H2: Five questions investors should think about

by Witold Bahrke 

1. Robust macroeconomic momentum confirms bullish expectations. At the same time, the United States business cycle seems mature as Europe accelerates with Germany in the lead. What are your views for the second part of the year? Will Chinese growth deliver relative to expectations?

We expect global economic momentum to slow in the 2nd half of the year and reflation expectations to wane. Our global economic momentum indicator shows the first signs of slowing. This is mainly driven by China, where the central bank is beginning to tighten in order to limit leverage risks. Europe, on the other hand, should continue to do relatively well in growth terms. Also, it has the advantage of having the most dovish of the G3 pack. For the US, we do not expect a growth acceleration in the 2nd half, as real disposable income is not growing strong enough to drive consumption growth higher on a sustained basis. At the same time, corporate investments are still not taking off, as Trumphoria is waning and scepticism around tax cuts etc. is growing. The US continues to be in a “wait and see” mode.

Graph 1

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2. The FED and ECB Governors send hawkish messages, which could hint at a hawkish bias gaining the upper hand. How do you see bond markets in light of this towards year end? Which bond class do you prefer?

This is an interesting observation: Despite tightening signals from major central banks and stellar equity performance YTD based on hopes for higher growth, rates are still relatively low, especially in the long end of the curve. Despite the recent wobbles, 10-year US government bond yields are down year to date.

At the same time, the interest rate curve has flattened since the start of the year in most of the biggest bond markets, normally signalling a weaker economic outlook. Lastly, fixed income market based inflation expectations are also down since the beginning of the year, contradicting central banks’ hawkish rhetoric as of late. So who’s right – equities or bonds?

We think the latter is right, which relates to the answer above. As we expect growth to disappoint in H2 2017 and headline inflation to fall or stay weak (see graph below) this should also support core government bonds, especially the US. So yields are unlikely to break out of this year’s trading ranges and even have the potential to fall further as we approach year end, although only moderately due to already low yield levels. Bond markets are apparently sharing our sceptical view on growth and inflation, hence the decent government bond returns YTD, despite the recent sell-off.

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3. After the new highs in the stock exchange, investors are asking themselves how to increase exposure towards Emerging Markets (EM): Equities or bonds? What do you suggest, considering the Fed’s monetary tightening? Is there more room for local currency bonds or is it better to focus on hard currency bonds?

We are neutral on EM equities and more positive on EM bonds. But differentiation is key in the EM universe. As we expect China to slow in H2, we would prefer countries with limited China and commodity exposure. In this context, Indian equities seem attractive. On the bond side, we prefer hard currency debt, as the US dollar is expected to strengthen (although only moderately so) again later in 2017. If the US economy is so weak that the Fed becomes more dovish and Goldilocks prevails (not too hot and not too cold), we would change this view.

4. With the good performance since the beginning of the year — equity returns seem to have already met investors’ expectations — what is your view on the stock market? Do you think that a hawkish Fed will impact stock market performance in the second part of the year?

We see three challenges towards a continuation of the Bull run in equities: 1) Peak reflation/ weaker commodities are expected to hurt companies earnings growth further down the road and we are likely to see downward revisions of earnings estimates and disappointments 2) implicit growth expectations derived from risk assets prices are very high and disappointments are increasingly likely in H2 2017 as growth in China is slowing down and Trump’s tax plans may be delayed (or even derailed) 3) monetary conditions are becoming a headwind with G3 central banks tightening and possibly even reversing unconventional stimulus as the Fed is preparing a balance sheet reduction. This is a big wild card, as we enter unchartered territory. So we expect the rally in equities to lose steam in H2 2017 and volatility to rise.

5. In the coming months, what are your portfolio preferences between bonds, equities and cash? How would you position a well-diversified portfolio?

Short term, we are neutral on equities and bonds. Towards year end, we would prefer core fixed income relative to equities given the points mentioned above. In an environment where central banks are tightening, equities need new drivers. With the growth and inflation outlook outlined above, these are unlikely to emerge in the near future.

Nevertheless, it makes sense to have cash proxies in your portfolio (like short duration bonds), as we have been in a Goldilocks environment in H1 where all boats are being lifted by benign monetary conditions, also thanks to a weak US dollar. The real risk to this “buy-everything” scenario is a “sell-everything” scenario as central bank tightening broadens and gathers pace. As the graph below illustrates, a wall of liquidity has supported risk assets since the Global Financial Crisis. If the Fed where to stop reinvesting its maturing bonds and thereby reduce its balance sheet, this would mean an adverse liquidity shock, limiting the support for especially risk assets. In this case, cash proxies would be one of the few places to hide. That said, this is only a risk scenario.

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About Nordea Asset Management
Nordea Asset Management (NAM, AuM 219 bn EUR*), is part of the Nordea Group, the largest financial services group in Northern Europe (AuM 332 bn EUR*). NAM offers European and global investors exposure to a broad set of investment funds. We serve a wide range of clients and distributors which include banks, asset managers, independent financial advisors and insurance companies.

Nordea Asset Management has a presence in Cologne, Copenhagen, Frankfurt, Helsinki, London, Luxembourg, Madrid, Milan, New York, Oslo, Paris, Sao Paulo, Singapore, Stockholm, Vienna and Zurich. Nordea’s local presence goes hand in hand with the objective of being accessible and offering the best service to clients.

Nordea’s success is based on a sustainable and unique multi-boutique approach that combines the expertise of specialised internal boutiques with exclusive external competences allowing us to deliver alpha in a stable way for the benefit of our clients. NAM solutions cover all asset classes from fixed income and equity to multi asset solutions, and manage local and European as well as US, global and emerging market products.

*Source: Nordea Investment Funds, S.A., 30.06.2017

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A., Nordea Funds Ltd and Nordea Investment Management AB (“the Legal Entities”) and their branches, subsidiaries and affiliated companies. This document is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. Consequently, the information contained herein will be superseded in its entirety by such Offering Memorandum or contractual arrangement in its final form. Any investment decision should therefore only be based on the final legal documentation, without limitation and if applicable, Offering Memorandum, contractual arrangement, any relevant prospectus and the latest key investor information document (where applicable) relating to the investment. The appropriateness of an investment or strategy will depend on an investor’s full circumstances and objectives. Nordea Investment Management recommends that investors independently evaluate particular investments and strategies as well as encourages investors to seek the advice of independent financial advisors when deemed relevant by the investor. Any products, securities, instruments or strategies discussed in this document may not be suitable for all investors. This document contains information which has been taken from a number of sources. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information and investors may use further sources to form a well-informed investment decision. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment. Prospective investors or counterparties should also fully understand the potential investment and ascertain that they have made an independent assessment of the appropriateness of such potential investment, based solely on their own intentions and ambitions. Investments in derivative and foreign exchange related transactions may be subject to significant fluctuations which may affect the value of an investment. Investments in Emerging Markets involve a higher element of risk. The value of the investment can greatly fluctuate and cannot be ensured. Investments in equity and debt instruments issued by banks could bear the risk of being subject to the bail-in mechanism (meaning that equity and debt instruments could be written down in order to ensure that most unsecured creditors of an institution bear appropriate losses) as foreseen in EU Directive 2014/59/EU. Published and created by the Legal Entities adherent to Nordea Asset Management. The Legal Entities are licensed and supervised by the Financial Supervisory Authority in Sweden, Finland and Luxembourg respectively. The Legal Entities’ branches, subsidiaries and affiliated companies are licensed as well as regulated by their local financial supervisory authority in their respective country of domiciliation. Source (unless otherwise stated): Nordea Investment Fund, S.A. Unless otherwise stated, all views expressed are those of the Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and affiliated companies. This document is furnished on a confidential basis and may not be reproduced or circulated without prior permission and must not be passed to private investors or any investors not covered by relevant regulation. This document contains information only intended for professional investors and eligible investors and is not intended for general publication. This document may not be reproduced or circulated without prior permission. Reference to companies or other investments mentioned within this document should not be construed as a recommendation to the investor to buy or sell the same, but is included for the purpose of illustration. The level of tax benefits and liabilities will depend on individual circumstances and may be subject to change in the future. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and/or affiliated companies.

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