Investment Policy - December 2014

PRIVATE BANKING – DECEMBER 2014
INVESTMENT POLICY
INVESTMENT RESEARCH MONTHLY PUBLICATION
EDMOND DE ROTHSCHILD (SUISSE) SA - INVESTMENT COMMITTEE
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INVESTMENT POLICY – DECEMBER 2014
CONTENTS
Wrap-up ............................................................................................................................................................................. 4
Global economic outlook .........................................................................................................................................5
Bonds ................................................................................................................................................................................... 6
Equities................................................................................................................................................................................ 7
Currencies......................................................................................................................................................................... 8
Allocation grid
Contact:
.............................................................................................................................................................. 9
Alessandra Gaudio | Global Chief Investment Officer
+41 58 818 86 78
[email protected]
EDMOND DE ROTHSCHILD (SUISSE) SA – INVESTMENT COMMITTEE
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INVESTMENT POLICY – DECEMBER 2014
WRAP-UP
 2014 has been a bumpy year to say the least, with economies around the world expanding at widely diverging
rates. The US, on the one hand, has managed to keep growth on track. Confidence has held steady among
consumers and business leaders and unemployment has eased. But on the other hand, Europe, Japan and the
emerging countries face structural difficulties that have slowed their momentum. These regions have tried to
spur economic expansion, mainly by pursuing accommodative monetary policies, but they must now strive to
bring down public debt and joblessness. It will take considerable time for these efforts to yield results. The Euro
Zone economy will remain sluggish in 2015.
 Over the past year the markets have taken their cue from central banks, which have served up some pleasant
surprises for investors. The US Federal Reserve (Fed) ended its third round of quantitative easing while
maintaining an accommodative approach by holding interest rates near zero throughout the year. Mario Draghi,
president of the European Central Bank (ECB), continues to do his
best to make his plans for massive bond purchases look credible.
The Bank of Japan (BoJ) and the People’s Bank of China (BPoC)
swung into action this autumn, the BoJ by stepping up the pace of
its asset purchases in late October and the PBoC by lowering its
key interest rates and required reserve ratio.
 Since all the leading central banks except for the Fed are printing
We are taking
some profits and
raising some cash
in the portfolios.
money, the US dollar remains under upside pressure. In the eleven
months to end-November the greenback appreciated 9.5%. This is
one of the factors that triggered the recent plunge in crude
petroleum prices, alongside rising shale oil production in the US,
increased exports from Gulf States and fears of falling demand in the emerging regions. Oil prices have shed 33%
in six months. Meanwhile, stockmarkets have recovered nearly all the ground they lost in their early October
pullback. Since the correction they have resumed their uptrend.
 In fixed income, central banks’ actions have driven sovereign bond yields back down to their previous 2014 lows.
Generally speaking, the stage is set for good performances by debt markets in 2015. The rise in US short-term
interest rates should be limited.
 We are taking some profits on the tactical decisions implemented recently in the portfolios.
Although we remain positive on equities for 2015, particularly as regards the US market, the gains chalked up
since our move to buy S&P 500 stocks in mid-October have prompted us to reduce this exposure (again, from a
tactical standpoint) with a view to repositioning ourselves sometime in 2015. The Swiss shares we bought during
the markets’ pullback have also performed very well and we are considering locking in those some profits as well.
 Thus, our equity exposure is temporarily reduced. We will take advantage of opportunities that could
arise between now and the year’s end.
EDMOND DE ROTHSCHILD (SUISSE) SA – INVESTMENT COMMITTEE
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INVESTMENT POLICY – DECEMBER 2014
GLOBAL ECONOMIC OUTLOOK
 The third quarter of 2014 was highlighted by the Fed’s decision to end its third round of quantitative easing
(QE). Altogether, the three programmes resulted in the injection of $3.6 trillion into the US economy in the
five years since the financial crisis. This was done by means of successfully handled asset purchases. With
added help from a Federal Funds rate at rock-bottom, the Fed’s QE has put the American economy back on
track. Private consumption, job creation and individuals’ net worth have all grown noticeably and household
debt has been drawn down. Wages could now start moving up. Indeed, with utilisation of labour resources
and production capacity on the rise, there are already signs that economic activity is overheating. The Fed is
watching wage growth and inflation carefully to choose the right timing for its first uptick in the federal funds
rate.
 In the Euro Zone the ECB is trying to stimulate growth and credit, but investors are sceptical. Until
consumption and growth pick up, firms—which are sitting on piles of cash—won’t be willing to increase
capital investment and thus won’t take out loans. Although the ECB’s stress tests and review of commercial
banks’ asset quality did not turn up any systemic risk, many indicators, including industrial production,
unemployment and inflation, show weakness in the Euroland economy. The International Monetary Fund
and the European Commission have revised their 2014 and 2015 growth forecasts for the Euro Zone
downward to 0.8% and 1.3% respectively.
 Germany has turned into a rather dismal performance this year and only narrowly avoided recession in the
third quarter. Tensions between Russia and the West have dragged down German companies’ capital
investment and exports. In France, over half of the growth observed in domestic demand during the JulySeptember period was fuelled by public spending. For its part Italy was still unable to pull out of a recession
that has now dragged on for six quarters. Spain has fared best this year among the large Euro Zone members.
 In Japan, Abenomics, the three-pronged plan hatched by Prime Minister Shinzo Abe, included a rise in tax
revenues to help draw down Japan’s crushing public debt. This was to be achieved thanks to a historic move
to increase the national sales tax in two phases, from 5% to 8% on 1 April this year and from 8% to 10% in
October 2015. The government believed that the tax hikes would only temporarily dent growth and that the
economy would bounce back quickly. But the first increase bit far deeper than expected and Japan’s GDP has
contracted this year. As a consequence Abe has put off the second sales tax increase, from October 2015 to
April 2017, and has called an early lower-house election for 14 December. He wants a new vote of confidence
from the Japanese people on the structural reforms that his government is undertaking, in a bid to extricate
Japan from the rut of recession and deflation that has left it bogged down for decades.
 China’s GDP growth will not exceed 7.4% year on year in 2014. The authorities are conducting a controlled
slowdown as they transform the country’s economic model. Competitive currency depreciation and realestate investment, the old growth drivers, are gradually being replaced by household consumption. However,
this paradigm change won’t be smooth. In a bid to keep growth at an acceptable level, the authorities will
continue to provide support for exporters and the construction industry as long as necessary. Their rule of
thumb is simple: GDP growth mustn’t fall below the rate of productivity gains. If it did, that would mean
China was destroying jobs, raising the spectre of social unrest.
EDMOND DE ROTHSCHILD (SUISSE) SA – INVESTMENT COMMITTEE
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INVESTMENT POLICY – DECEMBER 2014
BONDS
 Debt markets delivered excellent returns last month, extending the hefty gains chalked up earlier this year
thanks to falling yields all along the euro curve and at the long end of the dollar curve. Moreover, the
corporate segment recovered after slumping in early autumn.
 The probability of quantitative easing in the Euro Zone is looming ever larger. The ECB is starting to discuss
its plans openly and will likely implement the programme by buying corporate bonds. Euroland’s latest
economic data continue to show “lowflation", with growth in the CPI down to just 0.3% year on year. Eurodenominated debt securities are benefitting from this trend and in November extended the already sizeable
gains they had registered earlier in the year.
 The signals sent by Fed officials have been less clear. Some voting members of the FOMC have emphasised
the strong growth generated by the US economy in the second and third quarters and the sharp drop in
unemployment. Others, however, have pointed out the absence of inflationary pressure. Investors are
watching price-related data closely and their 10-year inflation expectation (as reflected by the TIPS yield) has
sunk to a three-year low. This explains the good performance of long-dated Treasury issues.
 2015 will probably see an on-going focus on inflation trends, with further extreme price weakness in Europe
forcing the ECB to introduce quantitative easing. This should continue to buoy euro-denominated debt, at
least during the first quarter, particularly peripheral bonds and BBB/BB corporate paper. In contrast, the
trend at the long end of the US yield curve will continue to hinge on the domestic economic outlook and
potential wage growth, in view of falling unemployment.
 The emerging debt markets lacked direction in November, although credit spreads did widen a bit. Sovereign
issues outperformed the corporate segment. Sentiment was depressed by the unresolved Ukraine crisis, the
plunging price of crude oil and the corruption scandal in Brazil involving the state-owned oil giant Petrobras
and the country’s leading construction companies.
 The outlook for bond markets generally remains upbeat. 2015 should see a contained rise in US short-term
interest rates, with credit spreads thus narrowing only slightly.
 Demand for emerging debt remains steady. Yield-hungry investors could beef up their exposure to this asset
class.
(%)
3.5
3.0
2.5
2.0
1.5
1.0
0.5
Nov-12
Feb-13
May-13
Aug-13
Nov-13
UST 10 Yr
EDMOND DE ROTHSCHILD (SUISSE) SA – INVESTMENT COMMITTEE
Feb-14
May-14
Aug-14
Bund 10 Yr
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INVESTMENT POLICY – DECEMBER 2014
EQUITIES
 The US economy continues to build momentum. Sales growth has been moving back up since mid-2013 and
is playing a major role in the upswing. America’s capacity utilisation rate has climbed to 79,3%. Thus,
companies with pricing power are in a position to raise their sales prices after a wage increase and fatten
their profit margins. Falling energy costs will have a beneficial impact on operating margins.
 In Europe sales growth has plunged to nearly -10% so far this year. The region’s prospects are therefore grim
for the moment, and getting consumption back on track will be key in 2015. Profit margins in the Euro Zone
have levelled out in recent months, providing some scope for a future improvement. Companies could get a
leg up from the weaker euro and low energy costs.
 While the S&P 500 continues to set new record highs, the Stoxx 600 is lagging. Asian equities, led by China,
are mounting a comeback. Industrial commodity prices have fallen further. Sector-wise, consumer
discretionary has risen sharply in the US, buoyed by easing petrol prices. Technology stood out again this
month, mainly thanks to Apple. Telecoms, driven by recent M&A activity, have powered ahead as well.
Finally, energy has plunged again this month, by the same percentage as oil prices. The fall was due to
OPEC’s failure to agree on oil output quotas. The energy sector’s multiple is near its high-water mark because
of downward earnings forecasts.
 Given the recent rise in equity benchmarks, all stockmarket multiples are higher. This is particularly true of
the US P/E, which is revisiting its 10-year high. On the other hand, Asia’s and Japan’s multiples remain
below their historical averages.
 For 2015 we expect an environment of weak growth, low volatility and slim bond yields. We continue to
advise overweighting equities in relation to fixed income in multi-asset portfolios, as far as the global
economy is likely to improve.
 We prefer the US and Japanese stockmarkets rather than the Euro Zone’s. In the Euro Zone, we confirm our
preference for financial stocks which will be benefitting from European Central Bank action.
 China, which we have already emphasised this year in our asset allocation, could turn out to be the wild card
in 2015 among Emerging Countries. Further deleveraging and structural reforms designed to change China’s
growth model will continue to slow down its growth potential. But the PBoC will be there to step in with an
accommodative policy if necessary. Furthermore, commodity prices will create an opportunities and provide
relief to those on the right side of the supply-demand equation, i.e. consumers rather than exporters, which
is the case of China.
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INVESTMENT POLICY – DECEMBER 2014
CURRENCIES
 Since all the leading central banks except for the US Federal Reserve are printing money, the dollar remains
on a roll. However, with sentiment now unanimously bullish on the greenback we are not reassured by this
herd behaviour, which we think calls for a contrarian stance. We cannot rule out a pullback of a few centimes
against the euro in the first three months of 2015. Caution is therefore advised.
 The ECB might disappoint investors and, paradoxically, cause the euro to appreciate. If it fails to increase its
balance sheet to a trillion euros, as it has promised to do, the perception of the euro being debased by money
printing would be less convincing. As a consequence, the single currency would win back some of the ground
it has lost against the dollar while waiting for the ECB to take additional action to substantiate its reflationary
intentions.
 The only way for Japan to avoid a rise in bond yields that would make its colossal public debt unsustainable
is by buying its own sovereign bonds. To do so, the BoJ will create as much money as necessary (a process
called monetisation). These bond purchases will cause Japan’s debt problem to drag on and, at the same
time, bring on massive yen depreciation.
 Sterling is depreciating as UK inflation eases. The fall could even turn sharper as the general election, due by
next May, approaches. While the Tories and Labour are neck-and-neck in the polls, the Europhobic UKIP
party is steadily gaining ground. In this context the Bank of England could put off its first uptick in the base
rate until the second half of 2015. That said, the BoE might still become the first leading central bank to raise
interest rates. If it did, the pound would capture the carry trade and ultimately rise somewhat as a
consequence.
 The SNB can buy other currencies in unlimited quantities to defend the 1.20 EUR/CHF floor rate, since it has
the power to print money. It can multiply its balance sheet by 10, 100 or even 1000 if it wants to. The only
drawback of such a strategy is that it creates inflationary pressure in the long run. For the moment this
pressure is largely out of sight, although the Swiss property market has been overheating for a number of
years. Moreover, the SNB has not played all its cards yet. If it wanted to reduce upside pressure on the franc,
it could charge negative interest on deposits, like the ECB does. So far it has not pulled this unconventional
monetary policy tool from its sleeve. In extreme conditions, it could even control capital flows.
 An alternative to buying dollars is to do so against emerging currencies. It is interesting to note that during two
previous structural uptrends in the greenback’s effective exchange rate, from 1978 to 1994 and again from
1995 to 2011, the movement started against the other major currencies and then, three to four years later,
accelerated as the dollar gained value against the emerging currencies. On the face of it we may now be
entering this second phase.
EDMOND DE ROTHSCHILD (SUISSE) SA – INVESTMENT COMMITTEE
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INVESTMENT POLICY – DECEMBER 2014
ALLOCATION GRID
In summary, we have made the following TACTICAL changes to the balanced portfolio:
 We are tactically taking profits on the S&P 500 and Swiss equities.
 We are tactically taking profits on the US dollar.
 We are raising cash to have more flexibility between now and year’s end or in 2015.
EUR
Portfolio with hedge funds
EQUITIES
HEDGE FUNDS
CHF
%
%
6
CASH
BONDS
USD
6
6
Sovereign
5
5
2
Corporate Investment Grade
16
16
12
High Yield
0
Emerging
10
10
8
Convertibles
0
0
0
Euro Zone
11
6
4
Swiss
7
7
14
US
7
Japan
3
3
3
Emerging
3
3
3
Long / Short
8
31
31
0
31
12
31
8
17
8
32
8
25
Non-directional
22
0
25
17
25
17
REAL ESTATE
2
2
10
GOLD
5
5
5
100
100
100
TOTAL
CURRENCIES
EUR
USD
CHF
EUR
78
0
0
USD
15
100
15
CHF
7
0
85
EDMOND DE ROTHSCHILD (SUISSE) SA – INVESTMENT COMMITTEE
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INVESTMENT POLICY – DECEMBER 2014
IMPORTANT LEGAL INFORMATION
This document was prepared by EDMOND DE ROTHSCHILD (SUISSE) SA, 18 rue de Hesse, 1204 Geneva, Switzerland, a
Swiss bank authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is provided
solely for your information and does not represent or contain a recommendation or offer to buy or sell any investment securities
or financial instruments and does not release you from the need to exercise your own judgment with regard to your specific
investment objectives. EDMOND DE ROTHSCHILD (SUISSE) SA provides no guarantee as to the accuracy or exhaustiveness
of this document. All the comments, analyses, quantified data and investment research contained in this document reflect
EDMOND DE ROTHSCHILD (SUISSE) SA’s view on market conditions based on our expertise, economic analyses and the
information in our possession. When you read this document, its content may no longer be current or relevant, particularly in
view of the date of publication or owing to changing market conditions. Every investment entails risks, particularly the risk of
fluctuating prices and returns. Past performance and volatility are no indication of future returns and volatility and are not
constant over time. You are advised to examine the information contained herein in consultation with your financial adviser in
order to judge whether it is appropriate for your situation, in light of your investment objectives and risk profile as well as your
personal, financial, regulatory and tax situation, and to enable you to develop an informed opinion. This document is not intended
for persons subject to legislation prohibiting their access to such information by virtue of their nationality or domicile. The analysts
mentioned in this document certify that the views expressed herein, regarding companies and securities that they research,
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recommendations and opinions set forth herein. Detailed information on EDMOND DE ROTHSCHILD (SUISSE) SA’s ratings
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EDMOND DE ROTHSCHILD (SUISSE) SA
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