Investment Monthly – September 2019- Bond markets rally

Investment Monthly ? September 2019 Bond markets rally

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This commentary has been produced by HSBC Global Asset Management to provide a high-level overview of the recent economic and financial market environment, and is for information purposes only. The views expressed were held at the time of preparation; are subject to change without notice and may not reflect the views expressed in other HSBC Group communications or strategies. This marketing communication does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. The content has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. You should be aware that the value of any investment can go down as well as up and investors may not get back the amount originally invested. Furthermore, any investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in established markets. Any performance information shown refers to the past and should not be seen as an indication of future returns. You should always consider seeking professional advice when thinking about undertaking any form of investment.

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Investment Monthly:

Viewpoint

2 September 2019

Acknowledging near-term risks and becoming more cautious

In the last few months, the global economy has stumbled amid worsening sentiment around US-China trade tensions, geopolitical risks and general late-cycle malaise. The global stock market, despite still having returned 12% this year, dipped in August. Although still positive on equities long-term, we advocate a more cautious stance for now.

We've written a lot since last year about the need to ignore market "noise" and stay invested in equities.* It's proved a good call so far: global equities have delivered solid returns in 2019. This positive performance has come despite a meaningful pickup in volatility and a slowdown in global growth, in large part due to the ongoing US-China trade war. Most notably, Germany's economy shrank by 0.1% in Q2, while Singapore and South Korea, whose exportheavy economies make them bellwethers for the global economy, have also faced challenges. Singapore suffered a 3.3% contraction in Q2 while South Korea barely avoided recession in the first half of 20191.

Chart 1: Equities and Bonds performance 2019

15%

Global Equities 12.1%

Corporate Bonds Government bonds

10%

9.0%

7.7%

5%

2.5%

2.2%

0%

-2.4% -5%

Year to Date Since July 2019

Source: Refinitiv Datastream; Global Equities: MSCI AC World; Corporate Bonds: Barclays Global Aggregate Corporate USD; Govnt Bonds: FTSE World Government Bond Index Performance as of 30 Aug 19

We expect volatility to persist in the coming months, as the chess-game of trade tensions and geopolitics is hard for markets to predict.

Our four-point approach to portfolio strategy in the current climate:

1. Monitor risk and don't over-reach. With volatility likely to persist till year-end, clients should review their exposure to risky assets like equities and high-yield bonds, ensuring risk levels are appropriate.

2. Diversify by mixing in high quality bonds or switch into multi-asset strategies. Even though interest rates are unattractive, high quality bonds can provide downside protection for your portfolio. Multi-asset portfolios are an easy way to make sure appropriate diversification and risk-levels are maintained.**

3. Consider safe-haven currencies that perform well amid volatility. "Safe-haven" currencies like US Dollars, Japanese Yen and Swiss Francs have historically done well in volatile periods.

4. Investing is a long-term undertaking and equities are currently more attractive than cash & bonds. Focus on lowvolatility equity strategies that offer some protection from shortterm volatility. These have the added benefit of sometimes providing attractive dividend yields that compound effectively over the long-term.

1 South Korea's economy barely avoided a recession by growing slightly by 1.1% in Q2 after shrinking in Q1

* Equity markets can be volatile. Stock prices rise and fall based on changes in an individual company's financial condition and overall market conditions. Stock prices can decline significantly in response to adverse market conditions, company-specific events, and other domestic and international political and economic developments.

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** Diversification is a tool that may be used in an effort to manage risk and enhance returns. However, it does not guarantee a profit or protect against a loss. It also cannot eliminate the risk of fluctuating prices and uncertain returns.

Investment Monthly: Viewpoint

Quarterly GDP contractions are always a cause for concern, since two in a row officially constitutes a recession. As Chart 2 shows, global manufacturing activity has slowed, and in some cases begun to shrink.

Central banks have been quick to respond. The US Federal Reserve showed its reactiveness with a 0.25% interest rate cut at the end of July, with a further cut in September considered a foregone conclusion by markets. Other central banks have also cut rates or signalled a willingness to do so. If monetary policy isn't enough to mitigate the effects of the trade war, governments stand ready to invest money in their economies as well.

Will stock markets continue to rally? That's a tricky question. One could argue that the markets have already factored in the abovementioned interest cuts earlier this year, prompting the rally we've seen so far. Given the near-term risks and the unpredictability of global trade, it's hard to fault investors for being cautious.

Why cash still isn't the best option While some may be tempted to sell up and move into cash, it's important to remember that interest rates are rock bottom, or even negative. In some parts of the developed world, cash rates are below the rate of inflation, meaning that the purchasing power of cash savers will diminish over time.

Bonds yields remain sparse Yields on government and investment grade corporate bonds are still unattractive. For example, in Japan and many parts of Europe, negative government bond yields mean investors actually have to pay for the privilege of parking their money in this asset class.

Where does that leave equities? As a result, we're still overweight on equities relative to cash or bonds, especially in the long term. Recent volatility also means that from a valuation perspective, equities are now even more attractive than high quality bonds, which have rallied recently.

But this is very much a long-term positioning. Think a year or more. In the shorter-term, investors should be more cautious when considering higherrisk assets, especially in an economy that's vulnerable to downside shocks, jittery sentiment and heightened geopolitical risk.

Chart 2: Global manufacturing activity since August 2017 (a fall below 50 indicates a slowdown)

62 60 58 56 54 52 50 48 46

Europe

US

Source: Refinitiv Datastream; Latest PMI Data

Global

China

Chart 3: Equities have already rallied on expectations of interest rate cuts

20% 15% 10%

5% 0% -5%

0.4% 0.2% 0.0% -0.2% -0.4% -0.6% -0.8% -1.0%

Global Equities Performance (%) LHS

Implied Change in Fed Funds Rate (%) RHS

Source: Refinitiv Datastream: Global Equities: MSCI AC World

Chart 4: Bond yields are low to negative

2.5% 2.0% 1.5%

USD Corporate Bonds 2.1%

US Govt 10-Year Yield 1.5%

1.0%

0.5%

0.0%

-0.5%

-1.0%

Source: Refinitiv Datastream; Yields as of 28 Aug 19

Germany Govt 10-Year

Yield

Japan Govt 10-Year Yield

-0.72%

-0.27%

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Summary

Macro Outlook

Global growth continues to face headwinds from a downturn in the industrial cycle and uncertainty related to trade tensions. Nevertheless, our global Nowcast remains stable at around 2%

US growth is being supported by a solid labour market, while there is some evidence that Chinese growth is stabilising. But the latest escalation in USChina tensions keeps risks tilted to the downside

US and global recession risk remains modest, although the extent of the downturn in the industrial sector and its impact on services activity requires monitoring. A "no-deal" Brexit is also a key risk going into Q4

Positively, muted inflation trends globally keep the door open to monetary policy easing.

Central Banks

At July's US Federal Reserve (Fed) policy meeting, Chair Powell confirmed that the 25bp rate cut was `insurance' against slower global growth, trade tensions and weak inflation. Further easing is likely in our opinion

The European Central Bank (ECB) has struck a dovish tone. The September meeting is likely to see rate cuts and a re-launch of its bond buying programme

The Bank of England (BoE) struck a cautious tone at its August's meeting, with the path for policy ultimately affected by upcoming political developments

The Bank of Japan (BoJ) has signalled it could ease policy if economic activity cools. A further trigger could be yen strength

Amid trade headwinds, the People's Bank of China (PBoC) is likely to act to maintain stable credit growth, with targeted support to private sector businesses

Key Views

Key Risks

A surprise escalation of the US-China conflict in early August, and worries that this conflict will damage economic growth, led to a sell-off across risky asset classes in August. Meanwhile, expectations that the Fed will cut rates further supported a rally in bonds

This is a tricky environment. The valuation gap between bonds and equities continues to increase, so we continue to be pro-risk in multi-asset portfolios. But we need to be careful of not overextending the risk positioning. The global economy is vulnerable to shocks at this point

Growth/recession risk

Political uncertainty could damage confidence

UK gilts look vulnerable at this juncture. A fiscal easing implemented by the new UK government could challenge gilts' current pricing

Profits

Source: HSBC Global Asset Management, Global Investment Strategy, September 2019 . All numbers rounded to one decimal place. The views expressed were held at the time of preparation, and are subject to change. Please refer to Basis of Views and Definitions section for additional information

Slower growth is beginning to challenge profits

1

Policy disappointment The Fed could under-deliver

on expected easing

Politics Politics remains the principal

threat to growth

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Investment Views

Our valuation work continues to suggest a pro-risk stance in multi-asset portfolios. However, given downside risks to global growth, we should be careful not to over extend the risk positioning

Global equities ? We remain overweight given valuations continue to improve versus increasingly expensive bonds. But given the global economy is vulnerable to further shocks at this point, we advocate a more cautious tactical (i.e. short-term) stance

Government bonds ? Relatively unattractive valuations keep us underweight in this segment. Large market moves during a month of poor liquidity, such as August, suggests to us chances of a near-term reversal in yields

Corporate bonds ? credit assets are overvalued in our view, and we prefer equities. Nevertheless, dovish central bank policy is supportive of this asset class

Equities Asset Class Global

US UK Eurozone Japan Emerging Markets (EM) CEE & Latam

View View move

Overweight ?

Overweight ?

Government bonds

Asset Class

Developed Market (DM) US

Overweight ? UK

Overweight ? Eurozone

Overweight Overweight

Neutral

? Japan ? EM (local currency) ?

View move: ? No change Upgraded over the last month Downgraded over the last month

Corporate bonds & Alternatives

View

View move

Asset Class

View View move

Underweight ? Global investment

grade (IG)

Underweight ?

Underweight ? USD IG

Underweight ?

Underweight ? EUR & GBP IG

Underweight ?

Underweight ? Asia IG

Neutral ?

Underweight Overweight

? Global high-yield ? US high-yield

Europe high-yield Asia high-yield

EM agg bond (USD)

Neutral ?

Neutral ? Neutral ? Overweight ? Underweight ?

Gold

Neutral ?

Other commodities

Neutral ?

Real estate

Neutral ?

Asian assets Asset Class

EM Asian fixed income

Asia ex-Japan equities China India Hong Kong Singapore South Korea Taiwan

View View move

Underweight ?

Overweight ? Overweight ? Overweight ?

Overweight ? Overweight ?

Neutral ? Neutral ?

Source: HSBC Global Asset Management, as at September 2019, and subject to change

All numbers rounded to one decimal place. The views expressed were held at the time of

2

preparation, and are subject to change.

Please refer to Basis of Views and Definitions section for additional information

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Asset Class Performance at a glance

Global equities fell in August amid an escalation in US-China trade tensions and some disappointing economic data releases in Europe and China

Government bonds ? US Treasuries and European government bonds rallied on the back of escalating US-China trade tensions, and investor concerns over the global growth outlook

Commodities ? Brent crude oil prices fell on concerns over global economic growth and rising trade tensions

Past performance is not an indication of future performance

%

Equitie s

Corporate bonds

Government bonds

Com modities and real estate

25

20

15

13.8

10

5

0

-5

-2.4

-10 -9.4

-15

-20 Global equities

3.9 -4.9

8.2 -1.6

-4.1

9.9 2.0

-3.2

7.3 2.6

-0.4

12.5 0.5

-4.6

18.5 7.5

-1.6

-14.6 GEM equities

Global HY corp bonds Global IG corp bonds Global government

Global EM local

bonds

currency government

bonds

Gold

6.7

-5.6 -13.8 Other commodities

16.6 0.9

-5.5 Real estate

2018

2019 YTD (as of 31 Aug. 2019)

MTD (as of 31 Aug. 2019)

Note: Asset class performance is represented by different indices.

Global Equities: MSCI ACWI Net Total Return USD Index. Global Emerging Market Equities: MSCI Emerging Market Net Total Return USD Index. Corporate Bonds: Bloomberg Barclays Global HY Total Return Index value unhedged. Bloomberg Barclays Global IG Total Return Index unhedged. Government bonds: Bloomberg Barclays Global Aggregate Treasuries Total Return Index. JP Morgan EMBI Global Total Return local currency. Commodities and real estate: Gold Spot $/OZ/ Other commodities: S&P GSCI Total Return CME. Real Estate: FTSE EPRA/NAREIT Global Index TR USD.

Source: Bloomberg, all data above as of close of 30 August 2019 in USD, total return, month-to-date terms

Source: HSBC Global Asset Management, as at September 2019, and subject to change

All numbers rounded to one decimal place. The views expressed were held at the time of

preparation, and are subject to change.

3

Please refer to Basis of Views and Definitions section for additional information

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Base case views and implications

Monthly macroeconomic update

Base case view and implications

A solid labour market continues to support consumer spending. The 12-month moving average of monthly non-farm job creation has held above 185,000 this year

However, business investment and trade activity remain subdued amid US-China trade tensions

US economic growth is likely to moderate this year as fiscal stimulus wanes and the labour market cycle matures

A lack of inflation pressure and increased downside risks to growth is likely to translate to Fed rate cuts this year

US Treasury valuations are at extreme levels. Equities remain preferable, in our view

US

Europe

Eurozone: Manufacturing data are still very weak, although services sector activity remains resilient for now. Underlying inflation is stuck at about 1%

Eurozone: European equities remain relatively cheap, supporting our overweight stance

UK: GDP contracted in Q2, although this was mainly due to the unwinding of Brexit related stockpiling in Q1. Labour market strength remains a key support

UK: We remain comfortable with an overweight view on UK equities given our view of very attractive valuations

Asia

China: Disappointing data releases for July, including a weak industrial production China: Ongoing policy loosening still has the potential to

print, are likely to see further policy support in the coming months

stabilise China's economy alongside global trade growth

India: GDP growth disappointed in Q2, while risks remain tilted to the downside amid a slow transmission between monetary policy easing and the real economy

India: The long-term structural story remains positive, supporting our overweight view

Japan: Growth remains sluggish amid external headwinds and a loss of momentum in business investment. This year's consumption tax hike is a risk

Japan: We believe the valuation of Japanese equities is still attractive while monetary policy is supportive

Other EM

Brazil: Positive reform momentum and improving financial conditions support the growth outlook. Recent weakness is mainly due to natural disasters

Russia: Activity remains sluggish, amid subdued domestic demand. More positively, the industrial and construction sectors are performing well

MENA: growth prospects are constrained by elevated geopolitical risks, a weaker global trade picture and oil production cuts

The backdrop for EMs has improved amid a dovish Fed and more accommodative EM central banks. We remain overweight EM equities.

However, corporate profitability has disappointed this year. Therefore, on a tactical (i.e. near-term) basis, we prefer localcurrency government bonds, which also offer higher riskadjusted prospective returns in our view.

Source: HSBC Global Asset Management. As at 2 September 2019. The views

expressed were held at the time of preparation, and are subject to change.

All numbers rounded to one decimal place. The views expressed were held at the time

4

of preparation, and are subject to change.

Please refer to Basis of Views and Definitions section for additional information

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Long-term Asset class positioning tables (>12 months)

Equities

Asset class View

Rationale

Our measure of the global equity risk premium (excess return over cash) still looks reasonable given other opportunities.

Risks to consider

Episodic volatility may be triggered by concerns about global economic growth and/or trade tensions, coupled with political risks.

Global

Overweight We believe global equities still offer attractive rewards despite the

?

risks to the growth outlook.

Policy support can help offset headwinds from more modest global growth, trade tensions, and political uncertainty in many regions.

A further significant deterioration of the global economic outlook could also dampen our view. However, we remain of the view that we are facing a "cyclical slowdown", not a more severe recessionary environment.

Corporate fundamentals are beginning to come under pressure. We are monitoring developments closely.

US Eurozone

?Overweight

US economic and earnings growth remains relatively robust. The risk of a US recession remains modest, in our view.

The boost from last year's fiscal stimulus is fading.

Positively, the Fed is enacting "insurance" policy easing against downside risks.

Risks from US-China trade tensions also need to be considered.

In our opinion, Eurozone equities benefit from fairly high implied risk On an unhedged basis, we measure higher risk-adjusted prospective

premiums (on a hedged basis).

returns in other developed markets.

Overweight

?

Ultra-low ECB policy interest rates are likely to persist until the early 2020s. The ECB has also signalled further policy easing.

Economic growth remains fragile, with the manufacturing sector facing headwinds from elevated global uncertainty and softer global demand.

Risks may be posed by Italy's fiscal dynamics and the potential for economic disruption from a possible "no-deal" Brexit.

View: ? No change Upgraded over the last month Downgraded over the last month

Source: HSBC Global Asset Management. As at 2 September 2019. The views expressed were

held at the time of preparation, and are subject to change.

All numbers rounded to one decimal place. The views expressed were held at the time of

5

preparation, and are subject to change.

Please refer to Basis of Views and Definitions section for additional information

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