The Headlines Are Relentless, but the News Isn’t All Bad

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No todo son malas noticias
CC-BY-SA-2.0, FlickrPhoto: Allan Ajifo. The Headlines Are Relentless, but the News Isn't All Bad

So far in 2016, the headlines have been somewhat harrowing: China imploding. Banking problems in Europe. Devastation in the oil patch. To be sure, there are reasons for concern. World trade is declining on a year-over-year basis. We’re not yet at recession levels, but there is a slowdown. What is not yet clear is whether the slowdown will be temporary or prolonged.

China remains a major concern as it attempts to transition from an export-driven society to one based on consumption. Both imports and exports have been declining, and concerns over China’s banking sector are mounting. Thankfully, Chinese debt is not owned by many investors outside the country, so a Chinese debt or banking crisis, while painful, would likely not have the same sort of global ripple effects that the US mortgage crisis did in 2007–2009.

Consumption creeps up

Meanwhile, the Chinese consumer is beginning to carry more weight. Consumption is growing year over year, and housing markets have picked up in China in recent months. I don’t anticipate implosion taking place there.

Europe is a mixed bag at the moment. While German exports are slowing, consumption in the eurozone is picking up and easy monetary policy remains in place. Japan’s diversified economy is in the midst of a multiyear re-engineering push — but without much to show for it thus far.

US consumer spending accounts for a larger share of the global economy than the entire economic output of China does. And US consumers kicked into gear in January. Apparently they didn’t get the memo about all the bad news in the rest of the world. US real incomes are rising, wages are growing and both the number of workers and their hours worked are climbing.

Overall, the global backdrop does not suggest an imminent recession.

Corrections don’t necessarily signal recessions

History tells us that market declines like we’ve seen so far in 2016 don’t always signal a recession. Since 1959, there have been 11 declines in the S&P 500 of the magnitude we’ve seen in recent months —between 10% and 19% declines. Three of those episodes ended in recession, while the other eight did not. The average decline during those eight episodes was approximately 16%. And just six months after the decline ended, the average return on the S&P was 18%–19%. It’s also worth noting that the average forward P/E ratio in those periods was 19 to 20 times. Today it is a more reasonable 15½ times.

Still some work to do

So are we headed for a recession? In my opinion, there isn’t a “yes” or “no” answer, but rather a two-stage process at work. The continued fall in oil prices —largely due to falling demand from China— is an input cost, and falling costs will initially cause some capital destruction. No doubt there will be defaults by energy companies that are geared to crude oil prices of $70, $80 or $100 per barrel. However, once the loss of capital works its way through the system, there will be a boost to manufacturing in the form of higher profits based on lower input costs.

As another ripple effect of China’s recent woes, the decline in commodity prices is suppressing expectations of higher interest rates — the cost of capital. Now we have two input costs that are likely to remain relatively low for the balance of 2016. And those should eventually benefit big economies like the US, the eurozone, Japan and, strangely enough, China itself.

Anxiety is understandable, and investors are wise to be cautious. It is probably best for investors to hold back a bit and to watch the macroeconomic data for the world’s major economies in the next few months. That should help us figure out if the worst of the crisis has passed.

James Swanson is Chief Investment Strategist at MFS Investment Management.

Listed Real Estate As An Income Investment

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Tres ventajas de incluir REITs en los portafolios orientados a rentas
CC-BY-SA-2.0, FlickrPhoto: Cucho Schez. Listed Real Estate As An Income Investment

The role that listed real estate can play in portfolio management is evolving, and there are three factors in particular which have been instrumental in determining how this sector can contribute positively to risk-adjusted returns for income-oriented funds.

The first factor is simply size. At the end of February 2009 the free float market capitalisation of the EPRA Global Index was US$297 billion and the sector represented just 1.1% of the global equity market. Fast forward to December 2015 and the free float market capitalisation of the EPRA Global Developed Market Index is now US$1,284 billion (a fourfold increase) and represents 2.7% of the global equity market (source: EPRA). As a result the investable universe of liquid global real estate stocks has expanded considerably.

Secondly, the sector has a unique structure. Real Estate Investment Trusts (REITs) are obliged to distribute a high, fixed, percentage (typically 90%) of their income as dividends. If they meet this requirement they are typically exempt from corporate and Capital Gains Tax. As a result REITs combine the liquidity benefits of equities, with attractive income characteristics, and total returns driven by real estate factors. REITs account for around 70% of the EPRA Global Index and are the predominant structures in the US, UK, Europe and Australia.

Thirdly, valuation. The yield on the EPRA Global Developed REIT Index tended to trade below that of the Merrill Lynch Global Investment Grade Bond Index prior to the Global Financial Crisis. Since then, the reverse has generally been the case with REIT yields trading at a premium even after the recent sell-off in corporate bonds.

Preferred characteristics

However, a significant yield premium is only one part of the valuation picture. The other component is the level of anticipated growth in rental and capital values, which translates through to dividends and Net Asset Values (NAV) at the company level. It is here where we see different geographic areas displaying different growth trajectories, due to variances in local supply/demand dynamics. In this regard we can split the sector into three categories; regions with positive rental growth such as the UK, US, Japan and Australia; those with flatter growth profiles such as Europe and Canada; and those with declining rental values including Hong Kong and Singapore.

Our preference is to invest in those companies which have a decent starting yield, positive rentals and NAV growth projections, a high quality real estate portfolio, experienced and high quality management, and sensible leverage, broadly those with loans to value of under 40%.

What about rising interest rates?

Clearly, there are concerns about the impact of rising interest rates on real estate values, and as a result real estate shares. However, there are a number of reasons why we believe that the impact of potential issues could be muted. Firstly, as discussed previously current pricing of the sector, with a dividend yield of around 4.1%, and a discount to NAV of c.9% provides a reasonable ‘buffer’ against rises in bond yields. Secondly, in terms of valuation yields on direct property a significant proportion of the capital which is targeting the sector is equity, not debt, so rises in financing costs may have limited impact on values. As an example in 2015 Blackstone raised US$15.8 billion for its latest global real estate fund. Thirdly there is a level of rental growth already embedded in forecasts, and we anticipate dividend growth of 3.5% p.a. over the next three years. Finally, any rise in bond yields is likely to be limited by low inflation, slow GDP growth and cautious central banks.

Conclusion

We believe that selective listed real estate companies have a valuable role to play in income focussed funds at the present time, due to a combination of a dividend yield premium, stable cash flows, and attractive growth prospects.

John Stopford is Co-Head of Multi-Asset at Investec.

Record Year for European Investment Funds with All-Time High Net Sales of EUR 725 Billion

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The European Fund and Asset Management Association (EFAMA) has published its latest quarterly statistical release which describes the trends in the European investment fund industry during the fourth quarter of 2015, and the results for the year 2015.

 2015 was a record year for the European investment fund industry.  Net sales of European investment funds rose to an all-time high of EUR 725 billion in 2015 and assets under management broke through to EUR 12 trillion thanks for a growth rate of 11%. 

Further highlights on the developments in 2015 include:

  • Investment fund assets in Europe increased by 11.3% to EUR 12,581 billion. Overall, net assets of UCITS increased by 13% to EUR 8,168 billion. Net assets of AIF increased by 8.3% to EUR 4,412 billion.
  • Net sales of UCITS reached EUR 573 billion. Demand for UCITS reached its highest level ever in 2015.
  • Long-term UCITS enjoyed a record year. Long-term UCITS recorded net inflows of EUR 496 billion, compared to EUR 479 billion in 2014.
  • Multi-asset funds attracted the largest net inflows (EUR 236 billion) as the broad market, asset class and sector diversification offered by balanced funds attract investors.
  • Equity funds recorded the best year for net sales since 2000 (EUR 134 billion) as investors remained overall confident in the economic outlook for Europe and the willingness of the ECB maintain its accommodative monetary stance to support activity.
  • Bond funds recorded lower net sales (EUR 83 billion) compared to 2014 against the background of a reversal in bond yields and the associated uncertainty concerning the evolution of the bond market.
  • Money market funds saw a turnaround in net flows, ending the year with positive net inflows (EUR 77 billion) for the first time since 2008.
  • Net sales of AIF reached EUR 152 billion, compared to EUR 149 billion in 2014.

Bernard Delbecque, Director of Economics and Research at EFAMA, commented: “The growth of fund assets has been substantially positive across Europe, with a very few exceptions, confirming investor confidence in UCITS and AIF.”

My Kingdom for a Hedge

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Si la deuda pública de los países desarrollados ya no actúa como un elemento defensivo en las carteras, ¿qué activo puede sustituirla?
CC-BY-SA-2.0, FlickrPhoto: Manuel. My Kingdom for a Hedge

Yet again most developed government bonds have proved their worth as a defensive hedge in the recent market turmoil. However, with yields at historically low levels and entering negative territory in a number of cases, the protective quality of such exposure in the future is surely becoming more doubtful. Recent market price action arguably suggests that market participants have increasingly abandoned bonds as material defensive positions in portfolios, in favour of ‘procyclical risk management’ which is designed to protect returns and mute any drawdowns in a generally rising market environment.

Lately, for example, we have seen a scramble to buy hedges to lower or cap increasing risk, as measured by short-term volatility. Given poor liquidity, there has also been a significant expansion in the use of proxies (designed to mimic the behaviour of traditional hedging instruments) to hedge positions, which in turn increases correlations. This can often result in ‘technical factors’ overwhelming fundamentals and contributing to bearish sentiment.

We have long been advocates of taking a broader view of the ‘defensive’ opportunity set and focusing on the qualities of structural diversification, rather than relying excessively on short-term market timing, particularly if it is reactive, to manage risk. If the laws of diminishing defensiveness increasingly apply to government bonds, what might take their place? This is a difficult question because bonds have typically paid investors a return and were generally reliably inversely correlated with growth assets.

Sadly, this golden era is largely in the past. Hedging is becoming more costly and less reliable. The behaviour of more complex defensive assets, when their qualities are needed, is more difficult to predict than more conventional hedges. Volatility-protection strategies are a good example of this, as they can show an alarming tendency to diverge from the underlying asset.

Despite its impressive recent performance, even a more conventional hedge, such as gold, pays no income and can be costly in terms of drawdown.

So what other defensive options are there? We would argue that currencies have long provided a fertile defensive opportunity set. Typically the currencies of credit or nations, such as Switzerland and Japan, have offered safe havens (although the yen lost this status under prime minister Shinzo Abe and governor of the Bank of Japan Haruhiko Kuroda), and periodically the US dollar by dint of its ‘world currency’ status. Naturally, as the depreciation of the Norwegian krone in the recent past reminds us, cyclical context and valuation remain important considerations, even if longer-term structural fundamentals are robust.

Taking short positions against currencies with poor or deteriorating macroeconomic fundamentals greatly expands the opportunity set. The Australian dollar was one of the main beneficiaries of China’s boom and as a consequence was driven up to unsustainable levels. Selling that currency forward proved to be an excellent hedge against general emerging market weakness, as it declined by 37.7% from a peak in November 2011 to its recent trough. More generally, the principle of shorting growth assets to create defensive ones applies more broadly than currencies.

In short, we need to consider the broadest range of defensive assets in order to sustain structural diversification in portfolios at a time when the traditional defensive ‘armoury’ is becoming challenged. True, this opportunity set is in some cases difficult to access and requires additional technical skills and competence, but we believe the alternative of placing undue reliance on market timing and the standard risk models is misguided.

Philip Saunders is Co-Head of Multi-Asset at Investec.

Abenomics in Crisis

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¿Corre Abenomics peligro de fracasar?
CC-BY-SA-2.0, FlickrPhoto: Chan Chen. Abenomics in Crisis

Japan’s economy contracted at an annualized rate of -1.4% in the fourth quarter. That was much worse than the Bloomberg consensus was looking for. Declining industrial production and weak household spending had pointed at renewed contraction risk. Most Japan watchers were probably focusing on the country’s composite PMI index, which improved to 52.3 in Q4 the best quarter in nearly two years.

Japan has already seen three recessions since 2009. In fact, in six years starting in 2010, Japan’s GDP has contracted in 11 out of 24 quarters(!). Amazingly the economy has still not recovered from the ill-advised Consumption Tax hike in April of 2014. Private consumption declined again in Q4 and is now 5.4% below the pre-tax hike peak.

The decline in consumer spending has been more than twice as large as the consumption contraction during in the 2008/09 financial market crisis. That’s astonishing for such the relatively small tax increase and for an economy essentially on full employment. Residential investment contracted mildly last quarter and inventories shaved 0.5% off the quarterly growth rate. The only bright spot was a 5.7% annualized increase in business investment.

Where is government?

I am surprised we are not seeing more fiscal spending in Japan. The government had promised to offset the Consumption Tax increase with fiscal stimulus, which never materialized. The average contribution to quarterly GDP growth after the second quarter of 2014 was a mere 0.2%.

The weak growth trend in Japan is another serious blow to the effectiveness of monetary policy as a growth stimulus tool. The Bank of Japan has been buying about $70 billion worth of bonds and ETFs every month for the past three years with very little growth or inflation to show for. Now the BOJ is trying negative interest rates, a tool that has not been tested and whose side effects are not yet fully understood.

Japan is trapped in a low interest rate world. What the economy needs is a significantly weaker currency to boost inflation, corporate profits and wages. Yet, with global interest rates unwilling to rise, the BOJ evidently felt compelled to widen the interest rate differential by further lowering Japanese rates. So far we haven’t seen any lasting effect on the yen.

Forecast impact.

Similar to the US, Japan will struggle to exceed last year’s growth rate in 2016. The sharp decline at the end of last year has lowered the starting point for 2016 such that even the 1.3% average quarterly growth rate we are forecasting will only add up to 0.5% growth for the full year. Like in the US, looking at the Q4/Q43 growth rate will be more informative about the growth momentum. Here we expect a modest improvement from the 0.7% last quarter to 1.2% at the end of this year.

Abenomics is in danger of failing. Structural reforms have done little to raise Japan’s actual growth rate. The damage from last year consumption tax still dominates the household sector, reflecting the lack of  income growth, which could have offset the modest tax hike. Absent faster rate hikes in the US there is little the Bank of Japan can do to stimulate growth and the focus is shifting back to fiscal policy.

Much of that is likely to be timed for the June Upper House elections where the ruling LDP enjoys a big majority. Elections for the Lower House where the cushion is much thinner aren’t required until 2018. So Prime Minister Abe has two more years to turn the economy around. More stimulative fiscal policy and greater efforts to weaken the yen as the year progresses should eventually boost growth and help Japan avoid a fourth recession since 2009.        

Markus Schomer is a Managing Director and Chief Economist of PineBridge Investments.

 

Matthews Asia’s Kenichi Amaki to join Miami Summit

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Kenichi Amaki, potfolio manager de Matthews Asia, analizará en detalle las reformas llevadas a cabo en Japón en el Fund Selector Summit de Miami
Photo: Kenichi Amaki, potfolio manager at Matthews Asia.. Matthews Asia’s Kenichi Amaki to join Miami Summit

Kenichi Amaki, portfolio manager at Matthews Asia is set to join the Second Edition of the Funds Selector Summit to be held on 28th and 29th of April in Miami.

Amaki manages the firm’s Japan Strategy and co-manages the Asia Small Companies and China Small Companies Strategies. Now that the time has come to re-engage with Japan, he will share his perspective on the relevance of key governance changes that investors may have overlooked with all eyes on “Abenomics.” Kenichi will also explain how Japan has transformed from a “value” market to a “growth” market, and how the Matthews Japan strategy provides exposure to interesting investment opportunities across the market-cap spectrum.

The conference, aimed at leading funds selectors and investors from the US-Offshore business, will be held at the Ritz-Carlton Key Biscayne. The event-a joint venture between Open Door Media, owner of InvestmentEurope, and Fund Society- will provide an opportunity to hear the view of several managers on the current state of the industry.

Prior joining in 2008 as a research analyst, he was an investment officer for a family trust based in Monaco, researching investment opportunities primarily in Japan. From 2001 to 2004, he worked on the International Pension Fund Team at Nomura Asset Management in Tokyo.

Kenichi received a BA in Law from Keio University in Japan and an MBA from the University of California, Berkeley, and is fluent in Japanese.

You can find all the information about the Fund Selector Miami Summit 2016, aimed at leading fund selectors and investors from the US-Offshore business, through this link.

Investigating the Market Correction

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La liquidez sigue siendo el reto clave
CC-BY-SA-2.0, FlickrPhoto: Tony Hisgett. Investigating the Market Correction

After any dramatic market sell-off there is invariably a flurry of after-the-event rationalisation, an exercise in ‘Who done it?’. Many believe the trigger of the current sell-off was pulled by the People’s Bank of China in December when it moved to measure the value of the renminbi against a basket of currencies rather than the dollar, which made it easier to devalue the currency by circa 1.4%.

As was the case last August, this was interpreted as further evidence of an increasing risk of a hard landing for the Chinese economy, and the inevitability of a substantial devaluation with its attendant deflationary implications. Huge though they are, Chinese foreign exchange reserves were apparently at risk of being overwhelmed by burgeoning capital outflows.

The US Federal Reserve Board (Fed) also made it on to the ‘who done it’ list. The risk of the Fed raising interest rates, in the teeth of increasingly alarming evidence of weakness in the US manufacturing sector, and the conflict in statements from its senior board governors, suggested a determination to fight inflationary, rather than deflationary, forces. Other suspects include plummeting oil prices, (which have been causing sovereign wealth fund asset liquidation and forcing banks to write off loans), deteriorating liquidity, pro-cyclical risk management and high frequency trading. In short, markets are full of convexity (interest rate risk) and prone to more violent, but episodic shocks.

Where now?

We continue to expect a weak, but positive, global growth outcome in 2016, believing recession risks in the key developed economies to be exaggerated.

In our view, oil price weakness is very much a supply problem rather than an indicator of collapsing demand, which continues to rise and, in any event, it has more than likely over-shot on the downside. Although disruptive in the shorter term, weak commodity and especially oil prices should, ultimately, be significant positive drivers for global growth. In contrast to manufacturing, the much larger consumer sector is in reasonably good shape across the developed world and the shift in the balance of demand will continue to move in the latter’s favour.

Despite the market angst, our view is that China’s economy is slowing down in a relatively measured manner and the capital outflow scare is wildly exaggerated. This is not to deny the transitional challenges it faces and that there are downside risks. If the Fed does raise rates in line with the higher estimates, it will be against a background of a strengthening US economy. For now, despite the downgrades, forecast earnings in the US, Europe and Japan remain positive.

Liquidity, the key challenge

Liquidity remains the key challenge. Tighter US monetary conditions and the anticipation of further tightening has caused emerging market liquidity to swing from abundance in the heyday of quantitative easing to scarcity now. This has effectively offset looser monetary policy in Europe and Japan. Paradoxically, global monetary conditions appear to be much more restrictive than the low level of nominal and real interest rates would seem to imply. Contrary to expectations, the Bank of Japan have effectively expanded their quantitative easing programme further, with the introduction of negative interest rates and the European Central Bank has intimated that it could do the same. A recognition of this on the part of the Fed in 2016 could well prove decisive in reducing the risk of more negative outcomes.

The return of Ro-Ro

We, therefore, believe the period ahead is likely to prove to be one of uncertainty and transition, not unlike the ‘risk-on, risk-off’ period we saw between 2010 and mid- 2012. Portfolio resilience will remain a particularly important theme, which requires selectivity in terms of the choice of defensive assets. Among these long-dated US Treasuries, the yen and the euro are our current preferences. Interestingly the dollar, which admirably fulfilled that role over the last three years, may be losing some of its lustre against other developed market currencies. Arguably, the US dollar has moved far further than likely real rate divergence really justifies.

In our view, equities, especially after the recent market weakness, are not trading at excessive valuations. Risk premia relative to bonds are high, if, as we suspect, bond yields are going to remain low on a structural basis. Patience may still be required with regards to assessing value asset classes that are repricing, such as high yield bonds and emerging market currencies and debt. However, selective opportunities are arising where risk premia have risen to levels that should prove to be attractive over the medium to longer term.

Finding bottom-up equity opportunities

From a bottom-up equity perspective, as has been the case for a while, it should still prove to be a challenging environment for cyclical stocks, with investors likely to continue to be prepared to pay up for ‘quality’. There is ‘value’ in the out-of-favour financial, materials and energy sectors, but earnings dynamics remain resolutely negative. Established technology stocks are one of the few subsectors that could be described as squaring the circle between quality and value and, as such, are a favoured area.

In a more volatile environment there is a general assumption that the large index constituent stocks should be preferred. However, the dynamics of indexation may have reached a tipping point, because our bottom-up steers are favouring the merely large cap and mid cap stock territories and ‘active shares’ in our equity allocations are high. We believe volatility will continue throughout 2016, which will increase the need for portfolio resilience. Investing in quality stocks should help to navigate this environment.

Philip Saunders is Co-Head of Multi-Asset at Investe.

 

The Japanese Equity Outlook After the Nasty New Year Start

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Perspectivas para la renta variable japonesa tras un desagradable inicio de año
CC-BY-SA-2.0, FlickrPhoto: Takadanobaba Kurazawa. The Japanese Equity Outlook After the Nasty New Year Start

An outlook for any major asset market likely involves QE, so a comment on such is firstly warranted. Clearly, it is wrong to state definitively that QE works or not in any given country, as one can only make an educated guess as to whether events would have been better or not, in sum, compared to a counter-factual estimate of what would have occurred without QE. In that sense, it seems QE has done far more good than harm for participating countries, especially when one recalls the dark days of 2009 and the various European crises.

More recently, QE (in either balance sheet holdings or new purchases forms) has helped counter one of the greatest deflationary factors in world history, which has occurred outside the control of central banks: shale drilling. Major technological inventions often cause boom and deflationary bust cycles, but have rarely, if ever, have affected the world’s most important commodity in such substantial way. The effect on the oil price did not occur immediately, but when it did, the 80% decline, also partly caused by geopolitically-driven factors, was astonishing. This is another reason to ignore those who state that QE failed to create inflation in Japan or elsewhere, as shale drilling was an uncontrollable external factor, and inflation would likely have been much lower without QE. Indeed, a global depression was a likely counterfactual scenario. One must also realize that deflation characterizes only commodity prices and quality-adjusted technology goods, whereas the most important asset class in the world, real estate, is quite significantly inflating, greatly due to QE’s effects.

In the current equity environment, one of the most important aspects of QE is its effect on corporate profits. Of course, forex rates are affected by QE, so the size of one country’s QE is important in relation to other countries’ QE, and the forex rate significantly influences corporate profits. In this regard, Japan has clearly benefited more than the West in recent years due to its massive QE program. QE also lowers interest costs, which usually increases capital expenditure and personal consumption, at least compared to what would have occurred without QE, which contribute to corporate earnings, as well.

With QE, the Yen reversed its overvaluation and confidence in general increased greatly. Asset prices, including equities, increased, partly due to increased valuation metrics, but mostly due to the rise in underlying earnings. Indeed, earnings growth expectations in Japan have remained high, while such in the US and Europe (not to mention emerging markets) have steadily declined. This is the key reason why Japanese equities outperformed global markets in USD terms in 2015 and will likely do so again in 2016, as the earnings expectation divergence trend seems to be accelerating, so it is important to understand all the reasons for corporate earnings growth in Japan.

Fortunately, Japan has relatively minor commodity-producing exposure, so its corporate profits have performed much better than European or American corporate profits during the commodity bust of the last eighteen months, as mining and energy multinationals comprised a significant portion of corporate profits in the West. Meanwhile, the effects of low energy prices have pummeled energy-based economic zones in the US, as have low agriculture prices in its farm-belt.

Similarly, parts of Europe have been hurt by lower energy prices and the region has been hit by the effect of mutual economic sanctions with Russia. Corporate profits in Japan have also benefited from lower commodity input costs, and perhaps as much as any country, Japanese consumers have benefited from lower import prices of such (although partly offset by a weaker Yen). On the converse, recent media reports and analyst commentaries are suggesting the ECB’s QE program has failed to lift profits, although it seems clear profits would have been much worse without QE and that much of the profit problem was commodity price-related and, thus, out of the ECB’s control.

Importantly, yet completely separate from QE or other global fundamental factors, Japan has structurally improved its corporate governance. As my earlier writings have indicated, this improvement began ten years ago, but only became widely apparent in the last few years, and was augmented even further by Abenomics (along with the beneficial political stability that he has brought). The effect on corporate profits has been very strong, and expectations by the market for continued profit maximization has also boosted intermediate-term earnings estimates, which are extremely important for equity valuations. As corporate governance improvement has become mainstream, we expect this trend to continue developing this year, as there is yet much more to accomplish.

In any market, corporate profits should be the main driver of equity prices as long as valuations are fair, and on this front, as commodity prices remain low and corporate governance remains strong, Japan’s earnings and earnings expectations should outperform those in the West. Since equity valuations are also more attractive than in the West, these two factors strongly suggest that Japanese equities should outperform global equities in the next six months. Japan does have high operational gearing due to lower profit margins than the West, so if there is a global recession, the equity outlook vs. global markets is not as strong, but still relatively firm, in our view.

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

Monaco to Examine Draft Law on Multi Family Offices

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Mónaco prepara un ley para regular la actividad de los multi family offices en el Principado
CC-BY-SA-2.0, FlickrPhoto: Paul Wilkinson . Monaco to Examine Draft Law on Multi Family Offices

The national council of Monaco, the Principality’s parliament, is to examine a draft law on multi family offices’ activity in Monaco.

It points out that if single family offices have been run for years in Monaco, multi family offices which have started to flourish in recent years in the Principality remain unregulated so far in the country.

The further law will then provide a regulatory framework to the business.

Moreover, it seeks to promote Monaco as a centre of excellence for family offices, pursuing therefore Monaco’s government plan that aims to make the country more attractive to ultra-high-net-worth individuals and entrepreneurs.

Among compliance obligations enshrined in the draft law, multi family offices conducting financial transactions will have to be granted a license by Monaco’s state minister and will be subject to regulatory approval by Monaco’s financial authority, the Commission de contrôle des activités financières (CCAF).

Also multi family offices in Monaco will have to be structured in Monegasque public limited companies (Société anonyme monégasque).

Michael Roberge, MFS’ co-CEO: “We Do Not Believe The United States Will Fall into Recession in 2016”

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Michael Roberge, MFS’ CIO and co-CEO, was recently in Miami where he met with more than 120 investors in two events organized by Jose Corena, Managing Director for the aforementioned management company, together with Paul Britto, Regional Director, and Natalia Rodriguez, Internal Wholesaler.

Roberge, who has been working with the company for the past 20 years, began his review of the global macroeconomic and business landscape by emphasizing the huge disconnect between what markets are discounting and the realities of the economy. The current environment is much more favorable than a year ago, because, according to MFS’ co-CEO, market downturns have led to more attractive entry prices. “It is undeniable that there are risks. A year ago the markets were calm and everyone was buying, even though all asset classes were overvalued,” he pointed out.

But the fear factor currently extending through the market is not so much a concern over valuations, but is more focused on the possibility of a recession on the horizon. For Roberge, even if the market discount rate reflects a scenario of great pessimism, the United States will not fall into recession in 2016.

“Consumption accounts for seventy percent of US GDP, and its health is enviable. The unemployment rate is declining and heading towards 4%; real wages are rising by about 2-2.5%; and the price of energy has fallen considerably in the last 18 months — which for the consumer’s disposable income is comparable to a tax cut” he claimed.

“US manufacturing, which accounts for about 10% of the overall economy, is underperforming the consumer-oriented sectors of the US economy,” he said. “This is due to both a stronger dollar, which hurts exports, as well as a clean-up of accumulated inventories during the past year. Once these inventories have been depleted, it is likely that the manufacturing sector will not continue to be a drag on GDP growth.”

Finally, Roberge said that the public sector, which in recent years has either been neutral or has had a negative contribution, will contribute between 0.6% and 0.7% to GDP growth in 2016 through a combination of tax cuts and increased spending. “In short, the US economy is in good shape. Doing the math, it seems highly unlikely that the US goes into recession unless an exogenous factor which significantly affects consumer confidence takes place,” he explained to attendees. The factors which could affect consumption are gasoline prices and interest rates, neither of which appears to be going up this year.

Global Growth

With respect to global growth, a stronger US dollar helps Europe, as it favors exporters, and ultimately its manufacturing sector. The MFS executive believes this will last throughout 2016. He also believes the Old Continent is benefiting greatly from low energy prices. For its part, Japan is not likely to contribute in any great measure to global growth this year. Finally, emerging markets are expected to be the part of the world that will continue to deteriorate in 2016. “Continued pressure from China means they will grow, but less than last year. If we look at the world as a whole, I think there is a very low probability of falling into recession. It is the market which is mistaken and not the fundamentals of the economy,” he said.

With all of this on the table, MFS’ advice for investors is to consider equities over high quality bonds. The reason, he said, is very simple. The average dividend yield currently stands at 2.4%, while the yield on the benchmark 10-year Treasury is 2%. So unless the economy falls into recession, “which is something we do not believe will happen, it is better to have an emphasis on equities, given the current lack of profitability in the bond market.”

Limited Opportunities in Fixed Income

Among the few opportunities currently offered by fixed income securities, Roberge mentioned the high yield bond market, where the average yield is around 9%. “It will probably beat equities this year,” therefore, he believes it’s a good idea to include this asset in a portfolio. “We believe that the market is being a lot more pessimistic about high yield market conditions than our own vision of what will really happen. The key factors here are volatility and liquidity, two factors which are of great concern, but the market has already discounted both of those risks. This year, high yield should perform much better than US Treasuries and, in our opinion, also much better than stocks.”

MFS’ co-CEO also opts for dollar-denominated emerging market debt, and explains that “during the last five or six years, we have seen a flattening in the debt curve of developed countries, due to the slowdown in growth and the monetary policies of central banks, and we believe that the next debt cycle will favor emerging markets. We prefer debt issued in dollars because local currencies are still exposed to risk from China, to the price risk of raw materials, and to what the Fed does throughout the year,” he added.

The market is expecting the Fed to raise interest rates again in March, but MFS does not believe that will be the case. Roberge ventures that the board headed by Janet Yellen will go easy. “It is likely that this time it may be the Fed which moves the market and not vice versa. It will be difficult for the board to raise interest rates since the major central banks in the developed world continue easing monetary policy due to global deflationary pressures. Therefore, we do not see the Fed raising rates four times this year, and have positioned our portfolios accordingly,” he said.

In his analysis of Latin American countries, MFS’ co-CEO explained that there is dollar-denominated Mexican debt in their portfolios, and Argentine debt has recently been added as a result of the political changes brought about by recent elections. With respect to Venezuela, given political circumstances and the price of oil, the Boston-based firm believes that at some point it will have to restructure its debt because its current levels are unsustainable.

“Brazil has a lot of challenges,” he said. “The economy is stagnant, inflation is high, and the central bank has little room for maneuver; added to all this is the political turmoil as a result of corruption exposed during the last year. These factors make it almost impossible to implement the reforms which the country needs.”