State of af­fairs

Hav­ing crossed the mid-way point of a “lack­lus­tre” 2016, what else lies ahead? Neo Teng Hwee dis­cusses the global out­look

Prestige (Singapore) - - CONTENTS - Dr Neo Teng Hwee is chief in­vest­ment of­fi­cer and head of In­vest­ment, Prod­uct and So­lu­tions at UOB Pri­vate Bank

Hav­ing crossed the mid-way point of a “lack­lus­tre” 2016, what else lies ahead?

The year started with cau­tious op­ti­mism that the global econ­omy would re­cover from a slow­down since the se­cond half of last year. China, the epi­cen­tre of fi­nan­cial volatil­ity, be­gan cur­rency re­forms, clean­ing up cor­rup­tion and deal­ing with ex­cess ca­pac­ity in the state-owned enterprises. How­ever, the eco­nomic fall­out stoked mar­ket fears that a per­fect storm was in the mak­ing. At the same time, the free fall in oil prices sent shock waves through the emerg­ing world, as well as through the en­ergy in­dus­try and banks that have re­lated ex­po­sures.

Thank­fully, volatil­ity sub­sided as the Fed slowed the pace of pol­icy nor­mal­i­sa­tion, keep­ing in­ter­est rates un­changed in the first four pol­icy meet­ings this year. Al­though the Chi­nese cur­rency and econ­omy have sta­bilised, oil prices have re­cov­ered and the US econ­omy ap­pears to be re­cov­er­ing from the first quar­ter weak­ness, the global out­look re­mains chal­leng­ing and a cau­tious risk-tak­ing ap­proach is war­ranted.

We have main­tained our out­look since the start of the year, which is that 2016 will be a year of lack­lus­tre, sin­gle-digit re­turns for risk as­sets as they trade within broad ranges with higher volatil­ity. This out­look was based on the view that while key economies (par­tic­u­larly the US econ­omy) were not likely to tip into re­ces­sion, growth ex­pec­ta­tions were sub­dued. Ad­di­tion­ally, we held the view that ag­gre­gate global mon­e­tary pol­icy would tighten as the Fed em­barked on its rate hike cy­cle, but would see bouts of re­prieve in the event of eco­nomic or mar­ket shocks.

These per­spec­tives have held up rea­son­ably well. The rally since mid-fe­bru­ary ap­pears to be more of a re­lief rally than the next leg-up to new highs in the cur­rent cy­cle. We see few fun­da­men­tal up­side cat­a­lysts for growth and earn­ings, as the out­look re­mains muted. In­deed, the con­sen­sus fore­cast of global GDP growth for 2016 has steadily been re­vised down in re­cent months and cur­rently stands at three per­cent — not dis­as­trous, but fairly lower than the av­er­age 3.5 to 3.8 per­cent. As an ex­am­ple of the weak growth, US non-res­i­den­tial fixed in­vest­ment (a lead­ing in­di­ca­tor of broader eco­nomic ac­tiv­ity) con­tracted 5.9 per­cent year-on-year in the first quar­ter.

Where eq­ui­ties are con­cerned, there are other head­winds and hence our un­der­weight call. The first is sea­son­al­ity. Whether the Wall Street adage of “Sell in May and go away” en­cap­su­lates deeper wis­dom or is sim­ply a self-ful­fill­ing prophecy, the fact is that since 2000, the May to Septem­ber pe­riod has seen global eq­ui­ties post an av­er­age re­turn of -3.2 per­cent. Fur­ther head­winds in­clude al­ready high val­u­a­tions and peak­ing cor­po­rate profit mar­gins at a time when wages are be­gin­ning to rise. These con­di­tions make it dif­fi­cult to ex­pect sus­tained cap­i­tal gains on eq­ui­ties. Equity in­vestors may con­sider ro­tat­ing into de­fen­sive sec­tors with a fo­cus on de­liv­er­ing re­turns through in­come dis­tri­bu­tion.

Cor­po­rate bonds should re­main a sound in­vest­ment. While growth prospects look weak, they are un­likely to pre­cip­i­tate re­ces­sion­ary con­di­tions that would threaten gen­eral cor­po­rate cred­it­wor­thi­ness. Fixed in­come in­vestors may wish to be se­lec­tive and avoid seg­ments where spreads have al­ready tight­ened sub­stan­tially and val­u­a­tions are high. In par­tic­u­lar, we would be se­lec­tive with US en­ergy-re­lated is­suers, as well as Chi­nese high-yield prop­erty names. Sov­er­eign bonds present lit­tle value at ei­ther low or neg­a­tive yields and may en­counter mark-to-mar­ket losses as the global econ­omy re­cov­ers.

The US dol­lar rally since mid-2014 took a pause fol­low­ing down­ward re­vi­sions to US rate hike ex­pec­ta­tions and sub­se­quent dovish com­mu­ni­ca­tion by the Fed. That said, the sub­stan­tial rally in var­i­ous emerg­ing mar­ket as­sets, in­clud­ing lo­cal cur­rency bonds, is likely to con­sol­i­date af­ter strong gains. How­ever, emerg­ing mar­ket as­sets are likely to have bot­tomed out this year as valu­a­tion has be­come more at­trac­tive af­ter years of poor per­for­mance. In­vestors could also add gold to their port­fo­lio as real in­ter­est rates are likely to stay low and gold can act as an in­sur­ance in times of un­cer­tain­ties.

As a gen­eral guide, given the largely range bound mar­ket con­di­tions, in­vestors should avoid buy­ing into ral­lies and sell­ing into panic. For more so­phis­ti­cated in­vestors, ac­tive par­tic­i­pa­tion through de­riv­a­tives could also cap­ture op­por­tu­ni­ties as volatil­ity pe­ri­od­i­cally spikes.

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