Managing Director - Head of Global Asset Management
Weekly Investment View – 20 February 2017
Following the usual discussion of the markets, the Report looks in detail at: the ‘Trump week’, US Federal Reserve interest rate expectations, the latest ‘Yellen Watch’ (and US economic statistics), eurozone economic statistics, US and global inflation expectations, and the possible significance of the imminent change to be made in asset allocation at the world’s largest sovereign wealth fund.
As Friday approached it was looking as though the recent run of higher weekly S&P500 closes might finally end, at least for a while, and then came news that Unilever, one of the world’s largest consumer staples companies, had turned down a $143 billion approach from Kraft Heinz, another huge entity that is managed along totally different lines. With help from this shot in the arm (and strength in telecommunications services) the S&P500 closed the week at a further new record after all, at 2,351.16, up 1.51% over the week, and 5.02% ahead for the year-to-date. The MSCI World index (currently estimated to be 58.7% in US stocks) also closed at a new all-time high, up 1.20% over the week, and 4.87% ahead for the year-to-date.
‘The equity uptrend looks especially strong’
In the US it turned out to be a rather surprising week, in various ways. Janet Yellen’s testament to the Senate Banking Committee was deemed to have been more hawkish than of late. Turning to President Trump, he asked for the resignation of his National Security Advisor, only to be turned down by his chosen replacement for that position (supposedly because the latter had wanted to bring in his own team). We should also mention a Trump press conference at the White House which simply had to be seen to be believed, in which the President once again heavily laid into sections of the world’s press, with almost stand-up fights with CNN and the BBC. Those of us who have been bullish and content to look through and past a certain amount of Trump-generated background noise while awaiting details of tax changes et al began to lose some patience – until the weight of money in the markets reasserted its power. There has in reality been a growing dichotomy between many technical analysts on the one hand who view the markets (and the S&P and NASDAQ Composite and 100 indices in particular) as increasingly overbought, vs. those who draw attention to the fact that these equity indices, while moving ahead along their upper technical boundaries, have actually not moved beyond them – tantamount to asking whether it makes sense to bet against such an apparently powerful trend. Although staying long of equities during recent weeks has made sense, some general profit-taking will surely surface at some stage, although we would expect this to be short-lived.
The US dollar had a steady week, with its index closing 0.15% firmer, at 100.95. A degree of yen strength was offset by renewed worries for the euro as markets speculated on the outcome to Dutch, French, and also Italian elections, while it became increasingly clear that the Greek bail-out standoff was unlikely to be resolved in the short-term, and so could become more of a ‘live’ issue in those elections. The Janet Yellen headline quote from last week to the effect that it would be unwise for the Federal Reserve to wait too long to raise rates provided a more solid undertone for the dollar, with the latest Bloomberg futures-derived analysis registering a 34.0% probability of a 25 basis point hike for March (up from 30% earlier in the week), 55.9% for May (up from 48% earlier), and 74.8% for June. The US Treasury 2-year yield remained little changed over the week, at 1.1882%, with the US 10-year yield similarly little changed, at 2.4073%, following a rally to the 2.50% level after Yellen. The bottom-line here is that the latter bellweather yield remains substantially under control within its recent range, and the same remains true of the German 10-year, at 0.302%. Lastly, however, one of our sources reminded us that since the financial crisis, US (and other) banks have been adding to Treasuries because they qualify as ‘safe’ assets that help in meeting required regulatory capital ratios. US commercial banks are now thought to hold $2.4 trillion in government debt and related securities, more than twice the amount of nine or so years ago, according to the St. Louis Federal Reserve. More lax regulation would result in less demanding capital requirements, and they could accordingly reduce those Treasury positions.
‘The latest batch of US economic data was good’
In our latest ‘Yellen Watch’ section, please find below our key takeaways from her testimony last week, in addition to the widely-quoted, “…waiting too long to remove (monetary) accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession”. She said, “Ongoing gains in the labor market have been accompanied by a further moderate expansion in economic activity. US GDP real gross domestic product is estimated to have risen 1.9% last year, the same as in 2015”. She observed that, (1) “…business sentiment has noticeably improved in the past few months”; (2) “My colleagues on the FOMC and I expect the economy to continue to expand at a moderate pace, with the job market strengthening somewhat further and inflation gradually rising to 2%”; (3) “…most survey measures of longer-term inflation expectations have changed little, on balance, in recent months”. When it comes to the last point, although the comment specifically mentions ‘survey measures’, we - and others in the markets - are increasingly aware of a pickup in inflation expectations, to which we’ll return below. In other US economic news, retail sales rose by 0.4% in January, more than expectations for growth of 0.1%, and the December figure was revised upwards, to 1.0%, from 0.6%. The headline US consumer price index rose a seasonally-adjusted 0.6% last month (or 2.5% year-on-year), the largest amount for four years, and vs. expectations for a rise of 0.3%, partly due to higher gasoline prices. The ‘core’ CPI (excluding food and energy), however, rose 0.3% month-on-month (making 2.3%, year-on-year), counter to expectations for a small fall. The US producer price index rose 0.6% in January (vs. a 0.2% rise in December, and expectations for a rise of 0.3%, largely due to higher energy prices). Lastly, industrial production fell by 0.3% last month, largely due to a 5.7% fall in utilities output and vs. expectations for no change. So the latest batch of US economic data was broadly constructive.
Turning to the outlook for growth in the eurozone, the European Commission said last week that uncertainty about US policies, Brexit and elections in Germany and France could impact growth in the bloc this year. GDP growth in the 19 countries using the euro would likely slow slightly to 1.6% this year, from 1.7% in 2016, and then improve to 1.8% in 2018. They expect German GDP growth to be 1.6% this year, vs. 1.9% last year, and French growth to accelerate from 1.2% to 1.4% this year. Growth should remain in the 0.9% range in Italy this year. The Commission expects consumer prices in the bloc to accelerate to 1.7% this year, from only 0.2% last year. The latest wholesale prices statistics from Destatis for Germany, showed these increased the most in five years last month, increasing by 4.0% year-on-year, up from 2.8% in December. German consumer price inflation rose in January at an annual rate of 1.9%. Led by Germany, growth should continue to be at the low end although just about acceptable under the political circumstances, and helped by our expectations for a euro that should trade below parity against the US dollar later this year. As detailed in last week’s report, we continue to favour European equities.
‘China could now be exporting inflation, not deflation’
In China, we note that consumer prices rose 2.5%, year-on-year, in January (vs. expectations of a rise of 2.4%, and from 2.1% in December). Of possibly much more significance is the fact that Chinese producer prices increased by 6.9%, year-on-year, in January (vs. expectations of 6.6%, and up from +5.5% in December). So if we think back through this report, it does appear that inflation is picking up in a number of countries. We already know that China's imports of crude oil, iron ore, coal and other industrial materials have resulted in higher commodity prices generally in recent months. The bears would have us believe that China is about to see a tightening credit squeeze, and that their growth overall is slowing, while ‘hard commodity’ bulls talk about an imminent onslaught of infrastructure spending globally. In our Outlook document, we commented that the copper price, for instance, had probably risen too far, although any correction (below about $2.60/lb) should be bought into. Turning to Ms Yellen’s prepared comments in her testimony last week (about inflation surveys), we subsequently note from one of our sources that the Federal Reserve Bank of New York survey of consumer expectations released last Monday found that year-ahead inflation expectations in the US increased to 3.0%, from 2.8% in December and 2.5% in November. The expectation for three years ahead was 2.9%, up from 2.8% in December. Added to all this we have seen the Citi Global Inflation Surprise index rise into positive territory in recent weeks, to a reading of 9.86, the highest level since late 2011, and which is beginning to look like a trend change. The gold price perked up, and then came off. At school we were taught that increases in PPI feed through into CPI statistics when pricing power exists. In each cycle – and we have opined this could be an elongated one – the factors contributing to commodity price trends are different. We will report back to you.
INVESTMENT SUMMARY: At the very end of the ‘Economic & Investment Outlook’ chapter of the recent NBAD Global Investment View 2017, we wrote: “Norges, the largest sovereign wealth fund, is known to be increasing their equities exposure, and we expect others to probably be doing the same”. Last week it was announced that the Norwegian government has decided to submit to parliament a recommendation to increase the equity share in the Government Pension Fund Global (‘GPFG’) to 70%, from the current 62.5%. The government will also propose a downwards revision of the expected real rate of return of the fund from 4% to 3%. They said, “The expected return on equities exceeds that of bonds, thus supporting the aim of increasing the Fund’s purchasing power. At the same time, equities carry higher risks…”, before concluding that, “All in all, the government considers an equity share of 70% to carry acceptable risk”. The recommendation to increase the equity share of the GPFG will be presented to the Norwegian parliament on the 31st March. This is very interesting because this formal announcement by the Norwegians will create a stronger precedent for other SWFs to make similar moves, and underlines that we live in an increasingly equity-friendly world. The reduction of the estimated future real return on the GPFG is also instructive, probably recognizing that while they prefer equities over bonds, equities may not be that cheap historically, and that should bonds enter a bear market from these levels of still very low bond yields, overall average absolute returns would fall. Without immediately reading too much into this announcement we are nonetheless very excited by it, as for many years the accepted median/typical pension fund split between equities and bonds (ignoring for the moment real estate and alternatives) has been 60:40. While SWFs are individual and have their own specialist mandates, any tendency towards 70:30 for the ‘average’ fund will have significant (if gradual) implications for global securities markets.
Our Asset Allocation Committee meets later this week. In the meantime, our investment strategy remains unchanged.
This report has been prepared and issued by the Global Asset Management (“GAM”) of the National Bank of Abu Dhabi PJSC (“NBAD”) outlining particular services provided by GAM and does not constitute or form part of any offer or invitation to sell, or any solicitation of any offer to purchase or subscribe for, any shares in NBAD or otherwise or a recommendation for a particular person to enter into any transaction or to adopt any strategy nor shall it or any part of it form the basis of or be relied on in connection with any contract therefore. This report was prepared exclusively for the benefit and internal use of NBAD. This report is incomplete without reference to, and should be viewed solely in conjunction with the associated oral briefing provided by GAM. The report is proprie-tary to GAM and may not be disclosed to any third party or used for any other purpose without the prior written consent of GAM. The information in this report reflects prevailing conditions and our views as of this date, which are accordingly subject to change. In preparing this report, we have relied upon and assumed, without independent verification, the accuracy and completeness of all the information available from public sources or which was otherwise reviewed by us. In addition, our analysis are not and do not purport to be appraisals of the assets, stock or business of the recipient. Even when this presentation contains a kind of appraisal, it should be considered preliminary, suitable only for the purpose described herein and not be disclosed or otherwise used without the prior written consent of GAM. NBAD clients may already hold positions in the assets subject to this report and may accordingly benefit from the buying or selling of such assets as referred to in this report. This document does not purport to set out any advice, recommendation or representation on the suitability of any in-vestment, transaction or product (as referred to in this document or otherwise), for potential purchasers. Potential purchasers should determine for themselves the relevance of the information contained in this document and the decision to purchase any investment contained herein should be based on such investigation and analysis as they themselves deem necessary. Before entering into any transaction potential purchasers should ensure that they fully understand the poten-tial risks and rewards of that transaction (including, without limitation, all financial, legal, regulatory, tax and accounting consequences of entering into the transaction and an understanding as to how the transaction will perform under changing conditions) and that they independently determine that the transac-tion is appropriate for them given their objectives, experience, financial and operational resources and other relevant circumstances. Potential purchasers should consider consulting with such advisers and experts as they deem necessary to assist them in making these determinations and should not rely on NBAD for such purposes. NBAD is acting solely in the capacity of a potential arm’s-length contractual counterparty and not as a financial adviser or fiduciary in any transaction unless we have otherwise expressly agreed so to act in writing. NBAD does not provide any accounting, tax, regulatory or legal advice. NBAD is licensed by the Central Bank of the UAE.
NBAD London Branch is Authorized by the Prudential Regulation Authority. Subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from NBAD London branch on request. Registered in England & Wales: Company No: FC009142: VAT No: GB245 3301 91.
NBAD Paris Branch is licensed by the French Prudential Control Authority as a credit institution. NBAD Paris is registered in France under the company number: RCS Paris B 314 939 547.
This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness. All information and opinions as well as any prices indicated are currently as of the date of this report, and are subject to change without notice. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. At any time the National Bank of Abu Dhabi PJSC and/or NBAD Private Bank (Suisse) SA may have a long or short position, or deal as principal or agent, in relevant securities or provide advisory or other services to the issuer of relevant securities or to a company connected with an issu-er. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. Futures and options trading is considered risky. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. National Bank of Abu Dhabi PJSC expressly prohibits the distribution and transfer of this document to third parties for any reason. National Bank of Abu Dhabi PJSC and/or NBAD Private Bank (Suisse) SA will not be liable for any claims or lawsuits from any third parties arising from the use or distribution of this document. This report is for distribution only under such circumstances as may be permitted by applicable law. The “Directives on the Independence of Financial Research”, issued by the Board of Directors of the Swiss Bankers Association (SBA) do not apply.