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Can 2016 Earnings Justify Today’s Valuations?

Traditionally, equity people are supposed to be more optimistic than bond people, but I am prepared to buck the stereotype just a little as we enter day four of the Q1 earnings season.

Brad Tank, our fixed income CIO, followed Erik Knutzen in expressing cautious optimism that U.S. corporate earnings would recover enough in the second half of 2016 to justify much of the market rally that we’ve enjoyed since mid-February. They both wanted the economy to “show them the money” before dialing-up risk, as they put it, but they saw changes in the recent trends in the U.S. dollar and oil as the foundation for this recovery.

Truthfully, we are talking small degrees here. Brad and Erik both emphasized caution—as Erik put it, things were never as dark as they seemed on February 12, and they are probably not as bright as they seem today. Nor am I about to argue that we’ve inflated a bubble and stand on the brink of savage correction. Nonetheless, I think it’s fair to say that I am a little more circumspect.

The market pendulum tends to swing too far in both directions. Does the simple recognition that the world is not about to end explain why the S&P 500 Index went up more than 15% in 10 weeks? At 17.0-17.5 times forward earnings, U.S. large caps will not look particularly cheap should run-rate earnings for Q1 2016 come in at around $100-$105 per share, as seems likely. That’s a long way from the $120-$125 per share that we feel is required to support today’s multiples.

Amid the headline-grabbing extremes of pessimism, the more sober talk in January and February was of an earnings recession, and I don’t see anything that has fundamentally changed that narrative.

For sure, dollar strength has eased—but wasn’t that already underway by the second half of 2015? And yes, energy may be less of a drag this year—but does it follow that we are about to see break-out numbers from the financial, industrial, or consumer sectors?

Financials are especially important as it’s difficult to sustain a rally of this strength while banks are struggling to generate positive earnings. Q1 earnings from JPMorgan Chase, Bank of America Merrill Lynch, Wells Fargo and Citigroup have been released. We are used to the game in which analysts set expectations so low they’re almost impossible to miss: JPMorgan’s earnings per share beat the 13% slide that had been estimated. But the real takeaway was simple: the largest bank by assets in the U.S. saw its earnings fall by 7%. Citigroup’s, Bank of America’s and Wells Fargo’s reports told a similar story, with capital markets weakness hurting the first two and energy exposure the latter.

Elsewhere, some good news emerged out of Italy last week as a better-than-expected support program was thrashed out for its struggling lenders, but on the whole, European banks have performed poorly despite the expansionist policies announced by the ECB in March. Dealogic estimates that revenues in global investment banking are down 36% year-on-year, which would represent the toughest Q1 since 2009.

This background explains the elements of caution that underlie this rally in U.S. stocks. Small caps are still down year-to-date. The big value sectors that bore the brunt of the New Year sell-off, energy, materials and industrials, are up 6-8%, but the other big performers are defensive consumer staples and utilities.

I believe this is a “relief rally” that lacks a degree of conviction and is really a response to the excessive pessimism of the New Year. Again, to be clear, we are not talking about extremes in valuations. But the pendulum has swung far enough that I don’t feel compelled to chase this market, and I would need to see much firmer evidence of an earnings revival over the coming seasons to change my mind.

Discounting Discounts

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Los economistas están sobreestimando la inflación de la zona euro — CC-BY-SA-2.0, FlickrFoto: JJBAS. Discounting Discounts

Central banks usually target inflation, and for most central banks the target is headline inflation. But if a central bank actually tried to target headline inflation they would be changing rates every few months, and quite possibly changing direction each time. Both oil and food prices are very volatile and can have a big impact on inflation from one month to the next. Just think of what monetary policy would have looked like if central banks had tried to compensate for the fluctuations in oil prices over the last couple of years. And in any case, monetary policy has little impact on energy prices; monetary policy would just force the rest of the economy to compensate.

So central banks effectively target core inflation, because it is so much more stable. Markets, of course, are fully aware that core inflation is more stable and, for this reason, it does not take much of a surprise in the core inflation data to trigger an aggressive reaction.

Markets are quite good at understanding movements in core inflation that are driven by the economic cycle or consumer expectations. But there is one rarely considered factor that can cause quite significant inflation volatility: seasonality.

Inflation is meant to be an accurate measure of what the consumer pays for a certain basket of goods and services. If the prices of many consumer goods or services like clothes or airline fares, for instance, are affected by seasonal sales and public holidays then the consumer price index calculated on those prices should also mirror those seasonal swings.

The impact of seasonality on the price of goods and services can be quite substantial. For instance, the price of clothes or airplane tickets can move as much as 20% during sales and in the subsequent re-pricing. And this can have a relevant impact on the aggregate core price index.

Since we usually express inflation as the percentage change in the price of a basket of goods and services relative to a year ago, then in principle discounts during sales should have little effect on inflation. If sales take place every year on a given month then there should be little impact: prices drop this year but they also dropped last year, and the effects cancel out.

Although true in theory, this argument clashes with the crude reality that seasonality might not be constant over time and can change dramatically over the years. The Eurozone provides the best example of this. In fact, seasonal factors (i.e. the contribution to monthly changes in consumer prices due to seasonality) have changed radically since the introduction of the Euro (chart 1). Around a decade and a half ago, January sales would negatively impact core prices by just over 0.5% while July summer sales had almost no impact. This contribution has increased over time to about -2% for January sales and almost -1% for summer sales.

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By construction, seasonal factors have to total zero over a year. This means more aggressive sales in January will also imply a more aggressive re-pricing over the following months (such as February and March). This can, and has, increased the volatility of core inflation through the year.

This dramatic change in the seasonal pattern is much more visible in the Eurozone than in other developed economies like the US and UK, where inflation tends to have a much more stable seasonality. So, what could have caused such an evolution in the seasonal pattern of Eurozone core inflation?

There are a few reasons. The first is more a technical than an economic reason and it relates to improvements in the statistical methodology used to account for seasonal sales and discounts.

Seasonal sales are not a recent phenomenon. However, in most countries they were not included in the calculation of inflation until it was decided to create a measure of Eurozone inflation based on a common methodology, the so called Harmonised Index of Consumer Prices. This meant most European countries had to modify their methodology for surveying prices and calculating inflation. Furthermore, not all the statistical offices of the different countries decided to introduce the new methodological improvements at the same time. As a result, it looks as if in the Eurozone seasonal sales have only become more popular recently, whereas it may be that they are simply being measured more accurately.

While this explanation is possibly responsible for most of the intensification in the seasonal pattern, there are also other economic factors at play, such as competition. The internet not only created an alternative means of purchasing goods and services it, also allowed consumers to compare prices among different shops and providers. This has probably led to more aggressive competition during sales. At the same time, the prolonged period of economic crisis in the Eurozone could have forced shops and firms to be more competitive during sale periods since people were not willing to spend that much. This cyclical component could partially explain the reversal in the seasonal pattern that seems to be taking place at the beginning of 2016.

If core inflation has become more volatile over the course of the year because of the change in seasonality, it has also become more difficult to forecast given that neither statistical models nor economic judgement can easily cope with such changes in the seasonal pattern. This also means the change in the seasonal pattern might have created a seasonality in market surprises for core inflation (the actual reading relative to consensus expectations) (see chart 2), and potentially on market reactions too.

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The evidence suggests this is the case. Since 2004 core inflation has always surprised markets on the downside in January, July and November. Interestingly, it seems that over time, markets have accounted for more aggressive sales in January since the surprise has decreased over time. Conversely, markets have regularly underestimated core inflation in March and to a lesser extent in September.

The efficient markets hypothesis tells us that this should not really be happening. If there is a persistent seasonal bias in the data, the market should be capturing it. Perhaps market economists are not as good at capturing systematic patterns as the market is. But at least they do seem to be learning: economists are overestimating Eurozone inflation by far less in January than before, despite the increase in seasonality. The market (and especially economists) may not be as quick as the efficient markets hypothesis would suggest, but eventually they manage to discount the patterns. Or in this case, to discount, rather than miscount, the discounting.

Joshua McCallum is Head of Fixed Income Economics UBS Asset Management and Gianluca Moretti is Fixed Income Economist UBS Asset Management.

Japan’s “Show Me the Money” Corporate Governance

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Cinco razones que explican por qué los beneficios empresariales de Japón van a seguir creciendo — CC-BY-SA-2.0, FlickrPhoto: L'Ubuesque Boîte à Savon . Japan's "Show Me the Money" Corporate Governance

Given the 4th quarter slowdown in the global economy, it is no surprise that overall corporate profit margins in Japan decelerated during that period. But before one panics and says that they are about to plummet, one should realize that it would likely require a global recession for such to occur and that the 2005-2007 period showed that profit margins can plateau at a high level for an extended period of time. Indeed, the four quarter average is still creeping upward to new record levels, and like most of the rest of the world, the manufacturing sector is declining while the non-manufacturing sector is accelerating to record highs. Meanwhile, Japanese profits are performing much better than those in the US or Europe. We have covered the reasons for such in our recent piece The Japanese Equity Outlook After the Nasty New Year Start, but let us emphasize herein the corporate governance aspect of that piece.

The fact remains that, partially due to the encouragement of the Abe administration, Japanese corporations are continuing their structural shift towards improving profitability. This is “icing on the cake” of the “Show Me the Money” corporate governance improvement that we have long-highlighted in our thought leadership effort on Japan. Indeed, while increasing the number of independent directors and other recent governance issues are very important in the intermediate term for Japan, it is crucial for investors to understand that much of the profitability message has actually been understood by Japanese corporates for a decade. This is shown by the divergence in the profit margins from the trend in GDP growth in the chart below, showing that even though GDP growth has remained subdued, profit margins have surged.

Since the Koizumi era, Japan has embarked on major rationalizations in most industries, with the number of players often reduced from seven down to three. The fruits of this restructuring were slower to ripen than in Western world examples, and they were hidden by a series of crises (the Lehman shock, the turbulence in China, the strong Yen and of course, the Tohoku crisis), but since Abenomics began, the global backdrop for Japan has been stable and there have been no domestic crises, thus allowing the fruits to ripen.

The CY4Q15 data on overall corporate profits (not just of listed companies) recently announced unsurprisingly shows some flattening of this upward trend, with pretax profit margin’s four-quarter average hitting the slightly higher new record level of 5.36%. We expect that profit margins will flatten in coming quarters, partially driven by continued industry rationalizations and cost-cutting, but also negatively impacted by the stronger Yen. As mentioned above, the profit margin of services industries also surged to a new record high, as shown in the second chart below.

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One should also note that Ministry of Finance statistics do not cover post-tax income, and due to recent corporate tax cuts, the overall net profit margin is likely expanding significantly.

Conclusions

Japan’s overall corporate profit margin is unlikely to reverse soon on a four-quarter basis, while we believe the service sector will remain strong.
“Show Me the Money!” corporate governance: partly due to Abenomics, Japanese companies care even more now about corporate profitability and shareholder returns.
The dividend paid by TOPIX is surging upward and we expect it to double in the five years from 2013 through 2018.
Poor demographics can be linked with poor GDP growth, but countries like Japan with strong automation and efficiency capabilities will likely continue to completely offset this factor (see our report on Debunking Demographics).
As these charts show, even if Nominal GDP growth is fairly subdued, corporate profits can rise sharply in Japan due to productivity increases and gearing to global growth via multinationalization. Thus, weak domestic GDP statistics should not concern investors much. Indeed, normally, the service sector would be hurt the most by weak domestic GDP in a typical country, but Japan’s services sector profitability has been very strong despite weak GDP and we expect such to continue, which should assuage investors’ fears to a large degree.

John Vail is Nikko AM’s Head of Global Macro Strategy and Asset Allocation.

Japan’s “Show Me the Money” Corporate Governance

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Los márgenes empresariales se disparan en las compañías japonesas — Photo: Moyan Brenn. Japan's "Show Me the Money" Corporate Governance

The fact that due to the encouragement of the Abe Administration, Japanese corporations are strongly emphasizing profitability is extremely important to investors in Japanese equities. This is “icing on the cake” of the “Show Me the Money” corporate governance improvement that we have long-highlighted in our thought leadership effort on Japan. Indeed, while increasing the number of independent directors and other recent governance issues are very important in the intermediate term for Japan, it is crucial for investors to understand that much of the profitability message has actually been understood by Japanese corporates for a decade. This is shown by the divergence in the profit margins from the trend in GDP growth in the chart below, showing that even though GDP growth has remained quite subdued, profit margins have surged.

Since the Koizumi era, Japan has embarked on major rationalizations in most industries, with the number of players often reduced from seven down to three. The fruits of this restructuring were slower to ripen than in Western world examples, and they were hidden by a series of crises (the Lehman shock, the turbulence in China, the strong Yen and of course, the Tohoku crisis), but since Abenomics began, the global backdrop for Japan has been stable and there have been no domestic crises, thus allowing the fruits to ripen.

The CY2Q15 data on overall corporate profits (not just of listed companies) recently announced continues this upward trend, showing that the pretax profit margin’s four-quarter average hit a new high of 5.26%. We expect that profit margins will expand further in coming quarters, driven by continued industry rationalizations and cost-cutting. It is also worth mentioning that forex related profits are not the only driver of this improvement, as the profit margin of services industries also surged to a new record high, as shown in the second chart below.

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Of course, this improving structural profitability trend has become more fully realized by global investors, but there remain a decent number of Japan-skeptics, and 2Q profit margins surged so much that this dwindling group should reduce their remaining doubts; and thus, there is a significant amount of overseas capital that can still flow into Japanese equities.

Conclusions

Years of corporate restructuring’s progress was hidden due to successive global and domestic crises.
“Show me the Money!” corporate governance: Japanese companies care even more now about corporate profitability.
The dividend paid by TOPIX is surging upward and we expect it to double in the five years from 2013 through 2018.
On top of the corporate tax cut in April, Abenomics is having a strongly positive effect on profits due to the normalized Yen and further deregulation should gradually push profit margins higher.
Poor demographics are linked with GDP growth, but countries with strong automation and efficiency capabilities can completely offset such (see our report on Debunking Demographics). As these charts show, even if Nominal GDP growth is fairly flat, corporate profits can rise sharply in Japan due to productivity increases and gearing to global growth via multinationalization.

Opinion column by John Vail, Chief Global Strategist at Nikko AM

China: Real or Imagined Economic Improvement?

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¿Podrá la Fed adoptar una política monetaria completamente diferente a la del BCE y el Banco de Japón y resistir a la presión que llega desde China? — CC-BY-SA-2.0, FlickrPhoto: Billie Ward. China: Real or Imagined Economic Improvement?

The ‘lower for longer’ environment that we are experiencing has required central banks to adopt some extraordinary measures. Most recently the Bank of Japan adopted negative interest rates and the European Central Bank pulled multiple levers including cutting the depo rate by 0.1%, increasing quantitative easing and opening it up to non-financial corporate bonds, as well as introducing a new series of four-year targeted long-term refinancing operations (TLTROs). These measures, along with an upswing in corporate profitability and growing signs of stability in credit markets, have helped provide a backdrop against which risk assets look more benign. They have certainly resulted in a wild ride for banks.

Our view is that, in Europe at least, the ECB measures are probably a net positive for bank earnings and banking pressures should diminish from here; but market sentiment is still ‘see-sawing’ between confidence that central banks absolutely have enough in their policy toolkits to avert deflationary pressures and stimulate growth, and fears that those toolkits do not have a lot left in them – as seen by initial reactions to the ECB closing the door on further rate cuts.

In the US, a host of market participants had been circulating expectations that the US could be heading into recession this year, but economic data has begun to turn, with very strong US employment data in particular coming hot on the heels of other economic surprises, helping to ease financial conditions. But we must bring China in here. As China-watchers, we are trying to interpret whether the recent improvement in sentiment is backed up by real or imagined economic improvement. Clearly, none of the structural issues we have identified previously appears to have been addressed: the central bank is targeting a 6-6.5% growth rate this year and the liquidity taps have been turned on but, ultimately, we believe China is experiencing a cyclical rather than a structural improvement as the PBoC tries to ease the pace at which economic growth decelerates. For the US, the key question is one of divergence: is the Fed able to adopt monetary policy that diverges from ECB and Bank of Japan actions and operates independently of spillover pressure from the China slowdown? We believe the US dollar is ready for another leg-up, but it needs a catalyst such as the Fed raising rates – that may not happen until June.

Brexit uncertainties persist. The online polls seem unambiguously to be coming out in favour of leave, whereas the phone polls are unambiguously favouring remain – by a wide margin. Central establishment figures have entrenched themselves on both sides of the debate but this has not lessened the uncertainty, that is only intensifying as we move closer to the 23 June referendum. Sterling has been the main mover in this, with market forecasts indicating 1.50 against the dollar is the appropriate valuation for remain and 1.20 an appropriate valuation for leave. As the polls change, so Sterling gets battered about. How markets change in the run-up to the referendum will be interesting. The uncertainty is putting ever more distance between the Bank of England moving interest rates – despite relatively good labour market numbers – with our valuation research indicating the first rate rise in April 2019, though some analysts have pushed that back to 2020.

Mark Burgess is CIO EMEA and Global Head of Equities at Columbia Threadneedle.

Oil, the Dollar, Rates: Three Stars Align

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Last week my colleague Erik Knutzen wrote about today’s “show-me-the-money” markets. It’s an important element in our current thinking so I am going to expand on it a little here. But I also want to examine why the very mixed fundamental data we have been seeing, which may not appear to support the recent rally in risk assets, may also be favorable for fixed income credit.

The improvement in sentiment since mid-February, when it looked like the perfect storm was descending on financial markets, has been huge. But is it justified by better fundamental data? That’s not obvious—when you add up the news flow on growth, profits, central bank policy, global production, consumption and jobs, you end up with a pretty mixed bag. A lot of the re-pricing of risk since mid-February was fuelled simply by improved sentiment. We managed to sail around the worst of the storm.

So the big question now is whether the economy can sustain that with a significant improvement in corporate cash flows, earnings and profits: “Show me the money!”

We are cautiously optimistic because we believe the conditions for these improvements are relatively easily met and may already be evident. Four months ago when we took a step back to review 2015, two big themes stood out: We could see that better earnings in the second half of this year would likely result if the dollar stopped going up and oil stopped going down. In our view, it is no coincidence that U.S. corporate cash flow peaked in the second quarter of 2014, when oil was north of $100 per barrel and the dollar was 20% cheaper than today, but both were about to embark on enormous trends. Arrest those two trends and you likely stop much of the rot in both U.S. high-yield cash flows and U.S large-cap earnings. In our view, stable oil prices should relieve the drag the energy sector is exerting on S&P 500 profit margins. Normally a sector that generates above-average profits, the current gap between its margins and those of the rest of the index has never been bigger.

This is why the dollar cheapening by 5% and oil settling above $35 per barrel is a big deal for corporate earnings in the latter half of this year. Combine that with the base effect of coming off a terrible year for profits, and the fact that things have moved so fast that analysts’ assumptions probably haven’t yet taken all this into account, and the coming months could deliver some notable positive surprises in cash flows and earnings.

How do we make the moves we are seeing in U.S. Treasuries fit this thesis? Yields have been falling since mid-March, and some might see that as bond market skepticism about the scenario priced into risky assets.

We don’t think that is the case. There are negative central bank rates in Europe and Japan, and the potential of another summer flare-up of the Greek debt problem is pushing core Eurozone yields ever lower. It would have been impossible for U.S. Treasury yields to escape that gravitational pull even if the Federal Reserve had not become more explicit about the influence of global factors on its policymaking and moved its rate-hike projections substantially lower in March. If U.S. rates do not seem to be in line with U.S. fundamentals at the moment, the more complete explanation is that they are in line with global fundamentals.

Bring all of this together and we think you create a very interesting environment for fixed income credit. These assets eventually enjoyed one of their best quarters for five years in the first quarter, because a mixed bag of data drove rates down and credit spreads tighter—a combination that we haven’t seen much of lately. A similar combination of improving U.S. earnings and the continued gravitational pull of global rates on U.S. Treasuries yields could extend those conditions further into 2016. The contrast with where we were at the beginning of this year, when the Fed looked set to hike rates against a backdrop of faltering global growth, couldn’t be starker.

That is why we are cautiously constructive on risk today. And if the economy starts to show us the money over the next few months, we may be ready to lift some of that caution.

Boring Can Be Beautiful

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Aburrirse puede ser bueno — CC-BY-SA-2.0, FlickrPhoto: Harold Navarro. Boring Can Be Beautiful

While it’s easy to get caught up in campaign season — whether in the United States, where raucous primaries are underway, or in the United Kingdom, where the Brexit campaign is in full swing — that probably won’t help you make investment decisions. It’s probably better to see what’s going on inside some of the world’s biggest economies.

The US economy ebbs and flows, but the real average growth rate for this business cycle —after adjusting for inflation—has been about 2%. And we’re slogging along at about that pace as we begin the second quarter despite repeated, and so far unfounded, concerns that the economy is headed for a recession.

Here’s a look at the US economic scorecard for March:

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Looking around the world, China remains weak, but economic data is no longer worsening. There is still a lot of excess capacity, but fears of a deep recession have faded somewhat.

We have seen manufacturing weakness in the eurozone amid headwinds from slowing exports to emerging markets. Inflation has remained scant, prompting the European Central Bank to push interest rates deeper into negative territory and adopt additional unconventional monetary policy tools. Consumption is a bright spot, boosting companies that cater to consumers. We expect a real economic growth rate of slightly better than 1% in 2016.

Japanese growth continues to hover near zero. Despite negative interest rates, fiscal stimulus and structural reforms, Abenomics has not proven sufficient to rekindle growth.

Few signs of excess

We follow a number of business cycle indicators for signs that the present US expansion may be continuing, or conversely, coming to an end. Of these indicators, half are flashing signs that excesses may be creeping into the economy while the other half are showing no signs of stress. Several areas of concern have shown modest improvement of late. For instance, there have been tentative signs of improvement in the Chinese manufacturing sector, and oil prices, which until recently had wreaked havoc with corporate profits, have stabilized to some degree.

While US growth may seem boring, there are some intriguing phenomena going on in other parts of the world. Perhaps the most interesting — some would say crazy — phenomenon is the adoption of a negative interest rate policy (NIRP) by the European Central Bank, Bank of Japan and other central banks. About 40% of the sovereign debt issued by eurozone governments today trades with a negative yield. Not only are investors paying to lend governments money, but they retain all the credit and interest rate risk with no compensation. That’s anything but boring.

Where to turn in a world of NIRP?

Logically, investors are seeking more rational alternatives. Dividend stocks have proven alluring against a backdrop of negative yields. US dividend stocks are particularly attractive. Positive real yields and a steadily growing US economy will likely help companies generate the free cash flow necessary to pay out, and eventually grow, dividends. The US private sector has been producing strong, if not record, free cash flow since the end of the global financial crisis. And dividend-paying stocks outside the US have proven attractive in many developed markets as well. The key is not to chase the ones with the highest yields — they can be dangerous — but to look for sustainable cash flow growers.

Absent a recession, which is often fueled by excessive credit growth, investment-grade credit markets look like an attractive alternative to government securities. They are relatively cheap by historic standards and offer the potential to outperform Treasuries in a mildly rising interest rate environment. It is our belief that against the present backdrop moderate additions to risk assets may be appropriate for some investors. Moving out the risk spectrum, cheap high-yield bonds also look compelling in this environment. And large-cap stocks are another area of opportunity, given their moderate valuations.

This economy may not be as exciting as the latest accusations on the campaign trail, but boring can be a good thing. Especially for long-term portfolios.

James Swanson is the chief investment strategist of MFS Investment Management.

Two Afores Manage 2.2 Billion USD Through Mandates

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Dos Afores acumulan 2.200 millones de dólares en mandatos — CC-BY-SA-2.0, FlickrPhoto: Juan Barahona. Two Afores Manage 2.2 Billion USD Through Mandates

Afores closed March with 152.6 billion in assets under management (AUM). According to CONSAR, 13.8% of that is invested in international equities and 1.4% (2.2 billion) are under investment mandates. Only two of the eleven Afores in Mexico (Afore Banamex and Afore XXI Banorte) use mandates so far. Approximately 60% of allocations were made by Afore Banamex and 40% by Afore XXI Banorte.

An investment mandate through third parties is an investment vehicle of recognized value used by pension funds around the world, both in developed countries and emerging economies. In LatAm, central banks and Afores use mandates as the AFP use mostly mutual funds and ETFs.

Through this vehicle (where the Afore hires the services of a Global Asset Manager), Afores can effectively invest in international markets through specialized and experienced investment teams around the globe.

In all cases, the Global Asset Manager invited must meet requirements approved by the Committee for Risk Analysis (CAR) of CONSAR concerning experience, operational capacity, corporate governance, transparency, integrity and competitiveness criteria, among others.

Investment mandates in eligible countries are part of international diversification that Afores can perform. The set of eligible countries include members of the European Union, members of the OECD with which Mexico has a bilateral free trade agreement, members of the Pacific Alliance whose capital markets are integrated in the market known as conforms MILA and the member countries of the Financial Stability Committee of the Bank for International Settlements.

CONSAR authorized mandates in 2011, Afore Banamex began funding theirs in 2013 and Afore XXI Banorte stated funding them this year. It is expected that a couple of Afores join them this year and, that Asian equities also join the mix.

According to the CONSAR, Afores currently invest in 17 countries, but 40% of the international AUM is invested in the United States; while 26% in global indices; 15% in Japan; 5% in China; 4% in Germany and 3% in the UK. With investments between 1 and 2% are Hong Kong, South Korea, Italy and Canada; and with less than 0.5% are Switzerland, Spain, France, Brazil, Sweden, Australia, the Netherlands and Finland.

So far were two areas in which mandates have been assigned: European Equity (82%) and Global Equities (18%). Participants of mandates in European equities are: BlackRock, Pioneer, Schroders, BNP Paribas and Franklin Templeton; while the Asset Managers with mandates in global equities are BlackRock and Schroders.

To date, only 7% of the potential assets allocated to mandates are used given that Afores can mandate up to 20% of their AUM, which is equivalent to 30.5 billion, but considering that there is also a limit on investing in international assets this number is adjusted to 21.8 billion USD still to be mandated.

Fading Fears, Growing Risk Appetite?

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Todo parece indicar que la economía de Estados Unidos no va a entrar en recesión a corto plazo — CC-BY-SA-2.0, FlickrPhoto: Lucas Hayas. Fading Fears, Growing Risk Appetite?

For months, the marketplace has feared a US recession, driven by a sluggish global economy, the collapse in energy prices causing a marked decline in capital spending in several key market sectors and tightening financial conditions. Those concerns have begun to ease in recent weeks. We’ve seen a modicum of stability return to oil prices, pressure on high-yield credit markets has lessened and volatility has declined. While US economic growth is far from robust, it has held onto its post-crisis average of about 2%.

Given how much fear has become imbedded in market expectations in recent months, these modest signs of improvement could help rejuvenate the market’s appetite for riskier assets going forward. Even with sluggish growth late in 2015 and a plunging oil price, once you strip out the energy sector, profit margins actually expanded in the fourth quarter. As input costs such as the price of energy and other raw materials fall and if interest rates stay low, profit margins for many businesses will likely expand. It won’t take much to move the dial on profits for companies in the consumer discretionary staples sector, as well as those in tech and telecom, assuming they get a little bit of a lift to the top line. The consensus this year is for profit growth of 2%–3%. A modest uptick in sales could see that expand up to 6%, in my view.

Buying power being unleashed?

Where will that uptick in sales come from? The buying power of the US consumer, boosted by a moderate increase in wages as well as falling gasoline prices, lower home heating and cooling costs and declining apparel prices. For some months now, those savings have been stashed away. But history tells us that when consumers feel confident that price declines (e.g., energy) are here to stay, they tend to spend more. We’re seeing glimmers of hope that consumers are beginning to reallocate some of these savings to more consumption, which is likely to modestly spur manufacturing and the service side of economy.

We’re also seeing other signs of a turnaround. Container shipments and truck shipments are up. Some air freight indicators are beginning to rise. Spending in the technology and telecom sectors of the S&P 500 have begun to improve. Taken together, all of these developments point to a potential improvement in final demand.

It looks as though the US economy won’t disintegrate into recession any time soon but will more likely maintain the slow-growth pattern of the past several years. Against this backdrop, the Federal Reserve will probably see little danger of falling behind the inflation curve, so interest rate hikes should be gradual. It’s an environment where investors, depending on their age and risk tolerance, may want to consider adding to their portfolios some of the riskier assets on offer in the marketplace.

James Swanson is the chief investment strategist of MFS Investment Management.

Markets to Investors: It’s ‘Time In,’ Not ‘Timing’

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The old adage says that “time in the market” is more important than “timing the market.” Anyone who needed a reminder of that truth got it in spades during the first quarter of 2016. Who would have thought, on the dark morning of February 12 with the S&P 500 Index down more than 10%, that U.S. equities would finish the quarter up 0.8%?

Only the very brave, or the very foolish. And that’s the point of the adage: As long as you remain convinced that underlying economic fundamentals have not changed, trying to call the bottom of a volatile market is just as misguided as panic selling into tumbling prices. The “W-shaped” market kicked off by China’s devaluation last August is the perfect exhibit to back up our philosophy of maintaining a long-term view, putting the headlines into perspective, staying diversified and looking for opportunities to buy on volatility.

Things were never as dark as they seemed on February 12, and despite the arrival of daylight saving time they are probably not as bright as they seem today. Purchasing Managers’ Indices, a key measure of industrial activity, have been positive but not exciting; GDP expectations have not improved meaningfully; deflation fears still darken Europe and Japan; and China is still muddling through. High-profile defaults in the energy and mining sectors appear priced in but will likely cause shocks when they materialize, nonetheless. U.S. corporate earnings are still struggling—when the first profits estimates for Q1 came in a week ago they revealed a drop of almost 12% year-over-year, which would be the biggest decline since the depths of the financial crisis.

Markets show signs that they recognize this. For sure, there have been extraordinary rallies in some unloved places. The Brazilian stock market is up 18% on the year, and more than 25% since its mid-February lows. The Brazilian real is up almost 9%. Emerging market currencies as a whole enjoyed one of their strongest rallies ever in March.

After falling precipitously, the price of oil has recovered to finish the quarter near where it began the year; this, in our view, should reduce the uncertainty around the deflationary impulse and the distress levels in the wider economy. There has even been some outperformance of value over growth stocks in the U.S. If sustained, that would represent a bullish reversal of a multiyear trend, which may suggest that investors expect a return to more broad-based economic growth and no longer feel compelled to pay a premium for the most visible earnings.

But not everything fits this script. Gold, considered by many a safe haven asset, has hung on to most of the 20% gain it made during the New Year turmoil. So far, value is leading growth only by a small margin, and the underperformance of smaller companies this year is not characteristic of a full-throttle rally. Where growth and deflation concerns are most acute, stock markets have not drawn the same “W” as they have in the U.S.: Germany is down 6% year-to-date, and both Japan and China are down more than 10% year-to-date.

Market participants are watching the fundamentals and saying, “show me the money.” They know the next leg up in equity market valuations depends upon improving profits in the second half of the year, and while we believe they are likely to get this after the recent weakness, they need more reassurance that the headwinds of the falling oil price and the rising dollar have eased. They want to see clearer evidence that the “Third Arrow” of Abenomics can translate into real economic results. They want to see some inflation in Europe. They want more certainty that China is not planning another surprise currency devaluation.

We’d like further evidence of stabilization and improvement in these areas before we add aggressively to risk, too—but we are also prepared to hold fast to our steady-but-cautious outlook when markets have their next tantrum, as they inevitably will. We know that “time in the market” is critical, because it is often hard to see the turn of the cycle until it is behind you.

Column by Erik L. Knutzen, featured on Neuberger Berman’s CIO insight