You are here
Risk-on in 2018, but some notes of caution
Hugh Young, head of Asia-Pacific, Aberdeen Standard Investments
Virginie Maisonneuve, chief investment officer (CIO), Eastspring Investments
Dave Foord, CIO, Foord Asset Management
Joep Huntjens, head of Asian fixed income and emerging markets corporate debt, NNIP
Manish Singhai, head of Asian equities, Tokio Marine Asset Management International
2017 was a strong year for returns in many asset classes, but it was also dogged by a rapidly evolving geopolitical landscape, interest rate hikes and a slowing Chinese economy, among other speed bumps.
At an Investment Management Association of Singapore (IMAS) roundtable, leading asset managers discussed the opportunities and risks they see, and how investors should approach 2018.
What is your "big picture" for global markets? How do geopolitics, changing economies, regional conflicts and rising interest rates frame your macro view for 2018?
Hugh Young (HY): After a turbo-charged 2017, investors have become nervous of a market sell-off. But the end of the bull cycle isn't necessarily imminent, even though valuations are stretched. Global growth is improving, European exports and investment are up, China is not stalling as everyone had feared a year ago, and Japan is seeing better GDP numbers. Among emerging markets, years of deleveraging and balance sheet repair are now over.
While interest rates will start to go up, central banks remain vigilant to the risks of tightening too quickly and will make sure liquidity does not evaporate. Meanwhile, corporate margins and earnings are on the rise, in many cases leading to better dividend pay-outs.
Virginie Maisonneuve (VM): The global economy is now in a strong phase of synchronisation as Japan, Europe and emerging markets have joined the US in an upward growth path.
It appears that this Goldilocks scenario - positive GDP growth, high levels of liquidity, benign inflation and strong corporate earnings - which supported both equities and bonds in 2017, should continue into 2018. Asia especially stands to gain from a synchronised global recovery as China continues to improve the quality of its economic growth and development. Emerging markets in general could also benefit beyond current expectations if inflation remains benign.
Shifts in global leadership, demographic changes and technology advancements support our focus on the evolution of AI in 2018 as an investment theme, along with others, which will introduce new investment opportunities for many years to come.
Dave Foord (DF): Investors should remember that rising interest rates are a consequence of global growth, and synchronised global growth in 2018 will be positive for company earnings. It's important to keep an eye on this rather than just focusing on rising interest rates or geopolitical risk.
Joep Huntjens (JH): Looking into 2018, we expect Asian corporate bonds to continue to perform well relative to other regional spread products. Asian debt is well insulated from the expected rise in US interest rates given its relatively short duration and low interest rate sensitivity.
Fundamentals should remain stable, supported by the benign macro environment. High-yield corporates should have seen their worst in 2016, given the continued recovery in the metal and mining sector, while the recovery in the broader Chinese economy should offset a slower property sector that is impacted by cooling measures. Meanwhile, investment-grade fundamentals have seen improvements since 2013- 2014 as corporates cut back on capital expenditure.
Manish Singhai (MS): We enter 2018 on the back of very strong returns across asset classes. Current valuations are discounting a benign future, and against this backdrop, monetary tightening will be a key driver, especially if expectations of a dovish pace are believed. Global growth should continue to be strong, but China's resolve to refocus from headline GDP growth to the quality of its composition, needs careful monitoring. Geopolitics is a wild-card, be it North Korea or the Middle-East; the latter typically has a knock-on effect through oil prices. Overall, circumspection is definitely warranted, especially as we advance through 2018.
What is your investment focus for 2018?
HY: We believe that valuations for Asian and emerging market equities continue to look attractive compared to developed markets. That said, Japanese and European equities are interesting and there's always a case for diversifying into alternative assets.
On fixed income, we've been pulling out of the frothier parts of emerging market debt, but are still bullish on emerging market corporate debt denominated in dollars, local currency Indian bonds and selected frontier markets. Meanwhile, my equities colleagues in Asia have been increasing exposure in our regional portfolio to China, in recognition of changing patterns of domestic consumption and some evidence of better corporate governance practices.
VM: Going into 2018, we remain supportive of risk-on assets. In terms of overall equity valuation, we think there is still room for emerging market earnings and margins to accelerate more rapidly than their global peers, despite an improvement in performance over recent months. In addition, valuations are still supportive and emerging markets are still underweight among institutional investors - we think there is room for this gap to narrow in 2018.
From a fixed income perspective, emerging and Asian local currency bonds offer longer-term opportunities as the rate hikes and the liquidity clawbacks in developed markets are expected to be muted and gradual.
DF: In our view, equities are likely to perform best in 2018, with corporate earnings buoyed by continued global growth. Regionally, we expect emerging markets and China to have strong years; they are likely to outperform the S&P.
JH: We see attractive opportunities in Chinese USD bonds and while these bonds have recently underperformed on the back of heavy new issuance, we see an improving environment in 2018 with low default risk. China's goal to reduce leverage in the economy is also supportive of the fundamental outlook of Asian companies. The deleveraging trend will result in higher quality, more sustainable growth, but it will also lead to lower growth than the current level of 6.8 per cent. On the other hand, too aggressive a deleveraging might result in a more rapid deceleration of growth, which might trigger volatility from time to time.
MS: The strong coordinated returns across asset classes are unlikely to be sustained as we progress through 2018. Considering both the direction of interest rates as well as the reversal of quantitative easing by central banks, equities look relatively more attractive.
Even within equities, it is likely that dispersion across, and within countries, regions, and sectors would increase, offering better returns for stock-pickers. In the short term, US equities will be propelled by the boost in earnings from the recent tax reforms. Asian and other emerging markets look robust enough to absorb global and domestic monetary policy normalisation, assuming no negative surprises from China.
What do you think could possibly go wrong in 2018? How would you mitigate the effects in your portfolios?
HY: You can't rule out the possibility of a short-term correction. There are plenty of potential risks: passive fund flows distort valuations and sentiment can be fragile; conflict on the Korean peninsula; China's slowdown stifles growth even more than expected.
There are several ways you can mitigate these risks. You can look for markets where valuations can still be justified by earnings. You can diversify to reduce correlation between markets. You can look for assets that have fallen out of favour and are neglected. While 2018 may not deliver the same level of performance as last year, there are still opportunities. It's a matter of ignoring the consensus and doing the legwork.
VM: For all our belief in a Goldilocks scenario, we are equally mindful of the three bears too.
The first bear is the challenge for central banks as they navigate towards a new global liquidity paradigm. The second relates to labour markets potentially tightening in developed countries like the US which also faces the ongoing impact of technology and AI. The third relates to "economics versus politics" as geopolitics continues to weigh on the global economic environment.
In this context, we think it is worth protecting portfolios from potential "tail risk" events.We suggest including some exposure to low volatility strategies as well as diversifying across asset classes to include infrastructure and private equity in multi-asset strategies.
DF: I agree with what has already been said - it's always very sensible to have good diversification in place. I would also make a strong case that investing in asset classes with adequate liquidity and or in cash tends to be the best protection against adverse events.
JH: A primary risk is an unexpected rise in inflation, which could result in more hawkish than expected policies from developed-market central banks. In addition, main tail risks include US policy risk, such as the US' trade relationship with major global trading countries, and geopolitics.
We would mitigate some of these risks by focusing on liquidity and diversification in our investments. Moreover, we continue to focus on bottom-up credit selection rather than taking outsized interest rate duration positions to remain relatively insulated from unexpectedly hawkish policies.
MS: Subdued inflation readings around the world have allowed respective monetary authorities to go very slow in the interest rate normalisation process. Any surprise there, be it from demand - given low unemployment - or supply, say, from a spike in oil prices, could force their hand. Geopolitical flare-ups tend to stir volatility, at least in the short term. Staying highly vigilant and very selective at this stage of the bull market is the prudent approach.