of normalising its monetary policy, which it plans to
conduct very conservatively while providing a slightly more
For professional investors only
Asset Allocation Monthly | November 2014 – 2
optimistic scenario on the job market at a time when wages are
showing their first signs of acceleration and consumer
confidence is improving. In the euro zone, purchasing manager
and European Commission surveys stabilised in October after
several months of declines. The composite PMI index (i.e.,
both manufacturing and services) for the euro zone as a whole
thus came to 52.2 vs. 52 in September – the year’s low point –
and vs. almost 54 in July. The preliminary estimate showed a
slight uptick in inflation to 0.4% year-on-year in October.
Equity markets1
October featured a peak in nervousness and central bank
activity. Although the markets dropped spectacularly in midmonth, they quickly rallied. The MSCI AC World index, down
6% between the end of September and 16 October, ultimately
ended the month in positive territory (+0.6% in dollars).
Emerging markets also posted gains vs. the end of September
(+1.1% for the MSCI Emerging index expressed in dollars),
driven by Asia.
Eurozone HICP
MSCI World (ex EM) & MSCI EM
(% yoy)
4
1800
3
1600
2
1400
1
0
1200
ECB target
1000
-1
800
01/12 05/12 09/12 01/13 05/13 09/13 01/14 05/14 09/14
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
HICP
HICP-core
MSCI World
Source: Datastream, BNPP IP
MSCI EM
Source: Datastream, BNPP IP
Given the further decline in energy prices, inflation is likely to
remain weak over the next few months, and the later
acceleration in prices driven by the expected improvement in
the economy will be held back by a wide output gap. The
transmission of highly accommodating monetary policy to the
economy through the credit channel is likely to improve, driven
by the various measures announced by the ECB. In Japan, the
improvement in industrial output in September confirmed the
upturn in manufacturing activity that had been pointed to by the
surveys. The recovery has been slow and remains tentative,
but productive investment is likely to turn up. Consumption is
likely to remain sluggish due to the weakness in wages. The
BoJ decided on 31 October to accelerate the pace of its
government bond purchases. Exports from emerging markets
are still showing no signs of a clear acceleration, even in those
economies that historically are the most responsive to global
activity. Manufacturing surveys remain encouraging in Asia,
and a sudden slowdown is unlikely in the Chinese economy.
Emerging Europe (in particular Russia) and Latin America look
less solid but reforms may be undertaken in Brazil, now that
the presidential election is over.
The quickness of these shifts, both downward and upward,
suggests that hedge funds were very active. For, while investor
nervousness may be due to the release of rather disappointing
economic data early in the month – in particular in the euro
zone – and the downward revision in global growth forecasts,
there was really no change in the economy within a few weeks.
Similarly, the end of Fed quantitative easing (announced on 29
October) is no surprise, and the normalisation of key rates will
remain very conservative and steady. The (nice) surprise came
from the Bank of Japan, which on 31 October announced that
it was raising its monetary base target to 80,000 billion yen
(from 60-70,000 billion previously). This announcement helped
spark a steep rally in the main equity indices actions at the end
of the month. Meanwhile, earnings season is playing out rather
well in the US and more chaotically in Europe in the case of
some major companies. And, finally, the full assessment of
euro zone bank balance sheets is rather reassuring. Equities
moved very erratically, including during the upward phase. The
solidity of the US economy (and the Fed’s slightly more
positive analysis) led US indices to gains on the month. Within
the S&P 500 index (+2.3%), defensive sectors (discretionary
consumption, healthcare, and utilities) were the top
1
Unless otherwise mentioned, all indices are in local currency.
For professional investors only
Asset Allocation Monthly | November 2014 – 3
outperformers. The steepest decline was in the energy sector,
driven down by falling oil prices (-11.6% in one month for WTI).
In the euro zone, despite the rally in the second half of the
month, the indices ended the month down sharply (-3.5% by
the Eurostoxx 50), due to worsening economic indicators (in
particular in Germany). Boosted by the BoJ decision and
announcements by the GPIF public pension fund, which raised
its target weighting in Japanese equities (from 12% to 25%),
the Nikkei 225 gained 1.5% on the month (after rallying by
4.8% on 31 October). Unless otherwise stated, all indices are
in local currencies.
Bond markets
US government bonds in October mostly tracked equity trends.
A spectacular pullback in long bond yields thus sent the 10year US T-note yield under 2.15% at the 15 October close, in
reaction to the sudden drop in equities. During this session, the
yield underwent unprecedented shifts (-35bp), falling briefly
below 1.90%. The release of lower retail sales on top of rather
disappointing figures (ISM manufacturing index and regional
surveys) cast doubt on the true state of the US economy and
made investors believe that the Fed could postpone the
normalisation of its monetary policy. A rumour on Janet
Yellen’s confidence in the growth outlook partly reassured
market participants. The extent of the pullback called for a
correction, which ultimately came against a backdrop of the
equity rally and more solid indicators (industrial output,
consumer confidence, and GDP growth). The Fed’s rather
optimistic diagnosis in the FOMC communiqué led investors to
slightly raise their anticipations of a tightening in monetary
policy. The two-year T-note yield fell to 0.31% on 15 October,
ending the month at 0.49%, or 8bp lower than at the end of
September.
Two-year government bond yield
0.6
0.5
0.4
0.3
0.2
0.1
0.0
-0.1
01/12 05/12 09/12 01/13 05/13 09/13 01/14 05/14 09/14
US
Germany
Source: Datastream, BNPP IP
The 10-year yield fell to 2.34% on 31 October (-15bp in one
month). European bonds contributed to the sharp mid-month
pullback: the 10-year Bund yield hit a new all-time closing low
at 0.76% on 15 October (after approaching 0.70% intraday).
Greece’s inclination to exit the assistance programmes earlier
than expected had investors worried, triggering sharp upward
pressure on Greek long-term yields, which spilled over into
peripheral markets and sent investors retreating to the German
market against a backdrop of a still weak European economy
and very low inflation. Market movements then returned to
normal. The 10-year Bund yield ended the month at 0.84% (11bp), the Italian yield at 2.35% (+2bp), and the Spanish yield
at 2.08% (-6bp). The credit market was affected by receding
risk appetite in mid-month. As in other asset classes, shifts
were very sudden but short-lived, in particular in high yield
(HY) bonds in which spreads hit a high for 2014 in both the US
and Europe before pulling back. Investment grade (IG) bonds
in Europe quickly erased their mid-October declines.
INVESTMENT CLIMATE
Market volatility has not yet returned to the low levels of the
summer, but it has fallen. The market correction from midSeptember to mid-October has been mostly undone, with the
US taking the lead in the bounce. The S&P500 equity index
even ended October at a record high. European and Japanese
equities also rallied, but emerging equities lagged. Bond yields
rose by more in the US than in Germany, but fell in Japan. We
increased our exposure to risk at the start of the month through
a long global equity position and a long position in European
investment-grade corporate bonds.
Cross-currents
Markets are facing strong cross-currents at the moment. The
growth scare that caused the recent selloff in equity markets
looks overdone to us. Third-quarter growth in the US slowed
from the frantic pace of the second quarter, but was still strong
at 3.5% QoQ annualised. This overstates the trend somewhat
in our view, but the main message is that the US economy is
doing well. The eurozone definitely looks weaker. Third-quarter
growth data has yet to be released, but the economy clearly
struggled. That said, there are signs that growth will improve.
Japan has had difficulties regaining momentum after the
second-quarter plunge, while growth in China still seems to be
For professional investors only
Asset Allocation Monthly | November 2014 – 4
moderating. Elsewhere in Asia, growth is relatively uninspiring.
Among the BRICs, India has lost some lustre as the reform
process is slower than expected, while Russia and Brazil are in
recession.
The economic outlook is mixed and the same goes for
monetary policy. Ending its asset purchase programme, the
US Federal Reserve was more hawkish than expected in its
outlook, causing market expectations for rate hikes to be
brought forward. We think the first hike will occur at the end of
next year’s second quarter.
(Index, January 2008 = 100)
600
500
400
300
200
100
0
09
US
10
11
Eurozone
12
13
UK
Since we felt the negative market sentiment was overdone, we
went long global equities, long US versus European equities
and long European investment-grade corporate bonds. After
equity markets sold off further, we increased our long equities
position. US equities recovered more swiftly than European
equities due to a better economic performance and a strong
corporate earnings season. We later took profits on our US
versus Europe equity overweight.
Our overweight in European investment-grade credit is
strongly driven by monetary policy. ECB asset purchases may
lead to portfolio adjustments away from ABS and covered
bonds, as the ECB pushes up prices, and into corporate
bonds. The ECB could even start to buy these bonds directly,
which would support the asset class.
Central bank balance sheets
08
Increased risk in our asset allocation
14
Japan
Source: Datastream, BNPP IP
The ECB is still busy implementing new policy measures. The
programme to buy asset-backed securities (ABS) and covered
bonds may fall short of its target, so it could be expanded to
corporate bonds. We think purchases of government bonds
are less likely, although the chances of this happening have
increased as disinflation proceeds. The Bank of Japan
surprised markets with an earlier-than-expected increase in its
asset purchases. The move does not change the outlook. The
impact of QE on the real economy has so far been limited.
However, the drop in the Japanese yen and its impact on
exports should be watched. The Brazilian and Russian central
banks both hiked rates (by a larger-than-expected 150bp in
Russia), which was a bold step for both of them given the
weakness of their domestic economies.
Eurozone option-adjusted corporate spread
160
(basis points)
500
140
450
120
400
100
350
80
300
60
250
Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14
Investment-grade (lhs)
High-yield (rhs)
Source: Bloomberg, BNPP IP
When the opportunity presented itself, we closed our tactical
short duration position in US Treasuries. Currently, we do not
see any short-term trend in bond yields. They may be low
given the growth outlook, but low inflation and extremely loose
monetary policy should keep a tight lid on yields.
We see the recent decline in oil prices as positive on balance
since it increases purchasing power. But the downward impact
on already low headline inflation could fan fears of deflation in
some parts of the global economy.
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Asset Allocation Monthly | November 2014 – 5
Asset allocation2
Active weights
Multi-asset
Oct-14
Nov-14
∆ active
weight
Active weights
Fixed income
Oct-14
Nov-14
∆ active
weight
Euro Govies
Equities
Euro Govies AAA
Duration
Euro Short Dated
Investment grade
Corporate bonds (EUR)
High yield
Euro Inflation Linked
High Yield (EUR)
Emerging market debt
High Yield (USD)
Real estate
Emerging Bonds USD
Commodities
Emerging Bonds Local Ccy
Active weights
Equities
Oct-14
Nov-14
∆ active
weight
Foreign exchange
Active weights
Oct-14
Nov-14
∆ active
weight
AUD
European large caps
CAD
European small caps
CHF
US large caps
DKK
US small caps
EUR
Japan
GBP
Emerging markets
HKD
JPY
Active weights
Real estate
Oct-14
Nov-14
∆ active
weight
European Real Estate
NOK
NZD
SEK
SGD
US Real Estate
USD
Asian Real Estate
EM FX
* In foreign exchnage we are overweight CAD vs NZD and JPY and
overweight MXN vs GBP, AUD and NZD.
KEY
Overweight:
Increase:
Neutral:
No change:
Underweight:
Decrease:
Summary outlook
•
Fed asset purchases ended in October. First rate hike in Q1 2015 at the earliest, more likely in Q2. Cautious Fed tapering and an
improving outlook reduce the risk from the normalization of monetary policy in the US. Moving gradually, the Fed is keen to
prevent sudden increases in longer-term yields.
•
Europe’s fragile recovery has been undermined by geopolitical tensions, but the economy will not slide into recession.
Fundamental improvement in some peripheral countries and strength in Germany and the UK will prevent this. Fiscal drag is
fading. The ECB has contained systemic risks, but monetary policy support is still needed. Downward price pressures should
abate slowly. Main risks are lack of growth and reforms in some Eurozone members. Bond yields will stay low for an extended
period.
•
China’s trend growth rate has fallen and there are downside risks from the property and financial sectors. Growth in other
emerging markets is modest by historical standards.
•
Liquidity and monetary policy supportive for equities, but only cheap areas of the market are attractive. Better longer-term
opportunities in some fixed income markets.
The tables reflect net positions versus the benchmark within the MAS strategy model portfolio. Views on a particular asset class should not be seen
in isolation but in the context of the overall portfolio.
* Duration risk is managed independently of the underlying fixed income allocation using government bond futures.
2
For professional investors only
Asset Allocation Monthly | November 2014 – 6
Equities
Overweight
Changed. We still view the global economic cycle as negative on balance, with a rosy US outlook offset by the struggle of the eurozone,
Japan and emerging economies to regain momentum. Monetary policy is positive, especially with new stimulus measures in the eurozone
and Japan. Most importantly, we felt the selloff in September and October was overdone. We opened the overweight in early October and
expanded it around the middle of the month. In early October, we also went overweight US versus European equities, but took profits
when US equities outperformed, partly on a solid earnings season.
Small-cap equities:
Underweight
Unchanged. We are underweight European small caps versus large caps. Small caps are more exposed to the weak European economy,
while large caps should benefit from stronger growth abroad. We also regard European small caps as relatively expensive. Now that the
M&A cycle has slowed, small caps should benefit less as targets. Momentum and seasonal factors are negative, in our view.
Government bonds:
Neutral duration
Unchanged. Bond yields have remained low in Germany and the US. Falling inflation expectations, disappointing growth and the outlook
for low official rates largely explain the level of eurozone yields. We see no clear trend in yields, as expressed in our neutral duration
position. Yields look low relative to projected growth, but disinflation and extremely stimulative monetary policy prevent strong increases,
in our view. We closed the tactical short duration position in the US which we had in our flexible multi-asset portfolios.
Investment-grade corporate bonds:
Overweight
Changed. The ECB will not buy investment-grade corporate bonds directly, but its purchases of asset-backed securities and covered
bonds may lead to investors adjusting their portfolios in favour of this asset class. The ECB may even buy investment-grade credit directly
in a later stage. Direct or indirect ECB support should outweigh unattractive valuations, in our view.
High yield bonds
Overweight
Unchanged. We hold a small overweight. We expect defaults in the European segment to remain generally low. Ultra-loose monetary
policy by the ECB should also be beneficial. We like the coupon yield. Fed tapering may cause yields to rise, but since we have
implemented our overweight versus government bonds, which usually have a much longer duration, any yield increase should be hedged.
Emerging market bonds
Neutral
Changed. The economic outlook for emerging markets is clouded and the prospect of tighter US monetary policy weighs on emerging
currencies and spreads. At this point, we do not see a strong catalyst to reverse these trends, so we prefer to be neutral.
Real estate securities:
Neutral
Changed. We like certain fundamentals of US and European real estate such as falling vacancy rates and limited construction activity. But
we think the asset class is expensive in Europe and vulnerable to an increase in yields in the US. As we closed our underweight European
real estate versus European equities, we are now neutral in this asset class.
Commodities
Neutral
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Asset Allocation Monthly | November 2014 – 7
Changed. We are neutral overall, but we are overweight oil versus industrial metals. Although oil prices have fallen despite geopolitical
risk in the Middle East, we still expect this risk to drive prices higher, with added impetus coming from the pricing power of the OPEC
cartel and tight inventories. We think industrial metals markets are oversupplied already and further supplies can be expected which are
unlikely to be taken up given that global growth is modest. A recovery in metals prices does not look imminent.
For professional investors only
Asset Allocation Monthly | November 2014 – 8
Disclaimer
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**.
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1.
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2.
Any investment advice.
Opinions included in this material constitute the judgment of BNPP AM at the time specified and may be subject to change without notice. BNPP AM is not obliged to
update or alter the information or opinions contained within this material. Investors should consult their own legal and tax advisors in respect of legal, accounting,
domicile and tax advice prior to investing in the Financial Instrument(s) in order to make an independent determination of the suitability and consequences of an
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* BNPP AM is an investment manager registered with the “Autorité des marchés financiers” in France under number 96-02, a simplified joint stock company with a
capital of 64,931,168 euros with its registered office at 1, boulevard Haussmann 75009 Paris, France, RCS Paris 319 378 832. www.bnpparibas-am.com.
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