Vantage Point - BNY Global Page€¦ · and a capital markets shock could send yields to levels...

FOR FINANCIAL PROFESSIONALS AND INSTITUTIONAL INVESTORS ONLY.

Vantage Point TAKING OUT INSURANCE Q3.2019

1

Introduction ContentsWelcome back to Vantage Point, our guide to the global economic and markets outlook. This edition is a quarterly update and summarizes how our views have evolved since the second quarter.

Economies have been slowing worldwide and the slowdown is centered on global manufacturing and trade. Some of this is due to trade tensions, but bilateral U.S.-China trade isn’t large enough to account for all of the downturn. Domestic demand has also slowed in some of the world’s largest economies, driven in part by disappointing levels of investment spending.

Markets have reacted nervously. May saw a large sell-off in equities while bond markets have moved quickly to price in a number of interest rate cuts over the next 18 months. Much attention is paid to the various twists and turns in trade negotiations, both for their immediate economic impact but also because of the implications for long-term geopolitical relations and the global investment environment. The sanctioning of Huawei by the U.S. government has been particularly significant.

This update follows the same logical structure as past editions. We ask and answer the following three

questions: What do we think? What do the markets think? And what broad investment conclusions follow from the big differences?

When it comes to what we think, we start with our global macroeconomic scenarios. Once again, you won’t find any point forecasts in this document. Robust investment analysis depends on assessing risk as well as return, and the scenario-based approach allows us to draw important conclusions from the full distribution of likely outcomes, as expressed in our fan charts. Our global economic scenarios haven’t changed a lot since Q2, but the balance of risks is definitely shifting towards the downside.

We hope you enjoy the analysis contained in this update and look forward to hearing readers’ feedback.

EXECUTIVE SUMMARY 2

SECTION 1. ECONOMICS 5

1A) SCENARIOS 6

1B) FORECASTS 10

SECTION 2. CAPITAL MARKETS 12

2A) WHAT IS PRICED IN 13

2B) MARKET SENTIMENT 15

SECTION 3. INVESTMENT CONCLUSIONS 17

SHAMIK DHAR CHIEF ECONOMIST

Quarterly Outlook Q3.2019

2 3

PROBABILITY*

SCENARIO

Executive SummaryWHAT WE THINK – ECONOMIC SCENARIOS CAPITAL MARKET PRICING – WHAT THE

MARKETS THINK

Rates ● Markets have priced in at least two rate cuts in

2019 and two in 2020.

● Our interest rate fan chart is also more skewed to the downside than last time, highlighting the scope for ‘insurance cuts’ this year.

● That said, our view of the fundamentals – growth and inflation – remains more optimistic than the bond markets seem to expect.

Fixed Income ● Fixed income markets are pricing in a much less benign

economic outlook than they were three months ago.

● Further yield curve inversion, for example between the Fed Funds rate and 2-year Treasury and also 3-mth. to 10-year Treasury, suggest that markets expect growth, inflation and real interest rates to stay low for some time.

● Our bond yield fan charts are also skewed to the downside and a capital markets shock could send yields to levels below those of July 2016.

Equities ● Equities sold off sharply in May. Despite deteriorating growth

expectations, they have rallied again in June thanks to lower interest rate expectations (‘bad news is good news’).

● Whether trade tensions escalate or U.S. fundamentals weaken, a pro-active Fed could help to insulate markets from bad news, prolonging the “bad news is good news” investing environment.

Summary ● Overall, market pricing suggests the post-Global Financial

Crisis regime remains in place - that bonds and equities will stay negatively correlated, acting as a natural hedge within portfolios.

More of the same

Global growth slows in 2019 but no recession. There is plenty of spare capacity across the world. The global savings glut remains a key feature of the world economy. A U.S./China trade deal is reached in H2. Global manufacturing slowdown continues into H2, but then stabilizes and picks up again in 2020. Equity prices are buoyed by steady growth and no recession. The Federal Reserve (Fed) keeps rates on hold, but there is further easing in the Eurozone, Japan, and the rest of Asia. U.S. Dollar finishes broadly flat.

U.S.: leader of the pack

Growth fears are overdone, U.S. economy is closer to capacity than we think. Strong labor market leads to wage inflation. Fed accommodates the positive growth surprise leading to greater inflationary pressure. Fed realizes it’s behind the curve in the first half of 2020, starts to raise rates and re-taper more quickly. Growth slows sharply in later part of 2020 into early 2021– possibly recession. Higher rates and dollar prompt capital flight from some emerging markets, exacerbating the downturn worldwide.

Tail wags dog

Financial market-centered downturn. Overly-loose monetary policy further boosts search for yield. Financial stability risks rise. Small shock leads to sharp reversal in market sentiment. Flight from high risk assets raises cost of capital, tightens financial conditions and hits confidence, causing real economies worldwide to slow sharply – a self-fulfilling prophecy. Credit channel exacerbates real effects – fall in corporate net worth raises concerns about indebtedness, leveraged loans and private equity. “Dotcom 2.0 ensues.”

Globalization is Dead!

Trade-induced global slowdown. The world moves towards an increasingly protectionist trading regime. China is at the eye of the storm, knock-on effects through Asian supply chains. U.S. slows to just over 1% GDP growth in 2020, Germany moves into recession, trade-dependent Europe comes close to a recession. Risk assets are hit hard initially, but pretty soon ‘bad news becomes good news.’ Aggressive rate cuts eventually stabilize the markets, risk assets rise again in 2020. Dollar gains against major currencies.

50% 10% 20% 20%

IDIOSYNCRATIC RISKS

U.S./China Trade Brexit Italy and the new ‘doom loop’ Geopolitical flare-up (U.S./Iran, China/Hong Kong)

This information contains projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or expectations will be achieved, and actual results may be significantly different from that shown here.

* Views expressed are those of the author and do not reflect views of other managers or the firm overall.


4 5

SECTION 1

Economics ● We believe investors must

balance the opportunity for upside should macro uncertainty subside with the need for protection from sharp corrections in headline-sensitive areas.

● We think that markets are currently rich and risks are skewed to the downside in the short-term. We are neutral on European equities as a whole even though much of the bad news is already known.

● Overall, we favor U.S. and U.K. equities. Emerging markets remain an interesting buying opportunity for long-term investors throughout 2019

● The negative or low bond/equity correlation should remain intact.

● Absent serious recession fears, the investment grade corporate credit space remains attractive as an income-producing asset with limited liquidity risk.

● Even with Treasury yields at historically low levels, they remain higher than those of other safe haven sovereigns and should maintain their attractiveness in risk-off environments.

● Investors holding a degree of high quality duration (5-7 years) in their portfolios may have room for those securities to rally if equities become more volatile.

● The U.S. Dollar continues to be the currency of choice for capital flows in the face of global uncertainty.

● Since market risks are skewed to the downside, we expect the appetite for the USD to remain healthy, keeping it on a steady if not slightly upward sloping trajectory.

● We believe alternative strategies are good sources of alpha in a world of low returns and looming downside risks.

● We see value in locked-up capital and assets which are not correlated to bonds and equities.

BROAD INVESTMENT

CONCLUSIONS

Equities

U.S. Dollar Alternatives

Fixed Income

The job market remains strong and could lead to higher than expected inflation.

Labor markets remain strong. U.S. consumer strength could lead to higher than expected growth.

1974 1979 1984 1989 1994 1999 2004 2009 20192014

NFI

B S

mal

l Bus

ines

s Jo

b O

peni

ngs

Har

d to

Fill

U.S

. Wage G

rowth (%

y/y)

NFIB Small Business Job Openings Hard to Fill (LS)U.S. Wage Growth (% y/y, RS)

0

5

10

15

20

25

30

35

40

45

0

2

4

6

8

10

1992 1995 1998 2001 2004 2007 2010 2013 20192016

Une

mpl

oym

ent

Rat

e (%

)

Eurozone Unemployment Rate (%)U.S. Unemployment Rate (%)

3

4

5

6

7

8

9

10

11

12

13

U.S. LABOR MARKET – JOBS HARD TO FILL AND WAGES U.S. AND EUROZONE UNEMPLOYMENT RATE

Optimism among U.S. consumers and businesses remains strong and resilient.

2011 2012 2013 2014 2015 2016 2017 2018 2019

U.S

. GD

P –

Rea

l Con

sum

ptio

n G

row

th (

% y

/y)

Personal Consumption (% y/y)

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2003 2005 2007 2009 2011 2013 2015 2017 2019

Con

fere

nce

Boa

rd C

onsu

mer

Con

fide

nce

NFIB

Sm

all Business O

ptimism

Conference Board Consumer Confidence (LS)NFIB Small Business Optimism (RS)

20

40

60

80

100

120

140

160

75

80

85

90

95

100

105

110

115

U.S. GDP – PERSONAL CONSUMPTION U.S. CONSUMER AND SMALL BUSINESS CONFIDENCE


6 7

Economic Scenarios

Scenario #1 More of the Same (50% Probability)

Scenario #2 U.S. Leader of the Pack (10% Probability)

In this scenario aggregate demand continues to slow in 2019 in the major economies, against a background of plenty of spare capacity across the world. The upshot is low inflation and slowing growth but no recession. The global savings glut remains a key feature of the world economy, so the equilibrium world real interest rate stays near zero. U.S. economic fundamentals justify leaving rates at neutral, but we should see further easing in the Eurozone, Japan and the rest of Asia, since these are the regions most dependent on trade. A U.S./China trade deal is reached in H2 – reflecting political incentives on both sides, but the longer-term realignment of foreign policy

remains a concern for markets, as de-globalization/regionalization of the world economy continues. The global manufacturing slowdown continues into H2, but then stabilizes and picks up again in 2020. Equity prices are buoyed by steady growth and no recession, but only after a period of ‘good news is bad news,’ as markets digest the fact that rates don’t fall as far as they currently expect.

Given lower growth momentum since our last report, we have lowered the probability of our upside scenario from 20% to 10%. In this scenario, growth fears are overdone and the U.S. economy is closer to capacity than we think. Consumer and business sentiment remain strong, while labor markets continue to tighten, pushing up wage growth which eventually feeds through into higher price inflation. This is a world in which the U.S. finally escapes the post-financial crisis regime. Inflationary pressure and expectations rise, forcing the Fed to reassess its dovish guidance towards the end of this year.

Growth in the rest of the world is also higher than expected. A trade deal between the U.S. and China is resolved helping boost

growth in trade-dependent regions such as Southeast Asia; Chinese efforts to stimulate the economy are successful, and Europe’s struggles reverse.

At first, the Fed accommodates the growth surprise leading to greater inflationary pressure. The Fed realizes it’s behind the curve in the first half of 2020 and starts to raise rates and re-taper more quickly. Growth slows sharply in the later part of 2020 into early 2021 – possibly recession. Higher rates and U.S. dollar prompt capital flight from some emerging markets, exacerbating the downturn worldwide.

Quarterly data as of March 2019. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

Monthly data as of May 2019. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

Quarterly data as of Q2 2019. 3-month moving average used where quarterly data unavailable. For Q2 2019, 3-month moving average as of May 2019 is used. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

For the U.S., 3-month moving average used on a quarterly basis as of Q2 2019. Eurozone data through Q1 2019. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

50% 10%

Charts are provided for illustrative purposes and are not indicative of the past or future performance of any BNY Mellon product.


SECTION 1A


8 9Charts are provided for illustrative purposes and are not indicative

of the past or future performance of any BNY Mellon product.Charts are provided for illustrative purposes and are not indicative

of the past or future performance of any BNY Mellon product.

Scenario #3 Tail Wags Dog (20% Probability)

Scenario #4 Globalization is dead! (20% Probability)

Lower inflation and growth combined with greater political uncertainty since our last report have handcuffed central banks even further. Safe-haven government bond yields have fallen to near historical lows while equity prices climbed higher.

In this scenario, the search for yield picks up and investors allocate even more capital up the risk curve. Frothy markets diverge further from fundamentals. Financial stability risks increase. Irrational exuberance gains momentum as markets become overly complacent and reliant on central banks.

Credit spreads, default expectations, and equity risk premia remain low. But underpriced risk means it doesn’t take much to

launch fear into the market. A shock to sentiment, perhaps from trade talks or worse than expected growth, leads to a sell-off in risk assets. Financial conditions tighten, defaults rise sharply and expose credit market vulnerabilities particularly in high yield and leveraged loans. Stress in corporate debt exacerbates the downturn.

The rapid market decline becomes a self-fulfilling prophecy and economic growth slows sharply. Since the bulk of losses is borne by equity holders on the buy side, for instance private equity, as opposed to over-leveraged banks, the extent and duration of the downturn is limited and a Global Financial Crisis (GFC) 2.0 is avoided.

This scenario sees a generalized, trade-induced global economic downturn against a backdrop of worsening geopolitical tensions. The world moves towards an increasingly protectionist trading regime and the shock to global trade moves major economies towards recession. The trade shock is a similar size to the one that followed the bursting of the dotcom bubble in 2000. What starts as a higher-than-expected fall in global manufacturing ultimately spills over to the services sector, hitting corporate profits, sentiment and expectations, capital expenditure (capex) and hiring. Faced with worsening economic fundamentals and tightening financial conditions, central banks ease monetary policy significantly.

China is at the eye of the storm, and its economy takes a substantial hit from the trade war while the U.S. slows to just over 1% GDP growth next year. A China slowdown spills over to the tight-knit Southeast Asian economies: supply chains take time to re-adjust so output falls in the short run. There is a large impact on Germany and the Eurozone as well – the former moves into recession.

Equities and other risk assets are hit hard initially, but pretty soon ‘bad news becomes good news’ and aggressive rate cuts eventually stabilize the markets and allow them to rise again in 2020.

The gap between policy uncertainty and implied equity volatility remains historically wide.

The difference between high yield and investment grade corporate spreads is historically low.

2003200119991997 2005 2007 2009 2011 2013 2015 2017 2019

Glo

bal E

cono

mic

Pol

icy

Unc

erta

inty

Inde

x

VIX

Global Economic Policy Uncertainty (LS)VIX (RS)

0

50

100

150

200

250

300

350

0

10

20

30

40

50

60

70

1994 1998 2002 2006 2010 2014 2018

U.S

. Cor

p. H

Y –

IG O

AS

Dif

fere

ntia

l (B

P)

Spread differential between HY and IG

0

200

400

600

800

1000

1200

1400

POLICY UNCERTAINTY AND MARKET VOLATILITY U.S. INVESTMENT GRADE VS. HIGH YIELD CORPORATE SPREADS

Monthly data through May 2019. 21-day moving average used for the VIX index. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

OAS: option adjusted spread; HY: High Yield; IG: Investment Grade. Monthly data through May 2019. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

World trade stalled as the U.S.-China trade war escalated.

Trade war hits business sentiment and future capex decisions.

1995 2000 2005 2010 20151995 2000 2005 2010 2015

Inde

x, 1

991

Q1

= 1

00

Difference, per cent

ActualTrend Trade gap

0

50

100

150

200

250

300

350

400

-15

-10

-5

0

5

10

z sc

ores

Average

-5

-4

-3

-2

-1

0

1

2

3

201120092007 2013 2015 2017 2019

Range

WORLD ‘TRADE GAP’ U.S. BUSINESS SURVEY EXPECTATIONS OF FUTURE CAPEX

Trade gap= Actual World Trade-Trend World Trade. Index is a measure of real global trade with the level rebased to 100 in Q1 1991. Quarterly data as of Q1 2019. Source: BNY Mellon Global Investment Strategy, Fathom Consulting, and CPB Netherlands Bureau for Economic Policy Analysis.

Business Surveys from Dallas, Richmond, Philly and New York Federal Reserve Bank.Data as of April 2019. Source: BNY Mellon Global Investment Strategy and Fathom Consulting.

20% 20%


10 11

Forecasts

Following a period of robust economic growth, we expect to see a slower pace of expansion both this year and next across the major economies. For the U.S., the most likely outcome is a return to near trend. But geopolitical tensions have risen further over the past three months, with uncertain consequences. As a result, we have reduced the weight we attach to our ‘More of the same’ and our ‘U.S. Leader of the Pack’ scenarios. Each of our two downside scenarios are correspondingly more likely.

The downside risks are clear in our growth outcomes chart (shown below) for the U.S. economy, which is not only broader, it has a more pronounced negative skew than three months ago. We now see around a 1-in-5 chance that the U.S. economy contracts during the four quarters to the end of next year. With

weaker productivity growth, and a poorer demographic outlook, trend growth in the Eurozone is probably around a percentage point lower than in the U.S.. The risk of an outright contraction in the Eurozone through next year is correspondingly larger, at around 1-in-3. We think, on balance, the authorities in Beijing will be successful in preventing a dramatic slowdown in China, but our fan chart (not shown) suggests the chances of a marked upturn in growth are slim. China, a large exporter, is at the epicentre of ongoing trade disputes, which means risks to Chinese economic growth are skewed heavily to the downside.

There has been a further substantial repricing of fed funds futures since our previous forecast, which in our view has gone too far. In our ‘More of the same’ scenario, the Fed is on hold for

<-6 <-5 <-4 <-3 <-2 <-1 <0 <1 <2 <3 <4 <5 <6 <7 7>

Pro

babi

lity

per

cent

Growth in the four quarters to Q4 2020 (%)

0

5

10

15

20

25

Per

cen

t

Mode

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

20172016 2018 2019 2020 2021

Mean

Four

-qua

rter

per

cent

age

chan

ges

Mode

-3

-2

-1

0

1

2

3

4

5

20172016 2018 2019 2020 2021

Mean

Sep19

Dec19

Mar20

Jun20

Sep20

Dec20

Mar20

Jun20

Sep20

Dec20

Pro

babi

lity

per

cent

0

10

20

30

40

50

60

70

Probability S&P 500 < 2900Probability S&P 500 > 3000

DISTRIBUTION OF U.S. GROWTH OUTCOMES IN 2020 Q4 U.S. FEDERAL FUNDS RATEEUROZONE GDP OUTLOOK FOR THE S&P 500

Forecasts as of June 2019. Source: BNY Mellon Global Investment Strategy and Fathom Consulting.


The two solid lines show the modal (central) and mean (probability-weighted average) forecasts. The darker bands towards the center of the fan chart show the more likely outcomes, while the lighter bands show progressively less likely outcomes covering

90% of the forecast distribution. The width of the fan chart shows the level of uncertainty, while the fact the bands below the central forecast are wider than those above shows the balance of risks lies to the downside.



the duration of our forecast. But as with growth, the risks to U.S. interest rates are to the downside. We see a 45% chance of a cut in the U.S. policy rate this year, with a 45% chance that it remains unchanged. The odds of a tightening this year, at just 10%, are smaller than they were at the time of our previous forecast. We see a 1-in-10 chance that the policy rate is cut right back to the effective lower bound (0%). The picture elsewhere is similar, with little prospect of a major change to the European Central Bank’s (ECB) main refinancing rate over the next two years.

The most likely path for U.S. ten-year yields is gently upward sloping. But as with the policy rate, risks are skewed to the downside. With yields falling sharply in our ‘Tail Wags Dog’

scenario, as term premia are compressed in a search for safe-haven assets, historic lows are tested. We see around a 15% chance that U.S. ten-year yields move below the levels of July 2016 towards the end of next year.

In our judgment, the S&P 500 is more likely to stay below 2,900 than it is to move above 3,000 in the near term. But in late 2019 and 2020, the distribution of outcomes shifts in favor of more positive price returns. By 2021 Q4, we see almost a 2-in-3 chance that the S&P 500 has moved above its previous peak. Looking beyond the U.S., the most likely outcome is for equities to drift higher globally. However, in the present environment, the risk-reward tradeoff in markets that are exposed to the global trade cycle appears less favourable.



SECTION 1B


12 13

SECTION 2

Capital MarketsINTEREST RATESSlowing global growth, weakening inflation, and trade-related uncertainty have collectively shifted central banks towards a greater easing bias compared with our last report. After stabilizing in Q1, the decline in interest rate expectations has accelerated, most notably in the U.S. The market now expects at least two rate cuts in both 2019 and 2020. The move is consistent with a market that has moved away from our central scenario towards one that is closer to the downside scenarios. In our ‘More of the same’ scenario, we are neutral on rates for the rest of 2019 and see a cut if trade conditions were to deteriorate significantly. However, our balance of risks across scenarios highlights the downside risk to the outlook, though we think the market has moved too far. Overall, the market expects easy policy to persist for the foreseeable future.

GOVERNMENT BONDSFalling interest-rate expectations are also apparent in sovereign fixed income markets. Forward curves in the U.S. shifted downwards and steepened in Q2. Part of the current Treasury yield curve retreated further into negative territory, particularly between the Fed Funds and 2-year Treasury, suggesting the market thinks the Fed is too tight. 10-year real yields in the U.S. fell to the lowest since October 2017 and reached an all-time low in the Eurozone. Similar to the market, we expect real yields to remain suppressed as a result of the global savings glut. These moves also reflect growing concern about the prospects for global growth and increasingly dovish central bank communication. That said, our forecasts for bond yields imply a market that has shifted its estimates too far. We see a higher probability of an upward drift in yields.

What is Priced In?

Jan2018

Mar2018

Jun2018

Sep2018

Dec2018

Mar2019

Jun2019

U.S

. 1-m

th. O

IS 1

-yr.

forw

ard

(%)

EU

R E

ON

IA 1-m

th. 1-yr. forward sw

ap (%)

U.S. 1-mth. OIS 1-yr. forward swap (%, LS)EUR EONIA 1-mth. 1-yr. forward swap (%, RS)

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

-0.55

-0.50

-0.45

-0.40

-0.35

-0.30

-0.25

-0.20

1-year 2-year 10-year 30-year

%

Dec. 31, 2018Jun. 17, 2019

Mar. 31, 2019Current active curve

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

3.2

MARKET IMPLIED CENTRAL BANK INTEREST RATE (%) U.S. TREASURY CURVE: 1-YEAR FORWARDS (%) VS. CURRENT

OIS: overnight indexed swap. EONIA: Euro overnight index average rate. Data as of June 17, 2019. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

Data as of June 17, 2019. Market estimate of U.S. Treasury yields one-year forward at each date. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

SECTION 2A


Consumer strength could lead to higher than expected growth.


14 15

The theme for investors as we enter the third quarter is the fear and promise of policy choices on both the trade and rate fronts. Trade conflict with China has softened the U.S. growth outlook and threatens to shave earnings in 2019 and beyond. Further, inflation has been below the Fed’s 2% target, causing inflation expectations to plummet. Investors have looked past the obvious threat to fundamentals as they expect central banks to cushion the blow. Yields took another leg down in the last half of the quarter as the market priced in two insurance rate cuts in 2019 and two more in 2020. Further, the market still believes that trade talks will re-start during the summer with a deal a few months later, looking to the turnaround with Mexico as a guide. While the probability of recession has increased owing to a decline in U.S. manufacturing activity and some signs of softness in the consumer, earnings forecasts suggest the market remains constructive on U.S. growth, expecting GDP to come in around 2% as the hit from tariffs and slower growth is expected to be manageable.

Globally, while recent China data has been weaker than expected, investors expect that China will double down on stimulus to revive domestic demand and stabilize the economy as the country heads into the 70th anniversary of the founding of the People’s Republic of China (PRC).

All this has led to a “bad news is good news” environment for risk assets as investors expect signs of fundamental weakness to prompt the Fed to inoculate the economy from any further deterioration. While earnings estimates for the second half of 2019 and 2020 have barely budged even as individual companies have indicated trade war risk, investors remain optimistic on the Fed’s inclination to swoop in to save the market. While expectations are high for a first rate cut at the July 31 meeting, expectation and reality could have their first big surprise in the near future.

INFLATIONBoth short-and-long-term inflation expectations have fallen since our last report. After increasing through Q1, U.S. long-term inflation expectations fell to the lowest in three years and are near historical lows. In the Eurozone, market estimates continued to move lower and fell to an all-time low. Like the moves in rates, these changes reflect a market that has shifted closer to our downside scenarios. Our estimates still remain more optimistic – we see a slight pick-up in inflation over the next 12-months.

EQUITIES After falling sharply from Q4 to Q1, 2019 earnings growth estimates for the S&P 500 have hovered near 4%. We think this is consistent with our ‘More of the same’ scenario in which GDP growth slows in a number of countries, but we do not see an outright recession. Globally, we expect limited upside to earnings expectations unless China increases stimulus or trade uncertainty subsides. Led by dovish central banks, the market has substantially reduced its perception of volatility and the downside skew. This suggests a market that has become too complacent when compared with our forecasts. We see modest positive returns from here but with risks tilted to the downside, in contrast to market pricing. In addition, the market continues to think that some sort of U.S.-China trade deal will be reached.

2002199819941990 2006 2010 2014 2018N

Y Fe

d P

rob.

of R

eces

sion

in 1

2-m

onth

s (%

)0

10

20

30

40

50

29.6

1994 1998 2002 2006 2010 2014 2018

%

U.S. 5y5y Inflation Expectations (%)Eurozone 5y5y Inflation Expectations (%)

200-day moving avg.200-day moving avg.

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Fed

Fund

s Fu

ture

s: y

ear-

end

expe

cted

inte

rest

rate

(%)

0.0

0.5

1.0

1.5

2.0

2.5

Jun. 19, 2019Mar. 31, 2019Dec. 31, 2018

20192020

Current Fed Funds Rate

2002199819941990 2006 2010 2014 2018

SK

EW VIX

S&P 500 - SKEW (LS)S&P 500 - VIX (RS)

100

110

120

130

140

150

0

10

20

30

40

50

60

70

U.S. RECESSION PROBABILITY PER THE NEW YORK FEDINFLATION EXPECTATIONS FED FUNDS FUTURESS&P 500 IMPLIED VOLATILITY

Monthly data as of May 2019. Source: BNY Mellon Global Investment Strategy using data from Bloomberg and the New York Fed.

5y5y inflation swap: 5-year inflation expected 5 years from now. Data as of June 17, 2019. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

Data as of June 19, 2019. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

Data as of June 18, 2019. The CBOE Volatility Index (VIX) is a measure of expected price fluctuations in the S&P 500 Index options over the next 30 days. SKEW measures the perceived tail risk of the distribution of S&P 500 investment returns over a 30-day horizon. Charts show the trailing 21-day average value per index. Source: BNY Mellon Global Investment Strategy using data from Bloomberg.

The probability of a recession has increased according to the NY Fed.

The market is now pricing in rate cuts for both 2019 and 2020.

SECTION 2B

Market Sentiment



✓ Insurance rate cuts by the Fed

✓ 2 cuts by September 2019 and 2 cuts in 2020

✓ A U.S.-China trade deal over the summer

✓ Earnings acceleration in the second half of 2019

✓ GDP of approx. 2%

✓ No recession

✓ Inflation never again

✓Absorbable impact from tariffs on the fundamental and earnings side

✓ No European auto tariffs

✓Ratification of United States-Mexico-Canada Agreement

✓ More China stimulus

✗ No Fed cuts or one cut

✗ No U.S.-China trade deal until year-end if at all

✗ Earnings deterioration

✗ U.S. GDP less than 2%

✗ An inflation spike

✗ Ineffective China stimulus

✗ Hard Brexit

✗ European auto tariffs

✗No ratification of United States-Mexico-Canada Agreement in the next few months

✗ A tariff induced fundamentals slowdown

✗ Certain presidential election outcomes

PRICED IN

NOT PRICED IN


16 17

Jul2016

Jan2016

Jul2017

Jan2017

Jul2018

Jan2018

Jan2019

Rel

ativ

e P

erfo

rman

ce to

S&

P 5

00*

90

100

110

120

130

140

150

160

Dec17

Mar18

Jun18

Sep18

Dec18

Mar19

Jun19

2019

ear

ning

s gr

owth

(%)

S&P 500

3.5

4.5

5.5

6.5

7.5

8.5

9.5

10.5

11.5

STOXX Europe 600

S&P 500 COMPANIES WITH THE MOST CHINESE REVENUE EXPOSURE RELATIVE TO THE S&P 500

S&P 500 AND STOXX EUROPE 600 2019 EARNINGS GROWTH ESTIMATES (%)

*Top 15 S&P 500 companies with the most revenue exposure to China relative to the S&P 500 Index. Index normalized to 100 = 12/31/2015. Data as of June 18, 2019. Source: BNY Mellon Investment Management using data from Strategas.

Source: BNY Mellon Global Investment Strategy (June 2019), based on internal team research and market observations. Actual market sentiment and activity may differ materially from views expressed here.

Data as of June 16, 2019. Source: BNY Mellon Investment Management using data from Factset.

S&P 500 companies with the most Chinese revenue exposure corrected as the trade war tensions re-escalate.

S&P 500 and STOXX Europe 600 earnings estimates continue to be revised lower.

SECTION 3

Investment Conclusions


EQUITIES

U.S. Equities: We believe that investors should balance the opportunity for upside should macro uncertainty subside with the need for protection from sharp corrections in headline-sensitive areas. We think that markets are currently fairly-valued, yet risks are skewed to the downside in the short-term. Yet, we remain sanguine on the overall asset class. If the Fed “insurance” cut comes before any deterioration in economic fundamentals, we think there is likely to be a rally in cyclical sectors. Alternatively, if the Fed waits for the fundamentals to worsen, we could see a rally in defensive sectors.

European Equities: We are neutral on European equities as a whole even though much of the bad news is already known. The European economy is the most levered to the auto sector, and therefore the lingering threat of auto tariffs renders caution for European markets as a whole. At the same time, the ECB is likely to turn more dovish which would support markets.

Emerging Markets (EM) Equities: A trade deal and global easing cycle coupled with an additional round of Chinese stimulus should help the risk on sentiment and global backdrop. As such, emerging markets (EM) remain an interesting buying opportunity for long-term investors throughout 2019. As always, keep in mind that EM is not a monolithic asset class and the watchword remains discrimination, since the landscape is likely to be much more varied and the returns to good selection greater. Global supply reconfigurations should provide attractive buying opportunities such as Vietnam, Malaysia, Thailand, and Mexico.

FX

U.S. Dollar and Foreign Exchange (FX): The U.S. Dollar (USD)continues to be the currency of choice for capital flows in the face of global uncertainty. Since market risks are skewed to the downside, we expect the appetite for the USD to remain healthy, keeping it on a steady if not slightly upward sloping trajectory.

ALTERNATIVES

Alternatives: We believe alternative strategies are good sources of alpha in a world of low returns and looming downside risks. We see value in locked-up capital and assets which are not correlated to bonds and equities.

FIXED INCOME

Sovereign Debt: With continued pressure on yields and a U.S. Treasury curve that is inverted at many points, the bond market is looking for rates to come down soon. By contrast, we expect a gradual rise in 10-year yields and return to an upward sloping yield curve over the next 12 months should the Fed start cutting over the summer. The negative or low bond/equity correlation should remain intact.

Global Investment Grade Credit (IG): Absent serious recession fears, the investment grade corporate credit space remains attractive as an income producing asset with limited liquidity risk. Even with Treasury yields at historically low levels, they remain higher than those of other safe haven sovereigns and we think they will maintain their attractiveness. We believe that investors should also hold a degree of high quality duration (5-7 years) in their portfolios that still has room to rally if equities become more volatile.

High Yield (HY) and Leveraged Loans: Spreads on HY corporates and bank loans have recovered year to date (YTD) and overall, we think the more accommodative monetary policy stance of the Fed and the ECB will help keep credit spreads in check. The risk to the outlook for HY is outlined in our alternative scenario (“Tail Wags Dog”) where a shock to sentiment leads to a sharp tightening in financial conditions, leading to a sell off in lower quality and the most-leveraged components of credit.

EM Hard Currency Debt: Overall we favor EM USD debt. External sovereign debt valuations currently look attractive, corporates seem less so (but they are supported by strong technicals and lower net issuance). The general philosophy for any EM asset class applies here as well: discrimination between countries/issuers and continuous monitoring of the fundamental outlook for issuers.

EM Local Currency Debt: Real local rates are attractive in EMs compared with developed markets (DM) in our view, as inflation expectations are actually lower for most EMs. Major developed markets central banks’ accommodative monetary policies will probably support emerging markets capital inflows and may help local economies with higher real yields (Brazil, Mexico, and China). Still, keep in mind that FX exposure is a material risk (on top of the typical volatility of the underlying bond, there is exposure to currency volatility) particularly in a risk-off environment.


18 19

BNY Mellon Global Investment Strategy team

Shamik DharChief Economist

Lale AkonerMarket Strategist

Alicia Levine, PhDChief Strategist

Bryan Besecker, CFA, CAIAMarket Strategist

Liz Young, CFADirector of Market Strategy

All investments involve risk, including the possible loss of principal. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment.

Important Disclosures:

RISKSEquities are subject to market, market sector, market liquidity, issuer, and investment style risks, to varying degrees. Bonds are subject to interest-rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. Commodities contain heightened risk, including market, political, regulatory, and natural conditions, and may not be suitable for all investors. High yield bonds involve increased credit and liquidity risk than higher-rated bonds and are considered speculative in terms of the issuer’s ability to pay interest and repay principal on a timely basis. Investing in foreign denominated and/or domiciled securities involves special risks, including changes in currency exchange rates, political, economic, and social instability, limited company information, differing auditing and legal standards, and less market liquidity. These risks generally are greater with emerging market countries. Small and midsized company stocks tend to be more volatile and less liquid than larger company stocks as these companies are less established and have more volatile earnings histories. Currencies are can decline in value relative to a local currency, or, in the case of hedged positions, the local currency will decline relative to the currency being hedged. These risks may increase volatility. Alternative strategies may involve a high degree of risk and prospective investors are advised that these strategies are suitable only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. The strategies may not be subject to the same regulatory requirements as registered investment vehicles. The strategies may be leveraged and may engage in speculative investment practices that may increase the risk of investment loss. Investors should consult their investment professional prior to making an investment decision.

INDEX DEFINITIONSU.S. Consumer Prices (CPI) Index measure of prices paid by consumers for a market basket of consumer goods and services. The yearly (or monthly) growth rate represents the inflation rate. The 10Y U.S. Treasuries Average Yield of a range of Treasury securities all adjusted to the equivalent of a ten-year maturity. The CBOE VIX Index (VIX) is an indicator of the implied volatility of S&P 500 Index as calculated by the Chicago Board Options Exchange (CBOE). The Majors Dollar Index (USD Index) measures the value of the U.S. dollar relative to a basket of currencies of the U.S.’s most significant trading partners including the euro, Japanese yen, Canadian dollar, British pound, Swedish krona, and Swiss franc. The MSCI EM Index tracks the total return performance of emerging market equities. The S&P 500 Composite Index (S&P 500) is designed to track the performance of the largest 500 U.S. companies. Europe STOXX 600 Index represents the performance of 600 large, mid and small capitalization companies across 18 countries in the European Union. Conference Board Consumer Confidence: monthly survey of U.S. consumer confidence levels conducted by the Conference board. It is used to gather information on consumer expectations regarding the health of the overall economy. NFIB Small Business Optimism: compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members and is a general reflection of their sentiment towards their future business prospects. NFIB Job Openings Hard to Fill: compiled from a survey that is conducted each month by the NFIB of its members and is a general reflection of the tightness in the U.S. labor market. Global Economic Policy Uncertainty (EPU): A GDP-weighted average of national EPU indices for 20 countries: Australia, Brazil, Canada, Chile, China, France, Germany, Greece, India, Ireland, Italy, Japan, Mexico, the Netherlands, Russia, South Korea, Spain, Sweden, the United Kingdom, and the United States. Each national EPU index reflects the relative frequency of own-country newspaper articles that contain a trio of terms pertaining to the economy (E), policy (P) and uncertainty (U). Bloomberg Barclays U.S. Corporate High Yield: covers the universe of fixed-rate, non-investment grade corporate debt in the U.S. Bloomberg Barclays U.S. Corporate Investment Grade: designed to measure the performance of the investment grade corporate sector in the U.S. 1-mth. 1-year forward swap: the avg. interest rate for 1-mth. in 1-year forward. GDP: gross domestic product is the total monetary or market value of all the finished goods and services produced within a country’s borders over a given time period. Fed funds Rate: the target interest rate for overnight lending and borrowing between banks. H2: second half.

STATISTICAL TERMSAlpha is a measure of risk-adjusted performance that compares an investment’s return to that of its benchmark. Skewness in statistics represents an imbalance and an asymmetry from the mean of a data distribution. In a normal data distribution with a symmetrical bell curve, the mean and median are the same. Probability-weighted mean is similar to an ordinary arithmetic mean, except that instead of each of the data points contributing equally to the final average, data points are weighted by the statistical probability for a particular scenario outcome. Duration is a measure of a bond’s interest-rate sensitivity, expressed in years. The higher the number, the greater the potential for volatility as interest rates change. Z-score: number of standard deviations from the mean a data point is.

20

www.bnymellonim.com

For Financial Professionals and Institutional Investors only.

BNY Mellon Investment Management is an investment management organization and a US wealth manager, encompassing BNY Mellon’s affiliated investment management firms, wealth management organization and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and its subsidiaries.

This material should not be considered as investment advice or a recommendation of any investment manager or account arrangement. For marketing purposes only. Any statements and opinions expressed are as at the date of publication, are subject to change as economic and market conditions dictate, and do not necessarily represent the views of BNY Mellon or any of its affiliates. The information has been provided as a general market commentary only and does not constitute legal, tax, accounting, other professional counsel or investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. The information has been provided without taking into account the investment objective, financial situation or needs of any particular person. BNY Mellon and its affiliates are not responsible for any subsequent investment advice given based on the information supplied. This is not investment research or a research recommendation for regulatory purposes as it does not constitute substantive research or analysis. To the extent that these materials contain statements about future performance, such statements are forward looking and are subject to a number of risks and uncertainties. Information and opinions presented have been obtained or derived from sources which BNY Mellon believed to be reliable, but BNY Mellon makes no representation to its accuracy and completeness. BNY Mellon accepts no liability for loss arising from use of this material. If nothing is indicated to the contrary, all figures are unaudited.

Past performance is not a guide to future performance.

Not for distribution to, or use by, any person or entity in any jurisdiction or country in which such distribution or use would be contrary to local law or regulation. This information may not be distributed or used for the purpose of offers or solicitations in any jurisdiction or in any circumstances in which such offers or solicitations are unlawful or not authorized, or where there would be, by virtue of such distribution, new or additional registration requirements. Persons into whose possession this information comes are required to inform themselves about and to observe any restrictions that apply to the distribution of this information in their jurisdiction.

This information should not be published in hard copy, electronic form, via the web or in any other medium accessible to the public, unless authorized by BNY Mellon Investment Management.

Issuing entities

This information is approved for Global distribution and is issued in the following jurisdictions by the named local entities or divisions: Europe (excluding Switzerland): BNY Mellon Fund Management (Luxembourg) S.A., 2-4 Rue Eugène Ruppert L-2453 Luxembourg. UK, Africa and Latin America (ex-Brazil): BNY Mellon Investment Management EMEA Limited, BNY Mellon Centre, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised and regulated by the Financial Conduct Authority. • Switzerland: BNY Mellon Investments Switzerland GmbH, Talacker 29, CH-8001 Zürich, Switzerland. Authorised and regulated by the FINMA. • Middle East: Dubai branch of The Bank of New York Mellon.Regulated by the Dubai Financial Services Authority. This material is intended for Professional Clients only and no other person should act upon it. • Singapore: BNY Mellon Investment Management Singapore Pte. Limited Co. Reg. 201230427E. Regulated by the Monetary Authority of Singapore. • Hong Kong: BNY Mellon Investment Management Hong Kong Limited. Regulated by the Hong Kong Securities and Futures Commission. • Japan: BNY Mellon Asset Management Japan Limited. BNY Mellon Asset Management Japan Limited is a Financial Instruments Business Operator with license no 406 (Kinsho) at the Commissioner of Kanto Local Finance Bureau and is a Member of the Investment Trusts Association, Japan and Japan Investment Advisers Association and Type II Financial Instruments Firms Association. • Australia: BNY Mellon Investment Management Australia Ltd (ABN 56 102 482 815, AFS License No. 227865). Authorized and regulated by the Australian Securities & Investments Commission. • Brazil: ARX Investimentos Ltda., Av. Borges de Medeiros, 633, 4th floor, Rio de Janeiro, RJ, Brazil, CEP 22430-041. Authorized and regulated by the Brazilian Securities and Exchange Commission (CVM). • United States: BNY Mellon Investment Management. • Canada: BNY Mellon Asset Management Canada Ltd. is registered in all provinces and territories of Canada as a Portfolio Manager and Exempt Market Dealer, and as a Commodity Trading Manager and Investment Fund Manager in Ontario. T7980 07/19.

MARK-67416-2019-07-02

Vantage Point - BNY Global Page€¦ · and a capital markets shock could send yields to levels...

Documents

Transcript of Vantage Point - BNY Global Page€¦ · and a capital markets shock could send yields to levels...