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Fixed Income Return 1 mth Return 2017 Return 1 yr Alternative Investments Return 1 mth Return 2017 Return 1 yr
JPM Money Mkt 0,0 % -0,3 % -0,3 % S&P Commodity TR 1,4 % 1,3 % 6,1 %
JPM EMU Govt 0,3 % 1,3 % 2,0 % Oil (spot) 5,1 % 0,6 % 7,6 %
Barcleys Infl.Linked 0,9 % 2,0 % 4,1 % Gold (spot) 0,2 % 9,5 % 7,2 %
JPM Credit Index 0,0 % 1,4 % 1,8 % HFRX Global HF -0,3 % 2,9 % 3,5 %
JPM High Yield -0,4 % 6,0 % 8,0 %
JPM GBI EM Divers. (LC) -0,7 % -0,1 % 2,4 %JPM EMBI+ (HC) -0,8 % 7,6 % 9,0 %
Equity Markets Return 1 mth Return 2017 Return 1 yr Foreign exchange 30.11.2017 31.10.2017
(Local currency, Net Total Return)
OMXH Cap Helsinki -2,3 % 11,4 % 17,5 % EURUSD 1,19 1,16
Euro Stoxx 50 -2,8 % 11,1 % 19,9 % EURJPY 133,96 132,34
Stoxx 600 -2,0 % 9,8 % 16,1 % USDJPY 112,54 113,64
S&P 500 3,1 % 20,5 % 22,9 % EURGBP 0,88 0,88
Dow Jones 4,2 % 25,7 % 30,0 % EURSEK 9,97 9,76
Nasdaq 2,3 % 29,0 % 30,5 % EURNOK 9,90 9,51
Nikkei (Japan) 3,3 % 20,9 % 26,4 % Interest rates
Hang Seng (China) 3,4 % 37,8 % 33,0 % Fed 1,25 1,25
India -0,1 % 26,1 % 26,0 % ECB 0,00 0,00
Russia (RTS) 1,6 % 2,3 % 15,2 % BoJ -0,10 -0,10
Brazil -3,1 % 19,5 % 16,3 % BoE 0,50 0,25
MSCI Europe -2,1 % 9,4 % 15,8 % Euribor 3m -0,33 -0,33
MSCI World All Country 1,3 % 18,3 % 21,2 % Euribor 12m -0,19 -0,19
MSCI Emerging Markets -0,8 % 27,3 % 27,5 % Germany10y 0,37 0,36
MSCI Latin America -3,6 % 15,1 % 13,7 % iTraxx Europe 5y (IG) 48,41 50,23
MSCI Eastern Europe 0,8 % 4,9 % 12,6 % iTraxx Crossover 5y (HY) 229,92 225,93
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Review of this year’s market performance
A year ago, a relatively strong surge was seen in economic growth and inflation expectations. Behind it lay the recovery of the energy and financial sectors from the earnings downturn, combined with expectations of strong financial policy stimulus in the US, as the new Republican administration took office. China cranked up its debt-driven stimulus policies. In Europe, this was felt as a large-scale increase in external demand.
The valuation levels of equities were already high, particularly in the US, reflecting a low interest rate environment. The expected return on fixed income investments was low for the same reason and measures to tighten monetary policy had already been begun in the US. The expected earnings growth of companies for 2017 was raised on the part of both Western and emerging countries by close to 13 per cent, i.e. clearly higher than the long-term earnings growth figures.
In hindsight, we can say that a year ago, market operators’ consensus forecasts for the 2017 investment environment were more accurate than in many previous years.
The earnings growth of Western companies was expected to settle at around 11 per cent, and it seems that we will end up close to this figure. What is refreshing is that earnings growth is based on a growth in sales and not so much efficiency-boosting measures as in many earlier years. This has been the foundation for a good equity investment year.
For fixed income investments, the year turned out even better than expected. Credit risk premiums have narrowed across a broad front and interest rate risk has not materialised – with market interest rates even decreasing in Europe in the second half – while inflation expectations remained firmly below the central banks’ targets.
Measures in our allocation solutions
In equities we positioned ourselves with a focus on Europe and the Nordics in the early part of the year. In fixed income, the weight was on corporate bonds. We moved in a more moderate direction as the year progressed: we increased the global diversification of equities and decreased the overweight in Europe. In fixed income, we have increased the share of cash and made new investments selectively. This strategy has proven successful. In alternatives, the portfolio construction stage has proceeded well, and in November, we made two new investments: we invested in the Capman Growth Equity capital investment fund, which makes minority investments in growth companies mainly in Finland, and in the unlisted company Royal Design, which offers consumer products mainly online.
The 2018 investment year is set to begin in a similar situation as at the start of the current year, where a low interest rate environment positions all of the expected returns from all the liquid asset classes below the historical averages. The difference is that central bank policy will normalise at an increasingly faster rate in the US next year and monetary stimulus will be reduced in Europe also. This will, most likely, increase market volatility and will make for a more challenging investment environment. In this context, the recipe for building an investment portfolio is utilising the asset classes on a broad scale and carefully considered risk taking within asset classes – with a substantial dose of patience.
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The financial growth of companies is promising, also diversify into alternatives
During the last twelve months, the world economy has experienced a forward momentum and this setup remains in place going into 2018. The risk of recession is very small in Western countries even though there is an unusually long upward cycle behind us. Despite the excellent short-term economic growth rate, long-term economic growth and, as a result, inflation is expected to remain lower than the historical average, due to weaker p r o d u c t i v i t y a n d u n f a v o u r a b l e demographics, among other things. Although the structural level of economic growth is low from a historical perspective, there is no particular reason to continue strong monetary stimulus measures and this is evident in the tightening of central banks’ monetary policy.
For fixed income investors, the situation is especially challenging. The normalisation of central banks’ monetary policy adds to upward pressure and thus weakens the return expectations from fixed income investments in relation to returns from the past 15 years. For the same reasons, the equity return level will also most likely remain low and valuation factors higher than the historical average. The return-risk ratio of equity investments will likely remain clearly more attractive than fixed income investments thanks to a low risk of recession and companies’ good earnings performance.
In long-term portfolio formation, there is thus reason to carry equity exposure. So that the portfolio’s return expectation does not suffer from the above-mentioned factors, there are grounds for making use of the liquidity premium offered by alternative investments, in addition to equity investments, at the expense of fixed income investments.
The stimulus policies of central banks have not raised valuation levels to the same extent in alternative investments as in liquid asset classes. This results mainly from the alternative asset class market, which is not open to a broad investor base. If the portfolio is very interest-oriented, it is worth considering, going into 2018, replacing some fixed income investments with alternatives, which yield better risk-adjusted returns due to a liquidity premium.
The liquidity premium means compensation paid to the investor for the investment not being automatically liquefiable at the investors’ preferred date. The additional income gained from the liquidity premium is attractive in particular in terms of liquid fixed income investments and can be used to gain the same expected return with a smaller investment. Non-liquid asset classes can furthermore be linked to a premium for value creation. This means a premium that the portfolio manager can make in addition to the decision to buy or sell by creating value, e.g. by impacting a company’s business activities (private equity) or making changes to a property that increase its value.
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Figure 1. The formation of the equity markets’ overall return expectation for the next five years in different markets. Source: BlackRock Capital Market Assumptions, August 2017.
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This Market Outlook is based on the views of Mandatum Life Insurance Company Limited (Mandatum Life) and on assessments based on data collected from public sources. Mandatum Life gives no guarantee as to the validity or completeness of the presented information, views or assessments, and Mandatum Life does not assume any responsibility for any direct or indirect damages, expenses or losses which may be caused by the use of the information contained in this Market Outlook. The assessments and views expressed in this Market Outlook are based on the data available at the time of its release into the public domain and Mandatum Life reserves itself the right to change its views or its assessments without any prior separate announcement. This Market Outlook and the information, assessments and views contained in it are all provided solely with the purpose of informing, and this Market Outlook should not be seen as a recommendation to subscribe to, to hold on to or to trade specific targets of investment or to implement any other actions affecting the value development of an insurance policy. The policyholder should examine with care the terms and conditions and brochures related to the insurance policy and investment targets before signing the insurance policy, before changes are implement-ed in the insurance policy, and before selecting or making changes in the selection of investment targets.
Increasing influence of earnings growth on equity markets
As monetary policies normalise, the development of the equity markets will be more dependent on companies’ ability to maintain and increase their earnings. With the tightening of the interest rate environment, it is unlikely that a rise in the equity markets would rely solely on a rise in the valuation level (Figure 1). For this reason, stock prices will be more sensitive than in recent years to changes in companies’ earnings growth. Earnings growth is expected to remain positive, however, and, as a result, maintain good dividends also in 2018. The valuation factors for Western markets are expected to fall and thus impact overall returns negatively due to a rising interest rate level. The impacts will most likely materialise gradually.
The valuation levels on the emerging markets are forecast to remain at their current levels and earnings growth to stay at an average level, historically speaking. Particularly the continuing brisk issue rate in China is expected to dilute the total return for the emerging markets by more than one per cent, however. A balanced stock position, which also takes currency impacts into account, will be likely to lead to the best result next year.
Low expected return on fixed income investments next year
Due to a, in absolute terms, low interest rate (Figure 2) companies’ refinancing costs will most likely remain below the historical level (Figure 3). This may mean low credit loss levels in corporate bonds, also next year. This setup increases the attractiveness of corporate bonds in relation to government bonds, where the rising market interest rate causes a loss in value.
The credit risk on corporate bonds is increased by a high level of debt in companies in absolute terms, especially in the US, where the volume of corporate debt has already risen to almost 50 per cent in relation to GDP. The risk of recession in the economy remains low and if companies’ earnings potential continues to be good, the likelihood of a significant credit risk materialising will remain low. For this reason, investors should include higher return level bonds in the interest rate exposure of their portfolio also next year. When selecting bonds, it is worth being prudent, and as monetary policies normalise, it is a good idea to keep the interest rate risk of the portfolio shorter than the average market interest rate risk.
Mandatum Life Insurance Company Limited • Postal address: P.O. Box 627, FI-00101 Helsinki, Finland • Registered office and address: Bulevardi 56, 00120 Helsinki, Finland • Business ID 0641130-2 • www.mandatumlife.fi
Carolus Reincke Head of Multi-Asset Solutions and Responsible Investing Topias Kukkasniemi Portfolio Manager, Multi-Asset Solutions and Responsible Investing�
Figure 2. Euro zone interest rates’ past performance by maturity. Source: Bloomberg.
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Figure 3. Past performance of credit risk premiums in the euro zone (HY = high risk high yield corporate bonds, IG = low risk investment grade corporate bonds, Govt = govern-ment bonds). Source: Bloomberg.