Central banks hold the key to growth or recesssion, say investment managers

Central banks hold the key to growth or recesssion, say investment managers
Soft landing: strategists say the China slowdown is of great concern but they do not expect it to slip into recession

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Investment officers at some of the world’s biggest family offices and private banks are cautiously optimistic over markets, the prospects for the continuation of the equity bull run and the global economy.

Six chief investment officers and strategists are broadly in agreement on the big trends that are likely to dominate over the next 18 months and what it means for their asset allocations.

Without exception they favour developed world stocks over underperforming emerging markets, with some increasing allocations to mid-cap companies, while others think hedge funds, private equity and infrastructure are worth a bet as they hunt for returns in a world of historically low yields.

In their view, the risk is the slowing Chinese economy, whether there will be a hard or soft landing, and the effects of the unwinding of extraordinary monetary policy with the US Federal Reserve eyeing its first interest rate rise in a decade. In particular, the US central bank seems to hold the key with the debate intensifying over how soon it should tighten monetary policy, the effects this will have on a strong dollar and fragile emerging markets, which could undermine global growth and the world recovery.

In short, investment managers say central bank decisions, not just in the US but in Europe, Japan and China too, over the next 18 months may prove critical for the long-term economic outlook and the health of the financial system, with recession a distinct possibility if they make the wrong calls.

Eric Verleyen, chief investment officer at Société Générale Private Banking:

“We think the recovery in the US is sustainable and we don’t think there will be a hard landing in China. The developed world equity markets and earnings should continue to do well.

“We prefer equity over bonds as we think corporates will generate earnings and growth and risk assets will benefit, which means we are broadly overweight equity and underweight bonds.

“We expect a pick-up in the eurozone economies with the help of accommodative European Central Bank policy, which should help growth. For that reason, we are overweight European equities.

“We are overweight Japanese equities, based on the view that there will be a soft landing in China that will benefit Japan, which should therefore see a recovery.

“On US equities, we are neutral. The US is growing and the economy looks relatively strong, but stocks are expensive.

“On government bonds, normalisation is on the way and we expect US rate rises soon. Being a government bond investor, you will therefore suffer as monetary policy is tightened.

“Government bonds are not great value with such low yields, so we are inclined to opt for corporate bonds because of higher yield, particularly as we don’t think there will be a pick-up in default rates as we expect the US economy will continue growing over the next 18 months.

“Overall, we are underweight in emerging markets, where falling commodity values are having a big influence. For this reason, we are more favourable towards Asian equities, where we are neutral, but we don’t like South America stocks. We are also underweight in eastern Europe.

“On currency, the dollar looks like it will remain strong while the euro is likely to remain weak, which means it is good to hold dollars and US companies, which are denominated in dollars.

“The consumer will benefit from low commodities, which means we like sectors that are linked to the consumer, such as consumer discretionaries and luxury goods groups. Cyclical stocks linked to the consumer and recovery are worthwhile investments.

“On the alternative front, we like hedge funds. We think they can perform better in a differentiating market where QE [quantitative easing] is not such an influence and a premium is on companies that are well managed.”

Willem Sels, UK chief market strategist at HSBC Private Bank:

“We downgraded global equity in May because we were worried about the emerging markets. For this reason, we are temporarily overweight in cash.

“We have also increased credit positions and hedge fund positions, while our equity allocations are neutral overall.

“In European equities we are overweight and hoping for strong earnings growth in Europe this year. Valuations in Europe are cheap relative to the US and fair overall. Monetary policy is also supportive in Europe.

“In corporate credit, we are overweight. We particularly like the cross-over space between investment grade and high yield — companies with a triple B or double B credit rating. These assets make sense, if you are a buy and hold investor who is not worried about liquidity. They offer relatively high yields, but it is not that easy to liquidate positions. We think the US economy will grow while the default environment is very benign.

“We are also overweight hedge funds because they are an uncorrelated asset class and we are in an environment of high volatility, which hedge funds should be able to exploit. We like private equity. You can’t get in and out of private equity easily, but you need to create value in equities and private equity creates value.

“There is a lot of nervousness about China, but we think over the next 18 months the country will stabilise, which will help equities.

Japan’s manufacturing sector has been affected by the China slowdown

“China can help its economy by increasing infrastructure spending and cutting rates while the currency can depreciate somewhat further, even if we don’t expect it to fall sharply. This should help to give markets more confidence that there is a gradual slowdown of growth in China, but it does not mean there will be a hard landing.

“We don’t expect equities to plunge, nor do we expect a big jump. Equities are more likely to trade in a sideways channel, which we are at the bottom of at the moment.

“On the dollar, we think the first rate rise has been priced in and that the dollar is the most overvalued of currencies so it would be hard for it to rally further.

“We are underweight emerging market equities because of the lack of clarity around China in the short term, and underweight government bonds because we think the yields are too low to offer decent returns.”

Bruce Stewart, chief investment officer of the family office services group at BNY Mellon Wealth Management:

“First, the overall trends favour developed world equities to emerging market equities. The most obvious decision in this environment and for the medium term over the next 18 months is to go underweight emerging markets because of the problems in this region.

“However, we don’t consider emerging markets to be a homogenous asset class. Eastern Europe and emerging Asia are holding up fairly well, as opposed to Latin America where there are big problems.

“In simple terms, you have to look at the net exporters and the net importers of energy. For example, India is doing well and Brazil not so well.

“On equities as a whole, we are re-allocating from large-cap stocks to mid-cap stocks. We like mid caps because they sit well between small and large companies. They are higher quality than small caps but present greater growth opportunities than large caps. On a risk-adjusted basis, mid caps are what we favour most.

“Internationally, we like small caps as it is one of the least inefficient asset classes. We think there is more opportunity to pick up capital value in small developed world companies.

“On the currency front, we have a climate of strong dollar and weak euro and we think that will continue for a while, which could make US dollar-denominated assets attractive.

“In bonds, we like floating-rate securities to offset expected US rate rises. We have also gone short US Treasuries, while going long the US aggregate bond index, which is a broad collection of fixed income securities including investment-grade and other bonds.

“Another trend among some family office clients is to hold cash and wait for good opportunities to invest.”

Anton Sternberg, head of investments at Stonehage Fleming:

“We are fairly optimistic on stocks over the next year or so. We are constructive on equities in a focused way. Our equity exposure is in global-based ideas in concentrated, high-conviction, defensive high-quality companies or with good exposure to consumer markets.

“We are happy to have companies that are exposed to emerging markets without them being emerging market companies themselves. We want decent growth and decent dividends.

“Emerging markets still have huge potential and still offer opportunities. We have companies with emerging market exposure such as Nestlé and AB InBev as they are quality businesses.

“We are not that keen on bonds. We have been wrong on the view of bonds as yields have remained low, but we find it hard to be constructive on bonds. We have some credit exposure.

“If you had to look at it on an analytical basis, we like the US as the economy looks healthy and is likely to grow over the medium term. We are, therefore, constructive on companies with headquarters in the US.

“We are looking at a slow recovery in the US, which will benefit from consumer deleveraging and the oil price dividend, but we are not yet optimistic on commodities and don’t hold miners because we think commodity weakness is likely to be a continuing trend.

“We are underweight bonds and we don’t have a strong view on currencies.

“On alternative investments, long-term multi-generational family wealth makes private equity, private debt, infrastructure and real estate assets attractive as these people are not worried about illiquidity.”

Simon Smiles, chief investment officer for ultra high net worth at UBS Wealth Management:

“We have seen higher volatility in recent weeks, which is concerning because it is against a backdrop of low volatility. But we think the overall investment trends still broadly favour developed world equities.

“We are overweight global equities, Japan equities and European equities. There is improving economic growth in the eurozone and Japan, while corporate earnings are continuing to grow in the US. Low interest rates should also help recoveries in Europe and Japan.

“The US, the world’s biggest economy, has also revised up growth in the second quarter while the jobs market is strong. Our views would change if corporate earnings were to fold, but they are robust and monetary policy is supportive with low defaults.

“We think China will grow around 5 per cent this year. But it is still a big concern with the possibility of further depreciation in the Chinese currency, which could hit economies such as Japan, South Korea and Taiwan.

“At some point, there will be another recession but we do not expect it over the next 18 months as some suggest.

“We were overweight US equities in 2013 and 2014, but we are neutral in 2015 because of high valuations. US earnings are growing but are more muted, which is a reason not to be overweight.

“Oil and the US dollar will be influences on economies and markets. Low oil prices should be good for global growth, but a stronger dollar is holding back US earnings. We are underweight emerging markets because of the oil and dollar factors.

“Over the next 18 months China is a big concern, but the single greatest risk is the unwinding of extraordinary monetary policy. It is not the first rate hike but how the US Federal Reserve will stage the next rate hikes that will determine the outlook for the world economy.”

Steven Wieting, global chief investment strategist at Citi Private Bank:

“We expect slow growth in the world economy to persist. We see this as a bull market with a curfew. We don’t expect a collapse in equities over the next 12-18 months, although we have seen some recent volatility.

“China’s economy has been slowing since 2010, but we do not think it will collapse. We also do not expect the US to have a contraction in 2016, but there are risks that there will be one in 2017. For this reason, we have made gradual cuts in our global equity overweight positions.

“We are neutral on US Treasuries and overweight US investment-grade bonds.

“A big risk is more Chinese devaluations, which could be disruptive. However, we remain overweight eurozone equities, with a smaller overweight in US and UK equities. We are also overweight in Japan and India equities with a smaller overweight in Chinese H shares.

“On emerging markets, we are neutral or underweight. We are neutral on Asian hard currency debt but underweight in Brazil and on emerging market debt.

“We also have a deep underweight in eurozone and Japanese government bonds, while we are overweight in dollar-denominated assets.

“In alternatives, we think there are opportunities in selective private equity and real estate, particularly as there are higher long-term returns in that asset class than in public markets, where we don’t think it is worth paying a liquidity premium.

“Overall, we are cautiously optimistic for the next 18 months but the risk for recession is increasing as the US economy is not enjoying the labour force strength of recovery that some people had hoped for.”

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