2016 Q1 House Views Update
by Nikko Asset Management's Global Investment Committee
- G-3 and Chinese Economies Moderately Firmer in 2016
- Fed in June and December, but ECB or BOJ Slight Easing
Nikko Asset Management's Global Investment Committee met on March 29th and updated our intermediate-term house view on the global economic backdrop, central bank policies, financial markets and investment strategy advice.
We expect June and December Fed hikes, but only mild further easing ahead for the BOJ and ECB. Meanwhile, we expect oil prices to creep higher through 2016 despite the stronger USD due to relatively firm economic developments in China and the G-3.
We expect that global equity and bond investing will be positive for Yen based investors due to Yen weakness, but for USD based investors, we are taking only a neutral stance on global equities due to a cautious forecast for US equities, whereas we are positive on Asia-Pac ex Japan, Japan and Europe. Meanwhile, we are moderately negative on bonds in each region when measured in USD terms, so we underweight them.
Bond and Currency Targets
In December, we expected US and Japanese bond yields to rise, but they did not do so due to the Fed’s and BOJ’s actions. We expected Bund yields to decline, but they did so more than we expected. Given our new scenario of moderate market and economic improvement, we expect yields to rise moderately further for the next two quarters. For US 10Y Treasuries, our target for September-end is 2.10%, while those for 10Y JGBs and German Bunds are -0.05% and 0.25%, respectively. For Australia we expect a rise to 2.7%. This implies (coupled with our forex targets) that including coupon income, the Citigroup WGBI (index of global bonds) should produce a -3.2% return from our base date of March 18th through September in USD terms. Thus, we remain negative on global bonds for USD based investors. This index should perform a bit better, at 0.8%, in Yen terms due to expected Yen weakness (see below). As for JGBs, we target the 10Y to have a -0.4% return in Yen terms through September, so we reverse last quarter’s successful preference for them over ex-Japan bonds.
Thanks to Japan’s easier monetary stance vs. the Fed, coupled with higher interest rates abroad, we expect the Yen to weaken to 116: USD by end-September. We expect the AUD to strengthen to 0.77 vs. the USD by then due to improved global economic and commodity sentiment, linked with a resilient domestic economy. As for the EUR, the ECB’s continued dovish policy and aggressive QE program will likely overshadow the region’s continually high current account surplus, and push the currency moderately lower to 1.08 then.
We went neutral on global equities in September and then went cautiously overweight on December, so we have not been very bullish for quite a while, but we certainly were negatively surprised by the volatility and bearish action in equities and commodities. As for our regional equity calls, we were correct on Pacific ex Japan’s outperformance, but were incorrect otherwise, with the US outperforming and Japan under-performing (see our note on the cover page). Our new macro-backdrop scenario also results in a cautious view on global equities, bearish on the US, but positive on other regions, especially Japan and Pacific ex- Japan. Aggregating our national forecasts from our base date of March 18th, we forecast that the MSCI World Total Return Index will rise 1.5% (unannualized) through September in USD terms (5.7% in Yen terms). These gains in USD terms are not attractive enough to justify an overweight stance on global equities (except for Yen-based investors), so we will take a neutral stance on global equities for US- based investors.
Why are we so cautious on US equities? We think the market is too expensive and is trading more on dividend yield than PER ratios. With rising bond yields, this dividend yield effect should retrace, while earnings will not likely improve much, so the PER is not attractive. Indeed, the SPX is now trading at 17 times NTM (next twelve month) bottom-up consensus earnings, which is high in a historical context (and if one fully expenses for option grants, the PE is probably a full point higher). We expect a slight de-rating since bond yields are likely to rise, and despite a fairly firm 2016 GDP outlook, we expect only a mild rise in the earnings outlook. Soft emerging market economies and a stronger USD will remain headwinds for earnings too. Although it is hard to predict, we believe uncertainty over the US election may also cause market jitters. In sum, these factors should drive the SPX to 2029 at end-September (-0.4% total return from our base date), which is obviously poor given the risks involved.
Eurozone equity prices in USD terms should fare a bit better, greatly due to the positive earnings effect of EUR weakness, with relief on the Brexit front and continued regional economic growth being the main factors. Any additional ECB easing should also assist risk-sentiment. Even though the EUR weakens vs. the USD in our forecast, we expect a 3.1% unannualized return in USD terms through September, so we will maintain an overweight stance.
In the last quarter, Japanese equities suffered unfairly in our view and we expect a strong rebound in the coming quarters, with a weaker Yen and an improved (though moderate) global growth outlook being the main factors. Although TPP’s delay may be a disappointment, fortunately, there are other economic reforms happening, especially in corporate governance and further declines in the corporate tax rate. Also, even though Japan’s economy is not very strong, this should not concern investors greatly. As we have long reported in our “Show Me the Money” pieces, we believe that Abenomics is working well, especially for corporations, with 4Q pretax profit margins (on a four quarter average) remaining at historical highs, with the non-manufacturing sector surging to a new high. On an after-tax basis, the improvement is even better due to lower corporate taxes. Abenomics is, thus, working very well for long-term domestic equity investors too (even after recent declines), and should continue to do so, in our view. Indeed, the market PER of 12.8 times consensus forward earnings estimate is attractive and consensus earnings estimates will likely rebound from their recent weakness due to a weaker Yen and improving global economic factors. In sum, we assume a moderate PER re-rating and rising earnings estimates to produce a 6.2% unannualized total return in USD terms through September (TOPIX at 1479), and 10.6% in Yen terms.
As for the Developed Pacific-ex Japan region, we expect major strength in both Hong Kong and Australian equities through September, as both will benefit from increased confidence in the Chinese economy. Thus, for the region’s developed markets, we expect a 9.6% unannualized return in USD through September, so we will maintain an overweight stance.
In sum, we forecast that Developed Pacific ex Japan, Japan and Europe will outperform in the next six months, while the US should underperform and, thus, deserve an underweight stance vs. all other regions.
Besides Brexit and possible fears that Trump will upset the world order, the largest risk factor continues to be increased terrorism in the West, even though the effects of such would not likely be long-lasting. Clearly, geopolitical risk in general remains very high, but at least Syria is somewhat more stable now. Emerging economies also remain a risk, and within such, corporations with large USD debts pose credit risks, especially as credit ratings decline. The large debts within the US shale oil sector are also likely to remain problematic in the coming quarters. As always, we watch the Ukraine and North Korea with concern, especially now that China seems quite serious about penalizing the latter.
Investment Strategy Concluding View
We forecast that global equities will continue to rise except in the US, so we will have a neutral stance overall, but firmly overweight ones on Japanese and Pacific ex Japan markets. Due to our expectation for global bond yields to rise moderately and for the USD to continue appreciating, we continue to underweight global bonds vs. USD cash for USD based clients. For Yen based clients, we strongly emphasize Japanese equities and prefer ex-Japan bonds to JGBs.