For the second half of the year, with global growth dull, and interest rates staying low for longer, Beta returns will remain low and thus clients should remain confident that active management can deliver good returns that meet the needs for income and capital gain according to Neil Dwane, Global Strategist with Allianz Global Investors, in his latest interview with Funds Society.
What is your vision/forecast for the markets in the second half of the year? Will there be volatility or will calm predominate, as in these last months?
In general we see little upside in many asset classes after a strong H1. The US equity market is now expensively valued with little dividend support and is desperate for Trump tax reform and fiscal stimulus. Also, the US is seeing dull economic growth and faces a Federal Reserve intent on raising rates.
Asia offers more growth opportunities as India and Indonesia capitalise on their modernising new Governments whilst we expect China to be stable ahead of the Party Congress in November. Longer term, Asia offers the opportunity of 4bn new consumers for whom the "American Dream" is alive and well.
Europe looks attractively valued as the political risks following Brexit fade and the new positive momentum from Macron could energise the "journey to the United States of Europe" in 2018, though actual policies seem unclear as yet. With interest rates likely to stay very low, Euro investors face the continuing conundrum of holding return-free bonds or switching into equities which offer either an attractive dividend or good industry exposure to the world's opportunities.
"If you take no risk, you will earn no return" remains our mantra and thus taking some risk will require active management to control the periods of volatility which may arise.
What will be the main sources of uncertainty?
For many global investors, the key generator of uncertainty remains the policy directions from President Trump who may yet become trade protectionist with Asia and NAFTA and may or may not actually achieve any tax reforms which can sustain the US economy.
Geopolitics in the Middle East and other areas related to the energy sector may also continue to unnerve investors as an oil supply shock is not priced into the current price of oil. Clearly this would hurt most oil importing economies and tax global activity.
More difficult to assess, is the troubling situation with North Korea where pressure from the US and China is not yet showing any substantial progress but which could be easily inflamed by a diplomatic mistake or misinterpretation.
At geopolitical level, the negotiations of the Brexit will begin ... how do you foresee that they will develop and what impact will there be on the markets, especially in Europe? Will the UK shares and the pound be the only ones harmed?
Brexit presents a period of great uncertainty, made worse by the recent result of the June UK elections. We think it very unlikely that a deal can be negotiated by 2019 and transition arrangements will be necessary. All European companies will hope that economic and business sense prevails and that the broad regulatory and trade processes used today are maintained. The UK will endure a significant period of economic uncertainty and weakness now, which may weaken Sterling further, whilst the EU may make better progress as Macron rejuvenates policy.
Both the Euro and Sterling are undervalued against the US Dollar, and we would expect Euro to strengthen from here first and further.
Also at the geopolitical level, there will be elections in September in Germany. After what happened in Holland and France, could it be said that populism has been banished in Europe or do we still have to wait?
For now it would seem that populism has peaked after the Brexit vote. However, it should still be noted that anti-EU parties received 40% of votes in recent elections and possibly, even in France, only half the electorate voted for Macron. Shorter term, Italy becomes the last fault line of significant political risk for Europe as nearly 60% currently favour anti-EU parties but at least we have until May 2018 to assess progress further. Thus, populism may slumber and awaken in the next electoral cycle if Europe's policies do not share its wealth, growth and opportunities better.
Do you see political risks in markets like Italy or even Spain?
Italy is of concern as above. Spain seems to us to offer little political risk to Europe given its short history as a democracy and the Catalan question may be addressed through further local economic empowerment in due course.
On monetary policies: Do you see a clear distinction between the US and Europe? What do you expect from the Fed?
Yes, we have entered a period of monetary policy divergence with the ECB remaining accommodative and the Fed now raising rates and considering how to reduce its balance sheet. Financial conditions in the US remain quite loose so we expect the Fed to continue to raise rates in H2. Global monetary accommodation is peaking and the consequences for many asset classes from QE will now beginning to manifest themselves, especially in the overvaluation of sovereign bonds.
When will the ECB act? In this sense, how can monetary policies impact global equity markets and investor flows?
We expect the ECB to finish tapering QE in 2018 and to then raise rates albeit slowly in 2019, dependent on the strength of the economy then. This should support the mid-cycle economic expansion we see today.
Regulation, such as MIFID II: impact on industry and markets
We expect MIFID 2 to offer better transparency and thus better investment solutions to clients as it will force all managers and distributors / advisers to explain what services they are providing to their clients and at what costs. This could be very disruptive. It will thus force new business models and new relationships to be forged with clients but it will change the current financial services landscape. Brexit too, will shake up the industry as it remains unclear if being equivalent will mean the same as it does now for many European banks and insurers.
At the market level ... what assets do you see more opportunities for the second half of the year and why?
Taking risk to earn a return, and managing client nervousness to headline shocks and uncertainty, leaves us with high conviction over the "hunt for income" where clients can find attractive levels of yield from US High Yield and Emerging Market Debt as well as European equities. With global growth dull, interest rates staying low for longer, Beta returns will remain low and thus clients should remain confident that active management can deliver good returns that meet the needs for income and capital gain.