Global Macroeconomic & Market Outlook A Tale of T wo Markets Neil Michael Chief Investment Strategist & Head of Multi-Asset Investments July 2019 Private & Confidential Crown Agents Macroeconomic & Market Outlook
Executive Summary • Bond and equity markets are sending different signals. • Bond markets focused on slowing growth and trade uncertainty. • Slowing world trade being compounded by strong Dollar. • Equity markets focused on the fact that despite weak manufacturing, service activity continues to hold up reasonably well. • Fed rate cut as an insurance policy could sustain the expansion as in 1994 and 1998. • Bond and equity markets pricing in different recession probabilities. • Personal incomes and labour market helping to keep recession probability low. • Fed has gone from expected rate increases to possible rate cuts in 2019. • Bond yields have probably over-reacted to recession fears; and inflation has likely bottomed-out. • Rates expected to peak in the US, remain on the floor in the Eurozone & Japan, rise Post Brexit in UK, & nudge down in China. • Equities supported by continued positive earnings growth, returns on capital greater than cost of capital and lack of compelling alternatives. • However, after a very strong performance so far this year, equity valuations – particularly in the US - are looking stretched, and any negative news on trade tensions for example, could trigger some weakness. Private & Confidential Crown Agents Macroeconomic & Market Outlook 1
Table of Contents Macro Outlook Bond Market Outlook Equity Market Outlook Private & Confidential Crown Agents Macroeconomic & Market Outlook 2
Macro Outlook Private & Confidential Crown Agents Macroeconomic & Market Outlook
Bond and Equity Markets Sending Mixed Signals S&P500, US 2Yr Treasury Yield & Fed Funds Rate Source: Bloomberg. Data to 28 June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 4
Fed Rate Cuts as an Insurance Policy Could Sustain the Expansion as in 1994 and 1998 S&P500, US 2Yr Treasury Yield & Fed Funds Rate Source: Bloomberg. Data to 28 June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 5
Bond Markets Focused on Slowing Growth and Trade Uncertainty Global Trade War Scenario – Impact on Global GDP Global Manufacturing PMIs Source: Bloomberg. Data to June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 6
Slowing World Trade Compounded by Strong Dollar, Which is Also Helping to Keep Inflation at Bay World Trade & Trade-Weighted Dollar Source: Bloomberg. Data to 30 March/June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 7
Dollar Should Weaken Given Rate Differentials & Twin Balance US Trade & Budget Balance vs Dollar Ave US Interest Rate Differential & Dollar Source: Bloomberg. 28 June 2019. Source: Bloomberg. 28 June 2019. Average of UK, Eurozone & Japan. Private & Confidential Crown Agents Macroeconomic & Market Outlook 8
Equity Markets Focused on the Fact That Despite Weak Manufacturing, Service Activity Continues To Hold Up Reasonably Well Global Services PMIs Global Composite PMIs Source: Bloomberg. Data to June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 9
Bond & Equity Markets Pricing in Different Recession Probabilities Probabilities of Recession & S&P500 Source: Bloomberg and Federal Reserve. Data to 30 June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 10
Personal Incomes & Labour Market Helping to Keep Recession Probability Low US Business Sales, Industrial Production, Personal Incomes & Non-Farm Payroll Source: Bloomberg. Data to May/June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 11
Global Consumer Confidence Supported By Solid Labour Markets Global Consumer Confidence Global Unemployment & Real Wages Source: Bloomberg. Data from Sept 2002 to May 2019. Source: Bloomberg. Data from Dec 2000 to May/June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 12
After A Slowdown, Global Growth Is Likely To Stabilise And Then Pick-Up Again, With Rising But Contained Inflation Global Inflation Forecasts Global GDP Forecasts Source: Bloomberg Consensus. July 2019. Average = Since Dec 2000. Source: Bloomberg Consensus. July 2019. Average = Since March 1996. Private & Confidential Crown Agents Macroeconomic & Market Outlook 13
Market Performance Private & Confidential Crown Agents Macroeconomic & Market Outlook
Risk Markets in Particular Have Had a Very Strong 2019H1 Thanks to Central Bank Dovishness & Optimism Over Trade Negotiations (Despite Set-Back in May) Market Performance % Year to Date Performance % Source: Bloomberg, Data to 30 June 2019 Private & Confidential Crown Agents Macroeconomic & Market Outlook 15
Bond Market Outlook Private & Confidential Crown Agents Macroeconomic & Market Outlook
Fed Has Gone From Expected Rate Increases to Probable Rate Cuts in 2019 Fed Dot Plot Source: Bloomberg. June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 17
Probability of 50bp July Rate Cut Has Dropped Rate cut probabilities for July 120 100 80 60 40 20 0 1.75-2 2-2.25 Source: Bloomberg. 8 July 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 18
Dot Plot Rate Outlook Longer Term Source: Bloomberg. 8 July 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 19
Source: Bloomberg. 8 July 2019. Falling Inflation Has Helped Ease Bond Private & Confidential -0.5 0.5 1.5 2.5 3.5 4.5 0 1 2 3 4 01/02/2010 01/05/2010 01/08/2010 01/11/2010 01/02/2011 01/05/2011 01/08/2011 01/11/2011 01/02/2012 01/05/2012 01/08/2012 01/11/2012 Crown Agents Macroeconomic & Market Outlook 01/02/2013 CT05 Govt - Mid Price 01/05/2013 Inflation versus 5-year UST 01/08/2013 01/11/2013 01/02/2014 01/05/2014 01/08/2014 01/11/2014 Yields CPI YOY Index - Last Price 01/02/2015 01/05/2015 01/08/2015 01/11/2015 01/02/2016 01/05/2016 01/08/2016 01/11/2016 01/02/2017 01/05/2017 01/08/2017 01/11/2017 01/02/2018 01/05/2018 01/08/2018 01/11/2018 01/02/2019 01/05/2019 20
US 5yr/5yr Forward Inflation – Inflation Expectations Have Likely Bottomed 5yr5yr FWD 2.35 2.25 2.15 2.05 1.95 1.85 1.75 Source: Bloomberg. 8 July 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 21
Rates Expected to Peak in the US, Remain on the Floor in the Eurozone & Japan, Rise Post Brexit in UK, & Nudge Down in China Expected Central Bank Rates Source: Bloomberg Consensus. As at 2 July 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 22
Government Bond Yields Have Probably Over-Reacted To Recession Fears Government Bond Yields 2Yr % Government Bond Yields 10Yr % Source: Bloomberg, Data to 28 June 2019 Private & Confidential Crown Agents Macroeconomic & Market Outlook 23
US & China Are The Only Major Bond Markets Compensating For Inflation Nominal & Real Yields % (2Yr) Source: Bloomberg, Data from 12 Jan 2001 to 28 June 2019 Private & Confidential Crown Agents Macroeconomic & Market Outlook 24
IG Spreads Have Narrowed & US Leverage Has Risen Investment Grade Spreads US IG Leverage Measures Source: Bloomberg, Bank of America Merrill Lynch. Data to 28 June 2019 Private & Confidential Crown Agents Macroeconomic & Market Outlook 25
HY Spreads Narrower But Not Back To 2018 Lows & Leverage is Picking Up High Yield Spreads US HY Default Rates Source: Bloomberg, Bank of America Merrill Lynch. Data to 28 June 2019 Private & Confidential Crown Agents Macroeconomic & Market Outlook 26
Emerging Market Bonds – Spreads Just Above Average But Countries With The Biggest CA Deficits Are Most Vulnerable EMB IG Spread (Versus 10Yr UST Yield) Current Accounts Balances & Changes In EMBI Spreads Source: Bloomberg. Data to 28 June 2019. Source: IMF. JP Morgan. April 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 27
Equity Market Outlook Private & Confidential Crown Agents Macroeconomic & Market Outlook
Equities – Continued Positive Earnings Growth Global Company Earnings Growth (%YoY) Private & Confidential Crown Agents Macroeconomic & Market Outlook 29
Equities – Return on Capital Still Above the Cost of Capital Global Return On Capital Source: Bloomberg. Data from Jan 2006 to June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 30
Equities – Equities Look Reasonable Relative to Bonds – UK Very Cheap Equity Dividend versus Bond Yields Source: Bloomberg. Data as at June 2019. Private & Confidential Crown Agents Macroeconomic & Market Outlook 31
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