market quarterly perspectives isights europe | 3q | 2013 · 2017. 3. 13. · a younger demographic...

MARKETINSIGHTS

Quarterly PerspectivesEurope | 3Q | 2013

David Kelly, CFAManaging DirectorChief Global Strategist

Andrew GoldbergExecutive DirectorGlobal Market Strategist

Dan Morris, CFAExecutive DirectorGlobal Market Strategist

Maria Paola ToschiExecutive DirectorGlobal Market Strategist

Kerry Craig, CFAVice PresidentMarket Analyst

David LebovitzAssociateMarket Analyst

To learn more about the Market Insights

programme, please visit us at

www.jpmam.com/insight

J.P. Morgan Asset Management is pleased to present the latestedition of Quarterly Perspectives. This piece highlights keythemes from our Guide to the Markets book and offers criticalinsights for engaging in portfolio discussions.

Both Quarterly Perspectives and Guide to the Markets are elements of our Market Insights programme, which was developed to provide investors with a way to address the markets and the economy based on logic rather than emotion, ultimately helping investors to make rational investment decisions.

This quarter’s themes

1 Is now the time to accumulate emerging markets exposure?

2 The incredible shrinking US deficit

3 The end of European austerity

4 Less easing requires more flexibility

Guide to the Markets

3Q | 2013As at 30 June 2013

EUROPE

Guide to the Markets

Quarterly Perspectives MARKETINSIGHTS

2

1Is now the time to accumulate emerging markets exposure?

OverviewEmerging equity markets have been the ugly sister to developed markets’ Cinderella performance so far this year. Exceptionally aggressive monetary policy has boosted stock markets in the developed world, while emerging markets have faced several headwinds including a policy-induced slowing intended to curb inflation. But the long-term potential in emerging economies should not be forgotten and valuations are attractive after a period of weaker stock market performance. Investors should consider increasing their allocation to this growing area of the global economy.

The performance of emerging and developed equity markets has diverged this year, with emerging equities seemingly stuck in reverse. While emerging market (EM) equities could fail to repeat the strong gains of 2012, investors may be remiss not to take advantage of a long-term opportunity given current prices.

First-quarter EM economic growth largely undershot expectations and over the next few quarters these economies are likely to experience softer than normal growth. The depreciation of the yen has hurt the competitiveness of emerging Asian exporters, particularly Korea, which manufactures similar products to Japan. Meanwhile, economies reliant on commodity exports, such as Brazil and Russia, have seen weaker global growth translated into lower export revenues.

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World Growth

Contribution to global GDP growth Share of global consumption

EM consumption % of global

US consumption % of global

2011: 26%

% 2011: 36%Developed Emerging

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52%44%

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Source: (Left) IMF, United Nations, J.P. Morgan Asset Management. (Right) United Nations, J.P. Morgan Asset Management.

(Left) IMF forecasts from 2011.

Share of global investment

EM investment % of global

US investment % of global

2011: 14%

2011: 51%

32% 36%

48%56%

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Guide to the Markets, page 29

The devil is in the detailInvestors should remember, however, that not all emerging markets are created equal; economic fundamentals diverge widely, and the sector composition of equity indices will vary by country as well. For example, 63% of the MSCI Russia Index is comprised of the cyclical energy, materials and industrial sectors,

•Emerging markets will become the biggest contributor to global growth this decade.

3

Europe | 3Q | 2013

while these same areas account for only 23% of India’s equity index. An active management approach towards EM will allow investors to target those sectors and countries that may perform better in the current economic environment, and mitigate the downside risk.

Use a telescope, not a microscopeInvesting in emerging markets is about playing the long game, on the basis that the pace of growth in EM will vastly outstrip that of the developed world in the long term. A younger demographic profile, an increasingly wealthy middle class, growing intra-emerging market trade, and the transition to a greater focus on domestic consumption-driven growth should all support economic success and set the stage for equity market outperformance.

Emerging Market Equity Valuations by Country

Emerging markets

+3 Std Dev

+2 Std Dev

+1 Std DevAverage

-1 Std Dev

-2 Std Dev-3 Std Dev

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Expensive relative to

own history

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world

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How to interpret this chart

Equi

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Russia China Brazil EM Index Taiwan ACWI Korea IndiaS. Africa Mexico

43

Source: MSCI, FactSet, J.P. Morgan Asset Management.

Each valuation index shows an equally weighted composite of four metrics: price to forward earnings (P/E), price to current book (P/B), price to last 12 monthsʼ cash flow (P/CF) and price to last 12 monthsʼ dividends. Results are then normalised using means and average variability over the last ten years. The grey bars represent valuation index variability relative to that of the All Country World Index (ACWI).

Current composite index

Current Ten year averageForward P/E P/B P/CF Dividend yield Forward P/E P/B P/CF Dividend yield

Russia -4,11 4,4x 0,6x 2,7x 4,4% 7,8x 1,3x 4,7x 2,3%China -2,25 8,3 1,3 5,0 3,6 12,0 2,1 4,3 2,7Brazil -2,21 9,7 1,3 5,2 4,1 8,9 1,9 5,6 3,4EM Index -1,58 9,8 1,4 5,5 3,0 10,8 1,9 5,8 2,7Taiwan -0,55 13,6 1,8 6,7 3,0 13,9 1,9 6,4 3,6ACWI -0,20 12,9 1,8 7,7 2,7 13,3 2,1 7,0 2,5Korea -0,17 8,1 1,1 4,4 1,2 9,5 1,5 5,1 1,8S. Africa 0,09 12,8 2,2 9,3 3,4 10,7 2,4 8,1 3,3Mexico 2,07 16,4 2,7 7,8 1,7 13,4 2,7 6,0 2,0India 2,12 13,6 2,4 10,4 1,6 14,8 3,3 12,4 1,5

Equi

ties

Russia China Brazil EM Index Taiwan ACWI Korea IndiaS. Africa Mexico


Valuations suggest EM equities look attractive, both in the context of their own history and relative to developed market equities. The price-to-earnings (P/E) ratio for many developed market indices is moving back towards the long-term average, whereas for many emerging market equities the P/E remains below average. Moreover, the MSCI Emerging Markets Index is trading at a price-to-book ratio of 1,5x, while the MSCI USA Index is at 2,4x.

Investment implications�� Emerging markets are expected to grow faster than developed economies in the long run despite several near-term headwinds.

�� Valuations on EM equities are attractive not only compared to their own history but also relative to developed equity markets.

�� The surge in developed market equities may have left investors over-allocated to the asset class, meaning an increase in emerging market exposure may be needed to achieve proper diversification.

•The price-to-book ratios for EM equities look attractive compared to their long term history.


4

The incredible shrinking US deficit

OverviewDespite a generally favourable view of the US recovery and markets, investors continue to express concern over the US fiscal situation. More work will be needed to solve long-term entitlement issues, but the worst of these risks appears to be years down the road. Meanwhile, a rapid reduction in the deficit should provide encouragement to investors that the US is making progress – but is this progress too much of a good thing?

By the numbersThe Great Recession took a major toll on the US economy, and by late 2009, the US had shed nearly 9 million jobs. This, coupled with a record low in S&P 500 operating earnings (and hence tax receipts) and massive spending on fiscal stimulus, left a gaping hole in the US federal budget, with the deficit reaching USD 1,4 trillion and 10,1% of GDP in fiscal year 2009 - a post World War II record.

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1960 1970 1980 1990 2000 2010$0.0

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Total Government Spending Sources of Financing

Federal Finances: Outlays and Revenues

The 2013 Federal BudgetCBO Baseline forecast, trillions USD

Econ

omy

Source: U.S. Treasury, BEA, OMB, CBO, J.P. Morgan Asset Management.2013 Federal Budget is based on the CBO’s May 2013 Baseline Scenario. Other spending includes, but is not limited to, health insurance subsidies, income security, and federal civilian and military retirement. Note: Years shown are fiscal years (Oct. 1 through Sep. 30). Data as at 30/6/13.

Total Spending: $3.5tn

Medicare & Medicaid:$852bn (25%)

Defense:$751bn (22%)

Social Security:$809bn (23%)

Other$359bn (10%)

Non-defense Disc.:$461bn (13%)

Net Int.: $223bn (6%)

Borrowing:$642bn (19%)

Income:$1,333bn (39%)

Federal Outlays and Receipts1960 – 2013, % of GDP

Average: 20.5% 2013: 21.5%

Average: 17.9%

2013: 17.5%

RevenuesOutlays

Corp.: $291bn (8%)

Social Insurance:$952bn (28%)

Other: $237bn (7%)

However, the US economy has since recovered nearly 7 million jobs, and corporate profits have surpassed (and remain near) record levels, both of which have helped boost federal revenues. Moreover, a combination of higher tax rates and a reduction in government spending – the result of the Budget Control Act, a sloppy fiscal cliff deal and sequestration - have contributed to a rapid plunge in the deficit.

2

•A surge in spending and a collapse in revenues, as illustrated in this slide from an earlier edition of the Guide to the Markets†, led to massive budget deficits in 2009 and 2010.

† Slides from previous editions are now available from www.jpmam.com/insight

5

Europe | 3Q | 2013

Under current law, the Congressional Budget Office (CBO) estimates that the budget deficit will shrink to USD 642 billion this fiscal year, which ends on 30 September 2013, the smallest shortfall since 2008, and only 4,0% of GDP. This should help stabilise the debt-to-GDP ratio, as nominal GDP growth that outpaces any corresponding growth in the federal debt should cause this ratio to decline. Standard & Poor’s recently upgraded its outlook for US long-term debt from ‘negative’ to ‘stable’, reflecting this improvement.

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US Federal Finances

Federal budget surplus/deficit% of GDP, 1990 - 2022

Federal net debt (accumulated deficits)% of GDP, 1990 - 2022

Forecast%

2012 actual: 72,5% 2022: 72,9%

2022: 58,3%

Forecast

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1990 1994 1998 2002 2006 2010 2014 2018 2022-12

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Source: US Treasury, BEA, CBO, J.P. Morgan Asset Management.

2012 numbers are actuals. Years shown are fiscal years (1 October through 30 September). Chart on the left displays federal surplus/deficit (revenues – outlays). Federal net debt comprises all financial liabilities of the Federal government (gross debt) minus all intra-government holdings as assets. Deficit and debt scenarios are based on CBO budget forecasts from August 2012 and May 2013, which include the American Taxpayer Relief Actʼs cost estimates.

May 2013 CBO baseline

Aug 2012 CBO baseline(Fiscal Cliff Scenario)

2013 CBO baseline

Aug 2012 CBO baseline(Fiscal Cliff Scenario)


Fiscal drag These numbers reveal the significant amount of fiscal drag that has undercut US economic growth over the past few years, making it all the more remarkable that the economy has continued to grow so far in 2013 (some key drivers of this growth are illustrated in the chart on page 6). Even the International Monetary Fund (IMF) has warned that the rapid decline in the deficit has been ‘excessively rapid and ill-designed’, indicating a preference for the US to focus first on economic growth with a medium-term plan for fiscal sustainability.

While the budget numbers should improve further in fiscal 2014 (due to a full year’s worth of tax increases and sequester cuts, as opposed to only nine months in fiscal 2013), the fiscal drag associated with the decisions made at the start of this year should begin to wane and economic growth should accelerate.

•The US federal deficit has been cut in half since 2009, helping to stabilise the debt-to-GDP ratio.


6

US Consumer Finances

US home sales, prices, and housing startsHousehold net worth$ billions, SAAR

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2Q13:$71.3263Q07:

$68.057

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Source: (Top left) Federal Reserve, FactSet, J.P. Morgan Asset Management. (Bottom left) Federal Reserve, FactSet, J.P. Morgan Asset Management. (Right) National Association of Realtors, US Census Bureau, FactSet, J.P. Morgan Asset Management.

(Right) Indices rebased to 100 at December 1999. Price index is the mean existing home sale price. SAAR is seasonally adjusted annual rate.

*2Q13 number for US debt service ratio is a J.P. Morgan Asset Management forecast.

US household debt service ratioDebt payments as % of disposable personal income, seasonally adjusted

%

2Q13*: 10,5%

Price index

Existing home sales

Housing starts

'90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12

'99 '01 '03 '05 '07 '09 '1125

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The long runAfter 2017, rising health costs, an ageing population and expanded eligibility for health insurance will contribute to higher government spending. Entitlement programmes like Social Security and Medicare account for roughly 50% of US spending, and any credible plan to achieve long-term fiscal sustainability will require steps that curtail the growth in these costs. The good news is that this is not a particularly daunting academic problem, as there are a variety of ways to achieve the desired result without too much economic pain. Politics, unfortunately, is the primary obstacle; as we have seen, the political process can be messy and take time. Rising interest rates could also boost the government’s debt-service costs, which accounted for a very manageable 2,3% of GDP in 2012. So, while US policymakers have time, they have their work cut out for them.

Investment implicationsThe declining deficit has a number of important implications:

�� Improved growth: fiscal drag has restrained growth; however, the resilience of the US economy is impressive and suggests much stronger growth potential in the future when the fiscal handcuffs are removed.

�� Reduced tail risk: while progress made on the deficit does not remove the need to raise the debt ceiling later this year, it may give the Treasury department more room to manoeuvre and reduce the political appetite for a drawn-out fight. This should be supportive of equity prices later in the year as rising confidence allows for expanded multiples.

�� Higher rates: recent deficit numbers make the US Federal Reserve’s current pace of Quantitative Easing (QE) purchases (USD 1,020 billion on an annualised basis) appear even more extreme, and the amount of supply they have been buying increases the risk to the bond market when the Fed phases out QE. Rising rates will require a flexible approach to fixed income investing.

• Increased household wealth thanks to higher stock prices and rising home prices, as well as lower household debt service costs, have thus far outweighed the negative effects of fiscal drag.

7

Europe | 3Q | 2013

The end of European austerity

OverviewIn April 2010, investors began to realise that certain countries in the European Union (EU) had fiscal balances that were unsustainable. As a result, sovereign bond yields of the most indebted nations skyrocketed to levels not seen since the inception of the euro. Although the Troika, which is comprised of the European Commission, European Central Bank (ECB), and International Monetary Fund (IMF), provided funding to help these countries avoid default, this assistance came with the stipulation that governments would impose austerity measures in an effort to curb their spending. Three years later, a lack of growth has caused many to question whether austerity was the right medicine.

Less emphasis on austerityThe appetite for austerity in Europe is dwindling, and it appears that policymakers are realising that while reducing spending is an important step toward fiscal balance, it is ineffective to do so at the expense of growth. At the end of May, the European Commission extended deficit reduction deadlines for France, Spain and the Netherlands, giving them more time to reach their fiscal targets, and Italy was released from the programme due to progress made in 2012. While this does not represent a wholesale change in policy, less austerity, coupled with the ECB’s capacity for further easing, should help Europe emerge from recession sooner rather than later.

However, additional reforms are still needed; for example, Europe needs to embrace the idea of a fiscal union, as this would improve financial sector stability and the ability of the EU to handle banking crises going forward. In addition, although the ECB has room for further policy easing, it desperately needs to fix the transmission mechanism, as low policy rates are not translating into stronger growth. Finally, various structural reforms are needed, particularly related to labour markets and their competitiveness.

Brazil

South Africa

Mexico

US

Turkey

Korea

China

Germany

India

Indonesia

Japan

Malaysia

Russia Singapore

10%

5%

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10GDP growth, debt-to-GDP and borrowing costs

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2014

F)

Bubble size = Ten-year government bond yield

Sovereign Debt Stresses

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Greece*

ItalySpain

Portugal

EU

UK

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Source: IMF World Economic Outlook April 2013, FactSet, Barclays, J.P. Morgan Asset Management. Borrowing costs based on local currency debt. EU overall borrowing cost based on Barclays Capital Euro-Aggregate 7-10 Year Treasury Index. South Africaʼs borrowing costs are based on 7-year government bond yield due to data availability. *Greece will be reclassified as an emerging market in November 2013.

Rea

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(201

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Gross debt-to-GDP ratio (2013F)240

Emerging Markets

Developed Markets

12

%


3

• If there is less of a focus on austerity and a greater focus on growth, debt and deficits could actually fall as a share of GDP as economic growth outpaces increases in debt.


8

Don’t dismiss European equitiesWhile it will take time for Europe to emerge from recession, this does not necessarily mean that investors should avoid European equities. The European economy is slowly but steadily improving, with deficits falling by 3,1% of GDP in the euro area over the past three years, but given that it is not out of the woods yet, the ECB should remain accommodative. Furthermore, it is important to keep in mind that investors are investing in companies, not the economy, as well as that many European companies have global revenue streams, which should help them continue to generate earnings despite weak growth in Europe. Finally, European equities are attractively valued and, on average, pay higher dividends than other developed market stocks, which should help contribute to returns.

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Europe Equity Valuations

Average: 13,9

X

Forward P/E ratio: MSCI Europe Index Europe-US relative valuations

Europe/US forward P/E30 Jun 2013:

12,1x

Europe relatively more

expensive

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Source: MSCI, FactSet, IBES, J.P. Morgan Asset Management.

(Right) The Europe-US relative valuation shows the forward P/E of the MSCI Europe Index divided by the forward P/E of the MSCI USA Index.

30 Jun 2013:3,7%

Average: 0,91

Europe relatively cheaper

Europe relatively more

Equi

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Dividend yield: MSCI Europe Index

%


Investment implications�� The European economy is slowly recovering, with recent data being ‘less bad’.

�� Policymakers may be realising that strict austerity is not the right answer for a region that is in recession.

�� Despite the broader macroeconomic environment, European equities are compelling for those who can handle interim volatility, both on attractive valuations and improved balance sheets.

•European equity valuations are attractive, particularly relative to the US, and attractive dividend yields can help investors enhance their stream of income in a low interest rate world.

9

Europe | 3Q | 2013

Less easing requires more flexibility

OverviewIn response to the global financial crisis, central banks adopted an array of unconventional monetary stimulus measures to revive a battered global economy. These included, among other things, large-scale asset purchases, better known as quantitative easing (QE). Today, however, signs of stronger economic growth, mainly in the US, are raising questions about when and how central banks will taper these asset purchases. When central banks eventually do scale back QE, a flexible investment approach will be needed to deal with rising interest rates and more volatile fixed income markets.

A market of distortionsWhen central banks engage in QE, they print new money and inject it into the money supply by purchasing securities. The most common purchases are government bonds, and during the financial crisis, a combination of large-scale asset purchases and a systemic risk-driven flight to quality drove massive flows into this asset class, inflating prices and crushing yields.

As confidence gradually recovers and economic momentum improves, these distortions should unwind and market fundamentals should normalise. Unfortunately, investors should not expect this process to be smooth, and a flexible approach to fixed income investing will be needed to shield against some of the volatility that this normalisation process could entail.

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Government Bond Yields

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Sources: (Left) Tullett Prebon, J.P. Morgan Asset Management. (Right) Jeremy Siegel, “The real rate of interest from 1800-1990”, Homer & Sylla, “A History of Interest Rates”, Ibbotson SIBI, Federal Reserve, J.P. Morgan Asset Management.

US government bond yields are high quality government bond yields. High-grade municipal bond yields used for certain years between 1800 and 1920. Real yield based on core CPI.

60 years

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Improvement in the US and the need for QE taperingWith the unemployment rate above the US Federal Reserve’s (the Fed’s) 6,5% target and inflation declining, economic conditions do not support an imminent end to the Fed’s accommodative stance. However, there is no doubt that the economy is getting better, and that some policy adjustment may be warranted.

•Massive inflows from QE and a flight to quality drove yields to historic lows. While subdued growth will keep a lid on yields, improving conditions could exert upward pressure on rates.

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As shown in the chart on the left, the US unemployment rate has fallen 2,4% from its peak in October 2009. With home prices rising, fiscal threats abating, consumer confidence improving and labour markets tightening, the case for easy Fed policy is gradually deteriorating.

This has two important implications: first, the 6,5% unemployment rate target seems achievable in the next 18-24 months (left chart), and second, a falling unemployment rate benefits equities more than bonds (right chart).

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US Fed’s Unemployment Target

US unemployment rate scenariosWhen unemployment rate will reach 6,5%

%

Market performance and employmentLog scale

US unemployment rate, inverted (lhs)

World equity/bond returns (rhs)%

Range of potential dates for reaching the target

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Source: (Left) BLS, J.P. Morgan Asset Management. (Right) Absolute Strategy Research (ASR), BLS, Federal Reserve, Thomson Data Stream, Barclays, J.P. Morgan Asset Management.

Current payrolls assumes monthly non-farm payrolls increase by 150k and participation rate is constant at 63,5%. Improving payrolls assumes increase in non-farm payroll rate to 200k/month and participation rate increases by 0,05% each month. Deteriorating payrolls assumes increase in non-farm payrolls of 100k/month and participation rate dropping by 0,05% each month.

Fed target: 6,5% unemployment

Faster payrolls growth

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The Fed is becoming increasingly aware that its rapidly expanding balance sheet carries dangers of its own. The Fed increased the size of its balance sheet without causing a surge in the money supply by paying interest on excess bank reserves held at the Fed, which encourages banks to keep their excess reserves there instead of lending them to the private sector. However, this also means that when the Fed finally does increase the federal funds rate, it will need to increase the interest paid on reserves in lockstep to prevent a flash-flood of liquidity from hitting the economy and causing inflation pressures, an expensive proposition when banks hold about USD 2,5 trillion in reserves with the Fed.

European rates less at risk than the USDespite progress in containing the crisis on the back of Mario Draghi’s ‘whatever it takes’ speech, the European economic environment remains challenging, with unemployment at untenable levels, credit dynamics still unfavourable, and inflation well below the level considered appropriate by the European Central Bank (ECB).

Moreover, the ECB has declared that monetary policy will remain accommodative for as long as necessary, and will continue to provide long-term refinancing operations (LTRO) for Europe’s commercial banks. This means that the eurozone should not suffer from the same risks related to the unwinding of monetary stimulus as the US.

While German Bund yields could remain low until the eurozone deleveraging process is further along, peripheral rates should continue to converge thanks to a reduction in trade imbalances and improving fiscal sustainability. That said, it will take time for the structural dynamics of these economies to improve.

•The unemployment rate could reach the Fed’s target sometime next year.

•A falling unemployment rate has typically coincided with equity outperformance.

11

Europe | 3Q | 2013

• It is important to keep in mind that some areas of the bond market are more sensitive to changes in interest rates than others.

Japan joins the QE partyThe Bank of Japan (BoJ) has announced sweeping new stimulus measures designed to end deflation and push inflation up to 2%. However, there appears to be a contradiction between the BoJ’s goal of boosting inflation and its implementation of a massive asset purchase programme designed to lower interest rates. In fact, instead of falling as intended, Japanese government bond yields have risen due to higher inflation and growth expectations, and it will be interesting to observe how these competing dynamics play out going forward.

Volatile markets require a flexible investment approach Monetary stimulus won’t last forever, and at some stage, interest rates will rise further. When this happens, the various segments of the fixed income market will react in different ways; government bonds will likely suffer the most, while assets with higher coupons, like corporate high yield or emerging market debt, should fare better as they are less sensitive to changes in rates.

Fixed Income Market Data and Interest Rate Risk

Source: Barclays, FactSet J.P. Morgan Asset Management.Returns are calculated in the currency of the underlying asset class if it is a single currency index otherwise they are hedged (ʻlocal currencyʼ) if the index contains assets in denominated in different currencies. Fixed income sectors shown are provided by Barclays Capital and are represented by – Treasury Europe: Barclays Pan-Euro Aggregate Government - Treasury

Yield ReturnEurope Treasuries Num. of issues Market value Avg maturity 30 Jun 2013 31 Mar 2013 2Q13 YTDTreasury: Europe 9,4 years 2,19% 1,97% -0,77% -1,12%1-3 years 1,9 0,96 0,87 0,36 0,045-7 years 6,0 2,18 1,84 -2,72 -0,9210+ years 21,0 3,41 3,16 -5,44 -2,30

SectorIG credit 7.979 €5.276 8,3 years 3,07% 2,59% -2,00% -2,37%Global high yield 2.995 1.421 6,5 6,92 5,85 0,40 -1,62EMD sovereign ($) 285 364 11,9 5,42 4,42 -7,94 -5,59EMD corporate ($) 450 268 7,2 5,93 4,56 -4,84 -4,96

Num. of issues: 671

Total value: €10.680tn

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Government - Treasury Index; IG credit: Barclays Global Aggregate –Corporates Index; High yield: Barclays Global High Yield Index; EMD sovereign ($): Barclays Emerging Markets –Sovereigns index; EMD corporate ($): Barclays Emerging Markets –Corporates Index; EMD sovereign (LC): Barclays Emerging Market Local Currency Government Index.Change in bond price is calculated using both duration and convexity.

EMD corporate ($) 450 268 7,2 5,93 4,56 -4,84 -4,96EMD sovereign (LC) 460 1.257 6,9 5,55 4,86 -2,26 -3,17

Estimated price impact of a 1% rise in local interest rates on selected indices%

Price returnTotal return

Treasury: Europe 1-3 years 5-7 years 10+ years Investment

grade credit High yield EMD USD sovereign

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EMD LC sovereign

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A more flexible approach to fixed income investing may be the key to helping investors deal with periods of high volatility. Investors can use their fixed income allocation to provide some downside protection in times of crisis, but should ensure that they are also appropriately positioned for an increase in interest rates.

Investment implications�� Despite recent volatility in fixed income markets, subdued growth and low inflation expectations should keep interest rates relatively low.

�� Positive US economic data could increase bond market volatility. Fixed income sectors with lower durations and higher coupons can help to protect portfolios when rates rise.

�� Equity markets will be less exposed to the risk of a pronounced correction because rates are still very low and economic conditions are improving.

The Market Insights programme provides comprehensive data and commentary on global markets without reference to products. Designed as a tool to help clients understand the markets and support investment decision-making, the programme explores the implications of current economic data and changing market conditions.

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Europe | 3Q | 2013

market quarterly perspectives isights europe | 3q | 2013 · 2017. 3. 13. · a younger demographic...

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