Out Outcom ome Mat Matter ers November 2019
Herman van Papendorp Head of Research and Insights Where to now, asset classes?
Gl Global obal asse asset cl classes asses Fundamentals and valuations
Global equities compared to bonds Few investments Rising recession High volatility likely cheap compared probability to history Equities and credit most at risk Improvements in financial advice sharp equity drawdowns Bonds already priced for typical around recessions recession, but not equities Flatter yield curve and more US bonds a recession safe activity from Tweeter Trump equities look cheaper than haven but can recession be bonds against own history avoided?
The argument for de ‐ risking global recession Meaningful recession risk Citi Rates Strategy Machine Learning Algorithm Predicted and actual probability of a recession within 12 months 100% 80% 60% 40% 20% 0% Jan ‐ 85 Jan ‐ 90 Jan ‐ 95 Jan ‐ 00 Jan ‐ 05 Jan ‐ 10 Jan ‐ 15 Actual Predicted Source: Citi
Source: Morgan Stanley Meaningful recession risk The argument for de ‐ risking global recession 10% 20% 30% 40% 50% 0% MS model ‐ all 12% variables Uncondiitional prob given not 13% currently in US recession probability in next 12 months recession 20% MS econ est. Unconditional 25% probability MS model ‐ 37% financial variables only New York Fed 38% model MS cycle model 42% est.
Recessions (mostly) mean equity bear markets Recent drawdowns between 20% and 60% Peak Trough Lenghts (Mths) Peak Trough Peak Trough Date Drawdown Oct ‐ 26 Nov ‐ 27 13 Aug ‐ 29 Mar ‐ 33 43 Y – Sep ‐ 29 ‐ 86% May ‐ 37 Jun ‐ 38 13 Y – Mar ‐ 37 ‐ 54% Feb ‐ 45 Oct ‐ 45 8 Y – May ‐ 46 ‐ 28% Nov ‐ 48 Oct ‐ 49 11 Y – Jun ‐ 48 ‐ 21% Jul ‐ 53 May ‐ 54 10 Aug ‐ 57 Apr ‐ 58 8 Y – Aug ‐ 56 ‐ 22% Apr ‐ 60 Feb ‐ 61 10 Y – Dec ‐ 61 ‐ 28% Dec ‐ 69 Nov ‐ 70 11 Y – Nov ‐ 68 ‐ 36% Nov ‐ 73 Mar ‐ 75 16 Y – Jan ‐ 73 ‐ 48% Jan ‐ 80 Jul ‐ 80 6 Jun ‐ 80 Jul ‐ 81 5 12 Jul ‐ 81 Nov ‐ 82 16 Jan ‐ 82 Jul ‐ 83 6 8 Y – Nov ‐ 80 ‐ 27% Jul ‐ 90 Mar ‐ 91 8 Apr ‐ 91 Dec ‐ 92 9 21 Y – Jul ‐ 90 ‐ 20% Mar ‐ 01 Nov ‐ 01 8 Nov ‐ 01 Jul ‐ 03 8 20 Y – Mar ‐ 00 ‐ 49% Dec ‐ 07 Jun ‐ 09 18 Dec ‐ 08 Sep ‐ 10 12 15 Y – Oct ‐ 07 ‐ 57% Source: Morgan Stanley
Equities and credit don’t like recessions US bonds a safe haven; gold runs ahead of the recession Returns going into a recession Returns after recession starts Asset 12m 6m 3m 1m 1m 3m 6m 12m MSCI ACWI ‐ 7.0% ‐ 6.9% ‐ 1.6% ‐ 2.4% ‐ 3.6% ‐ 6.5% ‐ 11.3% ‐ 17.1% S&P 500 1.1% ‐ 0.5% 0.5% ‐ 0.5% ‐ 2.9% ‐ 6.6% ‐ 5.6% ‐ 7.1% MSCI Europe 0.6% ‐ 1.6% ‐ 1.2% ‐ 0.2% ‐ 2.3% ‐ 8.6% ‐ 9.8% ‐‐ 8.8% TOPIX ‐ 5.0% ‐ 5.3% 0.5% ‐ 0.4% ‐ 2.9% ‐ 8.1% ‐ 11.1% ‐ 15.7% MSCI EM 15.4% 4.7% 6.1% ‐ 0.5% ‐ 7.0% ‐ 11.4% ‐ 18.0% ‐ 13.5% UST 10Y 3.3% 2.5% 3.1% ‐ 1.0% ‐ 2.2% 2.9% 6.6% 10.9% US IG ‐ 1.6% ‐ 1.7% ‐ 0.3% 0.0% ‐ 0.3% ‐ 1.7% ‐ 2.0% ‐ 5.0% DXY 3.8% 1.5% 1.5% 1.1% ‐ 0.7% ‐ 2.4% ‐ 3.6% 6.3% EUR USD ‐ 0.6% 0.5% ‐ 1.2% ‐ 0.9% 0.5% 2.4% 3.8% ‐ 7.8% JPY USD ‐ 7.9% ‐ 5.7% ‐ 1.8% ‐ 1.7% 1.6% 5.8% 6.5% 6.7% Brent 24.4% 4.2% 13.4% 8.1% 13.8% 27.7% 19.0% ‐ 20.1% Gold 34.0% 28.3% 20.4% 11.1% 2.6% ‐ 5.2% 0.8% ‐ 7.7% Source: Morgan Stanley
It ain’t over when the yield curve canary sings Equities can still go higher in the interim # of # of months months btw. # of btw. Perf btw. Date of curve months curve % of cycle curve Start of 10 ‐ 2Y Date of Start of inversion btw. SPX inversion when % of cycle inversion US curve S&P500 US & SPX peak & & curve when SPX & SPX upcycle inversion peak recession peak recession recession inverts peaks peak Mar ‐ 61 Dec ‐ 67 Nov ‐ 68 Dec ‐ 69 11 13 24 77% 88% 12% Dec ‐ 70 Mar ‐ 73 Sep ‐ 73 Nov ‐ 73 6 2 8 77% 94% ‐ 3% Apr ‐ 75 Aug ‐ 78 Jan ‐ 80 Jan ‐ 80 17 0 17 70% 100% 11% Jul ‐ 80 Sep ‐ 80 Nov ‐ 80 Jul ‐ 81 2 8 10 17% 33% 12% Dec ‐ 82 Dec ‐ 88 Jun ‐ 90 Jul ‐ 90 18 1 19 79% 99% 29% Apr ‐ 91 Feb ‐ 00 Aug ‐ 00 Mar ‐ 01 6 7 13 89% 94% 11% Dec ‐ 01 Aug ‐ 06 Oct ‐ 07 Dec ‐ 07 14 2 16 78% 97% 19% Average 11 5 16 70% 86% 13% US equity US recession: peak: Jul ‐ 20? Dec ‐ 20? Source: Barclays
Can renewed policy stimulus avoid recession? Growth support from more rate cuts 35 58 25 15 54 5 ‐ 5 50 ‐ 15 ‐ 25 46 ‐ 35 2009 2011 2013 2015 2017 2019 # of CBs easing vs. tightening (right, 6M Lead) China credit impulse (12M chg, 6M Lead) Global manufacturing PMI Source: JP Morgan
Can renewed policy stimulus avoid recession? Growth support from QE comeback USD tn 2.5 SNB 2 1.5 Total CB purchases 1 0.5 0 BoE ‐ 0.5 ‐ 1 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 EM BoJ ECB Fed Source: Citi
Rising equity volatility likely Flatter yield curve typically leads to higher equity volatility 52 100 2 – 10 spread (lead by 3y) 50 45 0 38 ‐ 50 31 VIX ‐ 100 24 ‐ 150 17 ‐ 200 10 ‐ 250 3 ‐ 300 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 2021 2 ‐ 10 year spread (3y lead, lhs) VIX (rhs) Source: BofA Merrill Lynch
Volatility rising activity from Tweeter Trump Trump’s Twitter activity has risen meaningfully during 2019 25 20 15 10 5 0 Jan ‐ 2016 Jul ‐ 2016 Jan ‐ 2017 Jul ‐ 2017 Jan ‐ 2018 Jul ‐ 2018 Jan ‐ 2019 Jul ‐ 2019 1 month avg tweets/day Excluding retweets Source: JP Morgan
Volatility rising activity from Tweeter Trump Tweets more frequently on market ‐ moving topics Trade (1/10) and monetary policy (1/15) 1000 100 800 80 600 60 400 40 200 20 0 0 Jan ‐ 2017 Jul ‐ 2017 Jan ‐ 2018 Jul ‐ 2018 Jan ‐ 2019 Jul ‐ 2019 Trade (dollar, trade, farmers, China, tariff) All tweets (RHS) Monetary (economy, inflation, federal, reserve, Powell) Rolling 1 ‐ month count of tweets containing select key words related to trade or monetary policy (LHS) compared to rolling count of all tweets (RHS); count Source: JP Morgan
Trump tweets induce market volatility Early in 2019, only two to three tweets per month moved US bonds; now this is 30+ Rolling 1 ‐ month count of tweets from the President’s personal account immediately followed by a 0.5bp+ net move in 10 ‐ year Treasury yields within 5 minutes of publication (LHS; count); 40 85 3Mx10Y ATMF swaption implied vol (RHS; abp) 80 30 75 70 20 65 60 10 55 50 0 Feb ‐ 2018 May ‐ 2018 Aug ‐ 2018 Dec ‐ 2018 Feb ‐ 2019 May ‐ 2019 Aug ‐ 2019 3Mx10Y swaption implied vol (RHS) Tweets followed by 0.5bp+ moves (LHS)2 Source: JP Morgan
Very few assets are cheap vs history Only gold and EM $ debt seem cheap vs past; equities look cheaper than bonds ‐ 2 0 2 Equities Metric Latest 20 ‐ year Z Score MSCI ACWI Fwd P/E 14.7 S&P 500 Fwd P/E 16.6 MSCI Europe Fwd P/E 13.1 TOPIX Fwd P/E 12.0 MSCI EM Fwd P/E 11.3 Rates Metric Yields (%) 20 ‐ year Z Score UST 10Y Real Yield ‐ 0.27 DBR 10Y Real Yield ‐ 1.81 JGB 10Y Real Yield ‐ 0.93 Credit Metric Spread (bp) 20 ‐ year Z Score US IG Loss Adj Spread 97 US HY Loss Adj Spread 154 EUR IG Loss Adj Spread 87 EUR HY Loss Adj Spread 206 EM USD Spread 387 FX Metric Spot 20 ‐ year Z Score EUR/USD REER 94 GBP/USD REER 97 JPY/USD REER 80 Commodities Metric Spot 20 ‐ year Z Score Brent Inflation Adj Price 0.5 Gold Inflation Adj Price 12.9 Copper Inflation Adj Price 2.2 Source: Morgan Stanley
Are asset classes priced for recession? Rates YES; other assets NO Valuation Implied recession probability in next 12 months Name Metric Long ‐ Term Z Score Data since ‐ 2 0 2 Equities S&P 500 P/E ‐ 0.61 1964 S&P 500 EPS 0.28 1964 S&P 500 Equity sectors Cons staples vs Mkt P/E 0.01 1974 Financial vs Mkt P/E 0.24 1974 Materials vs Mkt P/E 0.34 1974 Utilities vs Mkt P/E ‐ 0.10 1974 Small vs large caps P/E 0.16 1979 Rates UST 10y Real yields 0.38 1972 UST 3m10y Level 1.33 1959 UST 2s10s Level 0.89 1976 FX DXY Price ‐ 0.79 1981 GBPUSD Price ‐ 1.06 1981 AUDUSD Price ‐ 0.76 1981 Credit US BBB Spreads ‐ 0.22 1929 Commodities Brent Inflation ‐ adj price ‐ 0.92 1998 Gold Inflation ‐ adj price ‐ 0.17 1990 Copper Inflation ‐ adj price ‐ 0.79 1999 Source: Morgan Stanley
Loc Local asse asset classes classes Fundamentals and valuations
SA equities Equity returns not Poor 5 ‐ year Impact of potential sensitive to SA performance US recession economic growth Improvements in financial advice US recessions don’t matter for History points to strong future Similar returns in both low ‐ equity returns in the long run returns the shorter the (3 years+) but be cautious growth and high ‐ growth history, the cheaper SA periods of SA (and US) equities around equities’ forward P/Es look onset of US recession
History supports prospective SA equity returns From low 5 ‐ year trailing return levels, historical subsequent returns were lofty Subsequent Alsi annualised index returns when trailing 5 ‐ year returns fell below 3.5% One year Two year Three year Five year Full period (11 times) Average 27.2% 26.1% 25.0% 18.6% Median 26.6% 27.8% 25.8% 18.2% Since 1984 (5 times) Average 45.3% 30.9% 25.8% 19.5% Median 39.2% 31.6% 25.8% 18.2% Source: Iress, Momentum Investments
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