Issued in February 2016
For professional investors and advisers only
Schroders Multi-Asset Investments
Views and Insights
Section 1: Monthly Views – February 2016
Summary
Equities
0
Government
bonds
Investment
grade credit
High yield
Commodities
+
+
+
0
Cash
–
Category
View
Equities
0
We have retained the neutral view on equities. Despite the improvement in valuations, the
slowdown in the cyclical environment remains a threat. Our country views reflect a bias
for low beta markets, downgrading Europe and upgrading the more defensive US market.
US
+
We upgraded our view on the US market to positive. The recent tentative stabilisation in the US
dollar will help arrest the slide in earnings growth and the Federal Reserve (Fed) has also
sounded more dovish as of late, reflecting heightened financial market uncertainty. While global
growth expectations continue to decline, the high quality nature of the US market makes it an
attractive holding compared to other regions.
UK
0
We maintain our neutral score. This reflects a tug of war between a weaker sterling which would
provide tailwinds for multinationals on one side, versus concerns around fiscal tightening and
Brexit on the other.
Europe
0
We downgraded Europe to neutral. The region was previously able to rely on the European
Central Bank (ECB) and euro depreciation to generate economic growth and equity market
gains. Now the currency has appreciated on the back of the improving economy and
disappointment with further central bank action. Equity upside from earnings is capped from
limited currency depreciation and furthermore we believe that European economic growth will
not survive a global growth slowdown.
Japan
0
Despite positive momentum, we are concerned that consensus forecasts for Japanese earnings
are too optimistic and fail to make adequate provisions for a stable to strong yen. We therefore
maintain our neutral view.
Pacific ex
Japan
0
Valuations remain attractive in Pacific ex Japan equities. However, earnings momentum
remains relatively poor, particularly in those sectors exposed to a Chinese slowdown. We
therefore maintain our neutral score in the absence of a medium-term growth catalyst.
–
We remain negative on emerging markets (EM). Valuations are looking attractive. However,
while a lot of bad news has been priced in, we are not convinced that the slowdown in the
cyclical environment, the increased uncertainty around the outlook for the Chinese economy and
the risk to EM balance sheets has been discounted fully by the market to merit an upgrade to
our score.
Emerging
Markets
Comments
Schroders Multi-Asset Investments
Category
View
Comments
Government
bonds
+
We remain positive on duration, harvesting the positive carry in commodity exposed
countries, like Canada, while inflation and growth stay below trend. We continue to see
higher volatility created by uncertainty around central bank divergence.
US
0
We remain neutral on US bonds as weaker US data have yet to damage the upward trend of the
trade weighted US dollar. Whilst we favour further curve flattening in the near term, on a 12-18
month time horizon the outlook is less clear.
UK
+
Gilts remain one of the main beneficiaries of low eurozone interest rates. Stubbornly low inflation
and falling energy prices might force the ECB into more quantitative easing (QE) which should
benefit the gilt market as Bund yields approach the 0% bound again.
Germany
0
Having taken profit on our flattening position last year we remain neutral on German bonds. On
a relative basis we prefer higher carry, high quality bonds like gilts. That said further ECB QE is
likely to be front-run by investors and we are thus likely to see further compression across the
curve.
Japan
0
Despite the unattractive low/negative yields, we continue to suggest a hold for now on the
medium to long-end on the back of aggressive Bank of Japan (BoJ) support.
US inflation
linked
0
We remain neutral on TIPS (Treasury inflation protected securities) after the recent
underperformance as US dollar strength is likely to continue, though our outlook has become
more balanced with any US weakness causing lower real yields.
Emerging
markets
–
We continue to avoid the long end in EM local bonds while remaining underweight EM US dollar
bonds waiting for some stabilization in EM foreign exchange (FX) and further improvement in
EM fundamentals. External debt valuation has improved. Whilst we acknowledge carry is a
significant performance driver, we remain negative as spreads are still vulnerable to
deteriorating fundamentals linked to FX weakness and commodity prices.
Category
View
Investment
grade credit
Comments
+
US
+
On a twelve month horizon, we remain positive on US investment grade: Valuations remain
attractive, debt affordability remains good (with the increase in spreads being more than offset
by lower risk free rates relative to history), while interest rate related risks are rather subdued
given the contingent sluggish growth outlook. Main short-term risks to our view remain poor
sentiment and a supply glut in investment grade names (both forces that negatively contributed
to the performance of this asset class during the month of January).
Europe
+
We maintain a single positive on Europe. A backdrop of depressed rates and earlier stage of the
credit cycle should re-ignite the carry theme once the short-term sentiment stabilises and the
probability of market contagion via the different international financial channels recedes.
Category
View
High yield
credit
+
Comments
US
+
Energy and mining company deterioration is dominating the fundamental picture in the US,
though the contagion effects from energy companies appear lower than expected. We feel that
on a twelve month horizon there is some potential for a market rebound as cautiously-positioned
investors with high cash balances ought to be attracted back into the asset class at these yield
valuations.
Europe
0
We remain neutral on European high yield; we believe that this asset class faces similar
headwinds to the US names without offering the advantage of more attractive valuations.
Category
View
Comments
Commodities
0
We remain neutral on commodities as they continue to struggle while carry remains
negative and the global economy continues to undergo a sluggish and desynchronised
recovery.
Energy
0
In the short term, the market remains worried about inventories. We believe longer term pricing
is too pessimistic as capital expenditure cuts have been dramatic and we will see markets move
Schroders Multi-Asset Investments
into balance in the second half of the year. Carry is too negative to express a view which is more
upbeat than neutral.
0
Weaker US and global data is overwhelming the market’s rate expectations. This continues to
push real rates lower. We take a pause on our negative view as we would like to see global
macro data stabilise without requiring the Fed to ease.
0
We remain neutral with a downside bias as the cost of production continues to fall with currency
depreciation at the producers and lower oil prices, and thus less supply will be removed than
expected. With improvements in the Chinese economy on the margin, we are waiting to see if
base metals find a floor.
Agriculture
0
We remain neutral with an upside bias on agriculture. Major grains are in abundant supply, with
the third strongest harvest on record in 2015, and southern hemisphere crops are progressing
nicely. The fourth strongest El Niño since 1950, with an increasing likelihood of an intense La
Niña in 2016, could be disruptive to future crop yields.
Category
View
Gold
Industrial
metals
Comments
Currencies
US dollar
+
We maintain a positive view on the US dollar, primarily against Asian and commodity currencies,
with expectations of further strength through 2016 due to monetary policy divergence.
British pound
0
Despite recent weakness, we remain neutral on sterling over the medium term. Modest growth
in the UK and the relative hawkishness of the Bank of England should maintain upward pressure
on the pound versus some other G10 currencies, while Brexit concerns should moderate this.
Euro
0
The European economy has witnessed material improvement over the past year, driven by the
ECB’s policy to weaken the euro and lower bond yields. On the other hand, the ECB remains
very aggressive in seeking to maintain strength in the economy and combat deflationary forces.
As a result of these conflicting forces we remain neutral on the euro for the time being.
Japanese yen
–
We expect the Japanese yen to weaken over the medium term. In the face of structural
headwinds in terms of a declining population and an unsustainable fiscal path, we expect further
accommodative monetary policy from the BoJ over the coming year.
Swiss franc
0
We remain neutral on the Swiss franc as we see no clear catalyst for repricing.
Category
Cash
View
–
Comments
We continue to hold a negative view on cash in the environment of negative real rates.
Source: Schroders, February 2016. The views for corporate bonds and high yield are based on credit spreads (i.e. duration-hedged). The views for currencies are
relative to US dollar, apart from US dollar which is relative to a trade-weighted basket.
Schroders Multi-Asset Investments
Section 2: Multi-Asset Insights
After almost two and a half years of a consistently low
volatility environment, the volatility regime has started
to shift significantly higher since the summer of 2015.
This has been caused by the gradual deterioration of
the macroeconomic outlook and fundamental picture in
the last few months. Figure 1 shows one month implied
volatility of the S&P 500 Index over the past two years
and the lower/upper ranges of its corresponding high
volatility regime. As a consequence of this regime
change, we have observed higher than average
volatility across global assets and also more frequent
volatility spikes of significantly higher magnitudes.
Figure 1: Range of volatility based on the S&P 500 Index
Implied Volatility
33
28
23
18
13
8
Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16
SP500 High Vol Lower
SP500 High Vol Mean
SP500 High Vol Higher
1M ATM Implied Vol SP500
Source: Thomson DataStream, Monthly data, February 2016
In this environment, it is worth highlighting several
dynamics of high volatility regimes.
Increased contagion risks
While there is still evidence of differences in regional
growth outlooks, a high volatility environment is typically
associated with highly sentiment-driven market moves.
As a result, the contagion effects are expected to be
stronger than we typically experience. As shown in
Figure 2, despite the different underlying economic
cycles, volatility across different regional equity markets
has moved more closely in tandem in the recent sell-off
compared to the last few years.
Use appropriate comparators
When looking at the valuation of volatility, many
investors focus on the absolute level of volatility within
one market and compare this to other markets.
However, this misses the idiosyncratic differences
between markets. For example, in the second week of
January, the S&P 500 Index had already moved into a
high volatility regime, but the Nikkei 225 Index was still
in a low volatility regime. As a result, it is important to
assess the attractiveness of each volatility market
relative to its own history.
Figure 2: Current levels of implied volatility against
respective ranges of volatility regimes of each index
50
45
Implied Volatility
What does increased volatility mean for
investors?
40
35
30
25
20
15
10
S&P
500
- 1 STD
Euro
stoxx 50
FTSE
100
DAX
High Vol Regime Average
Nikkei
+ 1 STD
HK
Current
Sources: Bloomberg, Schroders calculations, 1 February 2016
Potential opportunities to take advantage of
delayed effects
Given the greater contagion risks associated with high
volatility regimes, the lead lag phenomenon could offer
opportunities for potentially cheaper hedges. For
example the S&P 500 Index and DAX Index moved into
a high volatility regime in the first two weeks of January
while the volatility in the Nikkei Index was relatively
more subdued. However, Japanese volatility then
quickly caught up with the other markets. Such
reactions offer opportunities for investors.
Place more emphasis on higher frequency data
Based on our research in 2013, we concluded that high
frequency macroeconomic data or indicators are
particularly valuable during high volatility regimes as
they can capture more of the market dynamics driven
by investor sentiment. As a result, we would suggest
paying more attention to the faster moving indicators
currently when managing our option strategies.
Current positioning
Our analysis suggests that the current market
weakness is based on weak investor sentiment rather
than representing the beginning of a prolonged bear
market or recession. However, we are mindful that
there is some complacency in terms of positioning in
volatility markets, with investors expecting central
banks to act as shock absorbers again, while
fundamentals remain weak. We therefore think it is
sensible to remain cautiously positioned, and our bias is
towards using lower implied volatility levels as an
opportunity to add protection positions to our portfolios.
Schroders Multi-Asset Investments
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These are the views of the Schroders’ Multi-Asset Investments team, and may not necessarily represent views expressed or reflected in other
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has expressed its own views and opinions in this document and these may change. Reliance should not be placed on the views and information
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