Navigating through the fog

The first months of 2016 were a reminder that we are not only living in a world of low to negative interest rates. It was also a good reflection of uncertainties around global growth in general and a long list of looming event risks.
The volatility witnessed during the first months of the year and the whipsawing in the valuation of risk premia is not a 2016 phenomenon: equity indices for Europe, the US or Emerging Markets unveil that high volatility and significant market swings have been with us since at least late 2014.

2016 so far, does not suggest to bring any more clarity. Expectations for world growth in 2016 where already fairly muted at the beginning of the year. But even low expectations have been revised downwards – again. While initially the hope was for a slight expansion in global activity we now expect growth to slow down further.

At the same time uncertainties around the transformation of the Chinese economy, the overcapacities in the global resource sector, the risk of Brexit, the future direction of Fed policy and the effectiveness of central bank policies in general, geopolitical tensions in the Middle East and the corresponding challenges caused by unprecedented immigration into Europe are only the most prominent event risks on investors minds.

Nevertheless and to make it short, we do neither expect China nor the US to enter into a recession any time soon. Global growth will continue to disappoint for the rest of the year, however, not in a catastrophic way. Europe so far is holding up quite well in this difficult environment and we expect expansionary ECB policy, improvements in employment and subsequent growth in consumption together with some fiscal expansion to keep European growth somewhere close to potential.

For global equities the deceleration of growth might prove to make significant EPS expansion unlikely. With average valuations for most developed markets on a multiple basis and cyclically low earnings this doesn't form a great investment case. While purely buying equity beta looks less attractive in this environment there might still be pockets of value left. While in some sectors even marginal EPS growth is not priced other sectors offer still attractive levels through the lens of dividend yields like real estate or insurance for instance.

On the fixed income side the continuous lack of any significant inflation should provide some comfort to investors. Buying more and more duration for hardly any or even negative yields does not sound like a great value proposition though. For corporate credit this environment might prove to be fairly supportive. Low growth might protect FCF generation and at the same time keep financial engineering and credit ratios in check. ECB intervention and the ongoing hunt for yield should at the same time bolster demand for the asset class. Furthermore diverging central bank policy might lead to diverging trends in default rates. Thanks to heavy ECB intervention European credit, especially for HY issuers, might do better than corporate issuers in the US.

Some of the above mentioned event risks demand careful monitoring and sound risk management. Further volatility bumps can and should not be ruled out. We still see selective investments that should provide decent returns for the year 2016. However, hedging strategies to protect against some of the looming event risks need to be considered seriously.

Our base case for the remainder of 2016 is for lackluster global economic performance and developed market inflation well below target. China will witness a further slowdown in GDP growth, but this is nowhere near the top of our "list of worries". The ECB and the BOJ might be forced into further easing down the road and FED policy for the rest of the year is everything but a done deal. Selected Emerging Markets might start suffering from balance of payment stress and falling domestic demand. The potential for uncontrolled deleveraging in countries that heavily rely on the resource sector needs careful monitoring, too. 

Authors:

Nicolas Chaput – Global CEO & Co-Cio, Oddo Meriten AM

Laurent Denize – Global Co-Cio, Oddo Meriten AM

Thomas Herbert – CIO Germany, Oddo Meriten Am GmbH