1 NOVEMBER 2016 LGIM MARKET VIEWS LGIM current market views Cuts through the haze of investment commentary macromatters.com For professional investors only, not to be distributed to retail clients
NOVEMBER 2016 LGIM MARKET VIEWS 2 Asset allocation core views Overweight + Japanese equities Cautious overall + Global REITS + Emerging market $ debt + US inflation-linked bonds + GBP Underweight - Emerging market local currency debt - Emerging market equities - European equities - US treasuries • Brexit fallout • Politics & populism Risks we are most Economic • focused on Central banks/ inflation Valuations Systemic Risk Cycle • Chinese Growth / EM Risks Economy remains mid Risk asset valuations Material risks from the • cycle, but getting closer are not excessive US Federal Reserve, GBP from neutral to positive to late cycle emerging market debt • Recent changes US treasuries from neutral to negative levels and Brexit fallout • EM equities from neutral to negative Source: LGIM, as at 14 November 2016
3 NOVEMBER 2016 LGIM MARKET VIEWS Déjà vu all over again? … and markets don’t always get it right! The favourite doesn’t always win… 1.5 18 100% USDMXN, GBPUSD inverted 90% 80% 70% 1.4 19.5 60% 50% 40% 1.3 21 30% 20% 10% 0% 1.2 22.5 200 150 100 50 0 01/06/2016 01/07/2016 31/07/2016 Days until the event 18/10/2016 17/11/2016 Brexit odds Trump odds British Pound vs US dollar (lhs) Mexican Peso vs US dollar (rhs) GBP & MXN both rally (c. 4%) going in to the event in anticipation of Remain/Clinton GBP & MXN both collapse (c. 10%) faced with the reality of Leave/Trump Source: Bloomberg LP, Pivit, LGIM
4 NOVEMBER 2016 LGIM MARKET VIEWS Trump (and Brexit) represent the shifting centre-ground Mainstream politics does not have a good answer to rising inequality 2015 • Not everyone is a winner of 210 globalisation, automation, quantitative Index, 1967 = 100 $351,000 easing 190 • Anti-establishment and populism are on 170 the rise in many countries • Trump and Brexit (and Sanders, 150 Corbyn, Front National, AfD) are symptoms, not causes 130 $34,000 • Is the centre-ground of policy making 110 shifting to the left? Independent of the protagonists? 90 US average household real income: Bottom 60% of income distribution Top 5% of income distribution Source: LGIM, BCA
5 NOVEMBER 2016 LGIM MARKET VIEWS What cards will Trump be playing? “Known unknowns” Recent positions “Known knowns” – Core beliefs “Unknown unknowns” Trump – behaviour “ Capitalist Protectionist Anti-Green I’m totally Unexpected Repeal Tighter Pro-fossil fuel announcements flexible on very, Obamacare immigration laws very many Pro-nuclear ” Sudden policy issues. Import tarrifs Lower tax “ changes Pro-gun rights (income and corporate) All policy Renegotiate trade Ill-advised proposals are Infrastructure agreements comments just flexible spending ” suggestions.
6 NOVEMBER 2016 LGIM MARKET VIEWS The shifting allegiances of the President-elect 1987 Republican Party 1999 Reform Party 2001 Democratic Party 2009 Republican Party 2011 Independent 2012 Republican Party
7 NOVEMBER 2016 LGIM MARKET VIEWS Potential asset class impact of a Trump Presidency US infrastructure US dollar US equities US treasuries ─ ! China Japan Other impacts Increasing inflation ! Mexico Source: LGIM
8 NOVEMBER 2016 LGIM MARKET VIEWS http://macromatters.lgim.com/tags/donald-trump/
9 NOVEMBER 2016 LGIM MARKET VIEWS Primary market focus has been on reflation trades The cost of Trump’s campaign promises The bond market reaction to Trump 3.5 % Tax cuts of Spending 3.0 $4.5 trn increases of (2.5% of GDP) $1.3 trn 2.5 $ trillion (over ten years) 3.5 (0.7% of GDP) 3.0 2.5 2.0 2.0 1.5 1.5 1.0 0.5 1.0 0.0 US inflation breakevens and -0.5 US nominal yields are now -1.0 0.5 more than 70bp off the low -1.5 0.0 2012 2014 2016 10 year US yields 10 year US inflation Source: Committee for a Responsible Federal Budget Source: Bloomberg LP, LGIM
10 NOVEMBER 2016 LGIM MARKET VIEWS Secondary market focus on emerging markets The EM reaction to Trump US involvement in the world economy is a … US involvement in the global economy is a... 115 Index, 01/01/16 = 100 Good thing, Bad thing, creates new lowers wages, 110 markets, growth costs jobs 49% 44% Total 105 100 Trump 65% 31% supporters 95 7% hit to emerging market equities 90 Clinton 4% hit to emerging market FX 55% 37% supporters 85 Source: Pew Research Centre, May 2016 -80 -60 -40 -20 0 20 40 60 80 MSCI Emerging total return / MSCI World total return JP Morgan Emerging Market Currency Index
11 NOVEMBER 2016 LGIM MARKET VIEWS The wrong time to add stimulus (1a) Recovery is already here: the US labour market
12 NOVEMBER 2016 LGIM MARKET VIEWS The wrong time to add stimulus (1b) Recovery is already here: the global picture
13 NOVEMBER 2016 LGIM MARKET VIEWS The wrong time to add stimulus (2) Inflation already set to increase US CPI inflation 6 Headline inflation Core inflation Forecast 5 4 3 % change on a year earlier 2 1 0 -1 -2 -3 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
14 NOVEMBER 2016 LGIM MARKET VIEWS The wrong time to add stimulus (3) Federal Reserve likely to respond by tightening more https://macromatters.lgim.com/categories/macrobites/and-then-there-were-nine/
NOVEMBER 2016 LGIM MARKET VIEWS 15 What are the greatest risks? Politics & populism US Fren rench UK tr triggers rs Pres residenti tial Pres residenti tial Art rticle 50(?) (?) electi tion electi tion June Decembe De mber March Octob tober 2016 2016 2016 2016 2017 2017 2017 2017 May May Novembe mber Q1 2017 2017 2016 2016 2017 2017 Dutc Dutch German rman It Italian UK UK general ral Federal ral refe referen rendum refe referen rendum electi tion electi tion Source: LGIM
16 NOVEMBER 2016 LGIM MARKET VIEWS Political focus to shift back to Europe Italian referendum is the next potential flashpoint Average of last five opinion polls 45 % 40 35 30 25 20 15 10 5 0 Yes No Don't know 17/10/16
17 NOVEMBER 2016 LGIM MARKET VIEWS Political focus to shift back to Europe Confidence in the French presidential elections now shaken
18 NOVEMBER 2016 LGIM MARKET VIEWS The Trump silver-lining: takes the focus off Brexit! https://macromatters.lgim.com/categories/macrobites/would-a-hard-brexit-really-be-worse-than-napoleon/
NOVEMBER 2016 LGIM MARKET VIEWS 19 Asset allocation core views Overweight + Japanese equities Cautious overall + Global REITS + Emerging market $ debt + US inflation-linked bonds + GBP Underweight - Emerging market local currency debt - Emerging market equities - European equities - US treasuries • Brexit fallout • Politics & populism Risks we are most Economic • focused on Central banks/ inflation Valuations Systemic Risk Cycle • Chinese Growth / EM Risks Economy remains mid Risk asset valuations Material risks from the • cycle, but getting closer are not excessive US Federal Reserve, GBP from neutral to positive to late cycle emerging market debt • Recent changes US treasuries from neutral to negative levels and Brexit fallout • EM equities from neutral to negative Source: LGIM, as at 14 November 2016
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