Q2 2018 Quarterly investment outlook - Dolfin...Contrarian Negative -2.5% Tech Positive 1.5% Japan Positive 13.3% Emerging markets Negative -0.1%* S&P 500 protection using SJNK carry

Q2 2018 Quarterly investment outlook April 2018

Vassilis Papaioannou Chief Investment Officer

FOR PROFESSIONAL INVESTORS ONLY

Q2 2018 quarterly investment outlook, April 2018 dolfin.com | 1

Contents

Letter from the CIO 3

Last quarter’s scorecard 4

Asset classes overview 5

Fixed income 5

Equities 5

Commodities 6

Currencies 6

Emerging markets 6

Investment ideas overview 8

Fixed income 8

Equities 9

Commodities 10

Thematic 10

Macro view: Regional 11

United Kingdom 11

Euro area 16

United States of America 21

Japan 26

China 29

India 33

Russia 36

Brazil 40

Macro view: Asset classes 44

Fixed income 44

Equities 46

Investment ideas 49

Fixed income 49

Equities 68

Commodities 96

Alternatives 103


More information 105

Contact 105

Authors 105

About Dolfin 105

Disclaimer 106


Letter from the CIO The first quarter was a tale of two halves with January delivering some of the best monthly equity returns in years, quickly superseded by a correction with equity markets down 10 per cent. The V-shaped recovery that we correctly predicted faded as Trump’s tariffs left investors uneasy, creating a cloud over the ‘synchronised global growth’ narrative.

What do Trump’s tariffs mean for global growth and the interconnected global trade system? Trouble ahead for the “Goldilocks” narrative or a negotiating tactic? We argue it could well be both.

The first tariffs on steel and aluminium were largely a pressure point, focused on Canada and Mexico during NAFTA negotiations. Days after the tariff announcement, most US allies were exempted until further notice.

The most recent, China-directed tariffs go beyond trade balance. In our view, they signal a tug-of-war between two superpowers for the upper hand in the new digital economy, encompassing artificial intelligence, digital payments, cybersecurity and intellectual property rights.

Of course, in a ‘tit for tat’ trade war, the only outcome is lose-lose. While the economic implications of tariffs on global growth are not significant, sentiment and inflation implications raise concern. The problem will start when Goldilocks finally meets the three bears and market participants readjust their views and positions in equity and bond markets.

Our macro playbook for the second quarter suggests higher inflation in the US, moderation of global economic growth (within a healthy macroeconomic backdrop) and a continuation of the rates normalisation process. We expect markets to remain volatile as the political ramifications from trade war rhetoric face up to the upcoming earnings season, where we expect further signs of corporate health.

The lack of consensus, persistent volatility and the Fed’s commitment to policy normalisation continue to send mixed signals to both equity and fixed income investors. We turn neutral on

global fixed income, with a preference for US credit on an absolute and relative basis. ‘Carry is king’ within the investment grade and high yield space, but we look for short duration issues from high quality companies despite tight spreads globally. A hawkish Fed within equity volatility and a reluctant ECB to tapering will keep rates at current levels, although the steepening bias in our positioning remains firm.

Turning to equities, we adopt a more neutral stance keeping our preference for eurozone and growth-sensitive sectors. Ahead of the earnings season, (and in anticipation of a relief rally), we look for opportunities in the financial, consumer and technology sectors. The recent data breach scandal that sent Facebook stock sharply lower (and Trump’s obsession with Amazon) may cause temporary profit-taking in the technology sector, but the long-term story remains intact. High dividend companies in both the eurozone and UK appear attractive and combined with a positive sterling outlook constitute an interesting opportunity for international investors.

Ultimately, our long-term thesis for higher rates and higher equities remains unchanged, but we acknowledge that equity markets could test recessionary levels from the 26 January high and sentiment could worsen before it gets better. As such, we remain neutral across asset classes with selective buying and await confirmation from the market for the next leg up.

Enjoy the read

Vassilis Papaioannou

“In a ‘tit for tat’ trade war, the only outcome is

lose-lose.”

Vassilis Papaioannou Chief Investment Officer

“The Facebook data breach may cause temporary profit-taking but the long-term story remains

intact.”


Last quarter’s scorecard A review of how the investment ideas from our Q1 2018 investment outlook performed.

Asset class Investment idea Performance Q1 2018 performance

Fixed income US investment grade: Smart beta Positive 2.4%*

Global high yield momentum Positive 0.2%*

Emerging market sovereign bonds Positive 1.6%

Non-rated bonds Positive 1.0%

Credit linked note on European IG Positive 0.3%

European crossover credit Positive 1.2%

Curve trade: US steepener Positive 1.4%

Equities Tax reform Positive 1.06%

Transportation Positive 1.8%*

Energy Negative -0.1%*

Europe preferred Positive 6.77%*

Robotics Negative -0.3%*

Lithium Positive 10.5%*

ESG Negative -2.4%

Contrarian Negative -2.5%

Tech Positive 1.5%

Japan Positive 13.3%

Emerging markets Negative -0.1%*

S&P 500 protection using SJNK carry Positive 0.7%

Commodities Contrarian trade: CFTC positioning Negative -2.7%

Pair trade: Long natural gas, short crude oil Positive 9.4%

Pair trade: Long AUD and CAD, short copper

Positive 1.9%

Thematic Short volatility strategy Positive 0.3%

Brexit: Return to normality Negative -0.6%

Pair trade: Long emerging market debt, short US high yield

Positive 0.4%

Black swan Positive 4.6%

Pair trade: Long EURJPY, short Nikkei Positive 1.5%

Benchmarks

S&P 500

-0.7%

Euro Stoxx 50

-5.7%

FTSE 100

-1.0%

UG IG (AGG US)

-1.5%

US HY (HYG US)

-1.1%

Returns are shown in local currency *Returns show relative performance against benchmark


Asset classes overview Fixed income

Asset class Our view Our rationale

Government bonds

Neutral/Negative

In the US, we expect rates to move around current levels, as increasing inflation expectations stands against worries from equity volatility spill-over effects. In Europe, steepening is the only game in town as short-term rates are firmly anchored, but no move in the long-end is expected until we see signs of inflationary pressures. In the UK, the BoE is preparing rate for the only hike in 2018, but economic fragility and subsiding inflation should keep bears at bay.

Investment grade bonds

Neutral/Positive

Following the recent rise in yields, we expect an element of stabilisation in the investment grade segment during Q2. The lack of potential IG issuance in US on the back of tax reform and cash repatriation will provide a floor to bond prices. In Europe, spreads are tight (especially within industrials and utilities) and we expect negative ramifications as the ECB begins to unwind their bond purchases although opportunities can be found in financials, especially AT1s. UK will remain technically well-bid.

High yield/emerging market bonds

Neutral/Positive

“Carry is king” in high yield (HY), but issuer selection remains key going into the second quarter. US HY should remain supported and we see no cause for widening on a broad index level. EUR HY remains expensive but the search for yield in Europe will continue to support performance. UK HY offers the most attractive spread within the asset class and is further supported by limited issuance. In EM, we prefer high yielding sovereigns that can cushion rising rates in the US, namely Turkey, Russia and Brazil

Equities

Region Our view Our rationale

UK Neutral

We remain neutral in the second quarter, albeit with cautious optimism. The economy shows signs of stabilisation and there has been some progress in Brexit discussions, which should ease negative sentiment.

Euro area Neutral/Positive

Softer-than-expected macroeconomic data, together with fears surrounding a trade war, sent European equities into negative territory in the first quarter. We adopt a neutral stance with selective buying as we hold a positive view for the remainder of the year.

US Neutral

Valuations have improved following the February correction and the tailwind of tax reform provides a cushion for equity investors. However, Trump’s isolationist agenda may well backfire as we move into the second half, with little fuel remaining for an equities rally.

Emerging markets

Neutral/Positive

We remain positive on the emerging market space, given our view that the dollar should trade range-bound and global growth remains robust. We favour high growth countries (such as India, Malaysia and Vietnam) or countries with a pro-business political agenda (like South Africa).


Commodities

Asset class Our view Our rationale

Oil Neutral

The OPEC-Russia supply cuts and increased global demand have so far outweighed US shale production resulting in crude oil trading rangebound in the $60-$65 area. In future, we see limited upside, hence our neutral stance, especially given investors’ growing concern over trade wars and a global growth slowdown.

Agriculture Positive

Tariffs on soya beans aside, we expect agricultural commodities to outperform in anticipation of elevated inflation due to tight labour markets globally and a weak US dollar. Agricultural commodities have lagged energy and metals in recent quarters – a trend we expect to reverse.

Precious metals

Positive We favour precious metals not only as a macro hedge but also in anticipation of higher inflation and reluctance from central banks to raise rates fast enough.

Currencies

Currency Our view Our rationale

US dollar Neutral

New Fed Chair Powell has committed to policy continuation and rates normalisation process. However, reserve diversification actions by central banks globally and Trump’s protectionist policies outweighed the hawkish Fed. Going forward we may see a temporary relief rally, but the US is well ahead in its economic and hiking cycle, which limits upside in our view.

Euro Neutral We expect the euro to trade rangebound at current levels during the second quarter as the stabilising macro story and a reluctant ECB removes further fuel to the currency.

British pound Positive Amid stabilising signs on an economic and political level we expect Sterling to move higher in the second quarter. The anticipated BoE hike contributes to our positive stance.

Japanese yen Neutral/ Positive

Early signs of life in Japanese inflation and sustainable economic growth (together with fears around trade wars) will support the yen, although at the expense of Japanese exporters.

Emerging markets

Country Our view Our rationale

China Neutral/ Positive

We remain cautiously optimistic on Chinese equities, given we don’t take the announced tariffs at face value. Chinese economic transformation towards a consumer-driven economy is underway with services and manufacturing indices at expansionary levels.

India Positive

We are positive on Indian equities as the buoyant Q4 suggests strong carry-over effect for 2018 and we are looking for stronger growth during the first half of 2018. The recent equity underperformance seems to have ended and an upward movement is expected.


Brazil Positive

Brazil’s economic recovery was supported more by fixed investment rather than private consumption. However, we remain positive on Brazilian equities as higher commodity prices and improving economic indicators will support the economic recovery.

Russia Positive

Putin’s widely expected re-election comes at a time of improving consumer sentiment and stabilising GDP growth in positive territory. We are constructive on Russian equities as we expect crude oil to remain at current levels and a dovish central bank to support the economy.


Investment ideas overview A summary of the ideas from this quarter’s outlook.

Fixed income

Idea Description Expected returns (% p.a.)

Risk grade (1-5)

Implementation

US IG: Smart beta bond portfolio

A basket of single US investment grade bonds using our smart beta bonds tool

2-4 2 Single bonds

Credit: Global high yield momentum

Buy single high yield bonds based on our proprietary momentum tool

4-6 3 Single bonds

EM sovereign bonds

Buy select sovereign bonds of emerging market issuers

6-8 3 Single bonds

Credit: Revitalising AT1s

Buy select AT1 bonds 5-7 4 Single bonds

Credit: US miner revival

Buy select bonds of US miners

8-10 5 Single bonds

Credit: ‘Fallen Angels’

Buy select bonds of US ‘Fallen Angels’

6-8 4 Single bonds

Rates trade: US-German

Pair trade based on long US 10-year vs German Bund

4-6 3 Futures

CDS warrant: Financials

CDS trade based on decompression of spread between subordinated and senior financial indices

7-9 3 CDS

Structured product: Funds

Capital-protected structured product on fixed income funds

7 2 Structured product


Equities


Risk grade (1-5)

Implementation

Global income Basket of stocks with a focus on income

6-8 3 Single stocks

Preferred sectors (European)

Basket of European stocks from preferred sectors

6-8 3 Single stocks

Preferred sectors (US)

Basket of US stocks from preferred sectors

6-8 3 Single stocks

Preferred sectors (UK)

Basket of UK stocks on from preferred sectors

6-8 3 Single stocks

US financials Basket of small and mid-cap financials geared to US deregulation

6-8 3 Single stocks

‘Growth and change’

Basket of ETFs in preferred emerging markets

8-10 4 ETFs

Cloud computing

Basket of single stocks with exposure to cloud computing

10+ 4 Single stocks

Augmented reality

Basket of single stocks with exposure to augmented reality

10+ 4 Single stocks

World Cup Basket of single stocks with exposure to the 2018 World Cup

6-8 3 Single stocks

Wage sensitive stocks

Pair trade based on outperformance of the S&P 500 vs wage sensitive stocks

10+ 3 Listed options

Highly leveraged companies

Options trade based on buying puts on highly leveraged companies with high dividends

8-10 3 Listed options

Trade war Options trade based on hedging risk of trade war escalation

10+ 3 Options

Real estate Basket of single stocks within the European real estate sector

6-8 4 Single stocks


Commodities


Risk grade (1-5)

Implementation

Silver vs copper Pair trade based on outperformance of silver vs copper

4-6 3 Futures

Agriculture Theme playing on the growth of the agriculture sector

8-10 3 ETFs

Precious metals Theme playing on the rise in precious metals prices

8-10 3 ETFs and futures

Oil Theme playing on the backwardation in the oil futures market

6-8 3 Futures

Thematic


Risk grade (1-5)

Implementation

Volatility Options strategy selling volatility

8-10 5 Options


Macro view: Regional United Kingdom

The UK economy has held up momentum in Q4, with growth driven by its traditionally important services sector.

UK real GDP growth printed in line with expectations in Q4, expanding 0.4 per cent q/q. Following previous quarter’s revisions (Q1: -0.1pp and Q3: +0.1pp), the annual GDP growth is slightly weaker than previously anticipated (1.7 per cent y/y). The release details reveal that investment (gross fixed capital formation, +0.6pp) was the main growth driver in Q4, helped by private (+0.2pp) and government consumption (+0.1pp), while net trade was a pronounced drag (-0.5pp) on growth.

Figure 1: UK GDP growth (%, QoQ) and contributions (pp)

Source: Bloomberg, Dolfin research

The good news is that the traditionally important services sector has strengthened throughout 2017,

expanding 0.6 per cent in Q4. The bad news, however, is that overall private consumption has remained

sluggish with regards to recent history, with average growth of 0.3 per cent in 2017, compared to 0.7 per

cent in 2016 and 0.8 per cent in 2015. Furthermore, net trade contracted in Q4 despite favourable

international trade momentum, robust growth amongst many of the UK’s trading partners and weak

sterling.

Overall, we remain cautiously optimistic on the UK economy in 2018 as we see that the UK economy

has averted the widely-feared serious downturn following the Brexit vote. We expect the economy to

remain on its lacklustre growth path, expanding at around 0.4 per cent quarterly pace with risks tilted to

the downside.

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Figure 2: UK GDP, Dolfin forecast

(%, sa) Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q2-18

Real GDP growth 0.3 0.3 0.40 0.40

Private consumption 0.1 0.2 0.2 0.2

Investment 0.8 1.2 0.6 0.6

Net trade (pp) -0.3 0.3 -0.2 -0.5


Looking at the industrial sector, industrial production expanded by 0.5 per cent q/q in Q4 after a buoyant third quarter (1.4 per cent q/q). The sector closed the year on a negative note with December industrial output falling 1.2 per cent, after an eight-month run of positive numbers. Looking at the details, however, both manufacturing and construction output increased in December (+0.3 and 1.6 per cent m/m, respectively). The decline in industrial production was solely driven by a slump in mining and quarrying output (-19.1per cent m/m and -4.7 per cent q/q), which was due to the closure of the Forties pipeline in the North Sea. As the pipeline reopens, we expect a jump in the same index in Q1. Overall, despite the decline in headline growth, the industrial sector looks strong with manufacturing having expanded 2.8 per cent y/y in 2017 – the fastest pace in three years.

Figure 3: Crude & petroleum output (%, 3m/3m)


Looking ahead, the CBI Industrial Trends Survey gauge declined to four points in March – the lowest level in five months. However, the more telling three-month moving average remained at a relatively robust 9.3, which is above the 2017 average. Similarly, the manufacturing PMI survey moderated to 55.2 in February, but remained at elevated levels. Positive sentiment among manufacturers combined with the fading drag from the mining index should translate into robust output in H1 2018. We therefore expect industrial production to continue to grow at a healthy pace over the next quarters.

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Figure 4: Total orders vs. industrial production (RHS)


Retail sales ended the year on a negative note, contracting 1.3 per cent m/m in December, but nevertheless expanding 0.5 per cent q/q in Q4. This is slightly higher than initially estimated but still below its Q3 and Q2 performance. Going into the new year, retail volumes have expanded 0.7 per cent in the first two months of the year, pointing to another positive quarter in Q1. However, unusual cold weather and snow in the UK in March has likely kept consumers at home, which will dampen the Q1 sales expansion.

Figure 5: CBI distributive trades survey vs. retail sales (RHS)


The forward-looking services PMI indicator rebounded to 54.5 in February, remaining in expansionary territory and only 0.2 points below its 2017 average. However, the CBI distributive trades survey has weakened somewhat, falling to a four-month low of 8 points (-4 points) in February with its three-month moving average declining to 13.3 points. While the development has taken a negative trend, the overall balance remains positive, pointing to continued expansion. Taken together, both indicators point to a slight weakening in the retail sector expansion going forward, leaving us cautiously optimistic on the UK retail sector.

In Q4, household spending was supported by further growth in employment and a slight increase in wages. The economy created another 134,000 jobs in Q4, bringing the overall employment change to a strong 1.1 million for 2017. Going into 2018, growth in the labour market continues unabated, adding

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168,000 jobs – the strongest increase since the summer. Contrastingly, unemployment also increased in Q4 (+45,000) and in January (+17,000), sounding the bells for a turnaround in the labour market. The simultaneous rise in employment and unemployment is due to a rise in the UK’s active population by 135,000. From the current levels, we do not expect unemployment to fall any further, while gains in employment are also likely to slow, given the record high employment rate (75.4 per cent). The absence of continued improvements in the labour market will be a negative for consumption growth.

Figure 6: Net change in employment and unemployment (thousands)


On the other hand, positive signs for consumption come from wage growth as we finally see a positive trend in core wage growth (excluding bonuses). Core wages increased to 2.8 per cent y/y in the three months to January, from their low of 1.8 per cent in March 2017. The increase in wages is a sign that tightening in the labour market has finally fed through to incomes, however, wages remain below inflation, leaving purchasing power of consumers once again in negative territory (Jan: -0.4 per cent). Yet, some relief to incomes should come in the coming months as we see inflation abating going into Q2, which should partially alleviate the negative effects on consumption and retail sales.

Figure 7: Inflation vs. (real) core wage growth (%)


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Turning to prices, inflation has finally marked a turnaround, falling to 2.7 per cent y/y in February, down from 3 per cent in the two previous months. Core pressures have also abated, declining 0.3pp to 2.4 per cent y/y. At the same time, producer prices decelerated by 0.5pp to 2.8 per cent y/y and the import price index declined strongly (-0.7pp to 3.5 per cent). As it stands, all signs point to a deceleration of inflationary pressures in the coming months. We therefore expect inflation to continue slowing gradually to around 2.4 per cent y/y by the end of Q2 2018, although risks remain to the upside. Our view is supported by our proprietary inflation forecasting model, which exploits past performance and seasonality effects in the main categories of the inflation index, combined with changes in the Brent crude oil price and the USD/GBP exchange rate.

Figure 8: Consumer Price Index (CPI) vs. Producer Price Index (PPI)


Given that, at the beginning of 2018, inflationary pressures were more persistent than the Bank of England had expected, while the overall economy remained robust und wage growth has picked up, the MPC has once again turned more hawkish. Indeed, in Q1 the Bank revised up both GDP growth and inflation forecasts: GDP is now expected to average around 1.7per cent (+0.2pp) over the forecast period and the outlook for inflation was lifted to 2.9 per cent (+0.3pp) for 2018. Bank of England Governor Mark Carney stressed that “monetary policy would need to be tightened somewhat earlier and by a somewhat greater degree” than it was anticipated in Q4. In March, the Committee became increasingly concerned with domestic inflationary pressures, noting that “the official data and other indicators suggested that the margin of spare capacity within the labour market was limited” and while “the impact of the past depreciation of sterling moderated, domestic cost pressures would continue to strengthen”. Indeed, at the March MPC meeting, two members of the Committee voted for an immediate increase in interest rates, albeit outvoted by the majority to leave rates on hold at 0.5 per cent. We see this as a clear sign that the Committee has turned more hawkish than in previous months and we now expect the BoE to tighten rates at its next meeting in May, should macro-economic data not deteriorate significantly in the meantime.

Economics aside, the UK and EU have reached a broad agreement on the transition period end of March, reducing political uncertainty for companies and consumers. The transition period should keep existing trade arrangements in place until end-2020, while the question surrounding the Irish border has been left open. Overall, we view this development as highly favourable and see now the likelihood of a no-deal scenario as significantly reduced. However, key swathes of the future relationship post-Brexit remain yet to be finalised.

Meanwhile, the UK political situation remains tense, despite Theresa May managing to hold her party together around the Brexit issue for now. We are looking to local elections in May for guidance on how the Conservatives are seen amongst the general population but expect the party to suffer heavy losses (partly owing to a backlash following Brexit).

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Euro area

The euro area economy has performed strongly throughout 2017, closing the year on a positive note.

The cyclical recovery in the Euro area has held up at the end of 2017 with Q4 real GDP growth printing at a strong 0.6 per cent q/q, after an upwardly revised 0.7 per cent in Q3. With this, 2017 annual growth amounted to 2.5 per cent y/y, 0.7pp higher than in 2016 and the fastest growth pace in a decade. The Euro area also comfortably outperformed its peers in the UK (1.7 per cent y/y) and USA (2.3 per cent y/y).

On a country level, Germany and France have grown in line with the EA average at 0.6 per cent q/q, ending the year at a buoyant 2.5 per cent and 2.0 per cent, respectively. Meanwhile, Italian growth momentum has slowed somewhat toward year-end, disappointing market expectations (Q4: 0.3 per cent q/q). However, when considering Italy’s past ten-year performance, it is nevertheless a strong result for the Italian economy and an improvement of 0.5pp compared to 2016 GDP growth. Spanish GDP held above the EA average for all of 2017 and printed at 0.7 per cent q/q, in line with the previous quarter. Elsewhere, we note that Greece has made a comeback in 2017 with its economy having expanded in all four quarters, amounting to 1.3 per cent y/y annual growth.

Figure 9: Euro area Q3 real GDP growth % QoQ

Source: Bloomberg, Dolfin research Note: Sample excludes Ireland; Q4 Luxembourg data not yet available

We expect GDP growth to remain healthy in the euro area in H1 2018. However, a weakening in soft indicators indicates that GDP growth has probably peaked in 2017 and we should see moderation from here. A question mark remains around the outlook for global trade, where risks of a global trade war have been increasing significantly in Q1. Should global demand remain supported (i.e. no trade war scenario), another year of strong results for the currency bloc looks likely to us.

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Figure 10: Euro area GDP, Dolfin forecast

(%, sa) Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q2-18

Real GDP growth 0.6 0.7 0.7 0.6

Private consumption

0.5 0.5 0.3 0.2

Investment 0.2 1.7 -0.2 0.9

Net trade (pp) 0.5 -0.2 0.5 0.4


Looking at the industrial sector, industrial production has been buoyant in Q4. Output has expanded by 1.5 per cent, accelerating from the third quarter pace (+0.2pp). The gains were broad-based across all major economies with the strongest expansion being recorded in Spain (+2.1per cent q/q). Overall, 2017 has seen exceptionally strong numbers from the sector with positive numbers in all quarters among the big four economies. Going into 2018, however, January has been sobering, with IP falling 1.0 per cent m/m due to a strong output contraction in Italy, France and Spain. Nevertheless, output was still 3.4 per cent higher than a year ago at this time.

Figure 11: Industrial production growth (%, QoQ) in Q3 vs. Q4


EC industrial sector sentiment declined from its highest value on record (since 1985) in January (9.0) but nevertheless remains buoyant going into 2018. The manufacturing PMI shows a similar picture, only declining slightly from its all-time record high of 60.6 in December to 58.6 in February, signalling strong growth going into the new year. Based on the strong positive signals from survey indicators and the somewhat weaker hard data, we expect IP growth to rebound in the next few months and to remain broadly positive in Q1 and Q2, albeit with an expectation that growth will occur at a slower pace than in previous quarters.

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Figure 12: Industrial production growth (%, YoY) vs. EC industrial confidence


Overall, the industrial sector should remain supported by strong global demand in 2018, provided President Trump does not proceed with further sanctions. At the time of writing, it looks most likely that the EU will be exempt from the recently announced US import tariffs on aluminium and steel. Moreover, the announced anti-dumping tariffs on steel wire will affect only a small share of exports in impacted countries. For instance, Germany and Italy export 5 per cent and 4 per cent of their steel wire exports to the US. These amount to a mere 0.03 per cent and 0.05 per cent of all products exported to the US in the respective countries, likely having a negligible effect on the industry.

Turning to the services sector, retail sales growth has moderated only slightly in Q4, growing at robust 0.4 per cent q/q in Q4 (-0.1pp). With this, we have seen an expansion in the retail sector with no quarter missed in two years. The first print in Q1 2018 was slightly less optimistic with retail sales falling 0.1 per cent on the month. While this is a relatively mild drop, it comes after a December decline of 1.0 per cent and casts a shadow at the beginning of the year. This stands in contrast to the buoyant services sector sentiment. The European Commission’s consumer confidence indicator stood only an inch below its December peak in February and the services PMI index has remained firmly in expansionary territory (56.2), indicating strong business activity. Given the positive sentiment, we expect retail sales to rebound and continue on an expansionary path throughout 2018.

Figure 13: European commission services confidence vs. retail sales (RHS)


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The services sector remains supported by improvement in the labour market. The euro area unemployment decreased by another 122,000 in December and 366,000 in Q4, pushing the unemployment rate lower to 8.6 per cent. Meanwhile, Eurostat reported a further increase in the vacancy rate to 2.0 – the highest value since the beginning of the series in 2004. This means that in every 100 jobs, on average two positions are unfilled. Typically, a high job vacancy rate is followed by strong employment growth as companies are hiring to cover the slack. Indeed, in 2017 employment increased by an impressive 1.6 per cent. We therefore believe that the underlying labour market strength remains intact and consequently expect sizable job creation in H1 2018.

Figure 14: Euro area employment growth vs, vacancy rate (RHS)


On the prices front, there has been little progress towards the ECB’s 2 per cent target recently. In Q4, the HICP inched down to 1.4 per cent y/y (-0.1pp) and core inflation fell to 0.9 per cent y/y (-0.2pp), moving away from the ECB’s 2 per cent target. The downtrend has continued into 2018 with inflation reaching 1.2 per cent y/y in February - its lowest annual pace since November 2016, as negative base effects and appreciation in the currency exerted a drag on the index. The only positive news is that core inflation has rebounded above the its Q4 average (1.0 per cent y/y in February), indicating that deflationary effects stem mainly from volatile components. On a country level, the picture looks mixed: French and German inflation has fallen 0.2pp in February (to 1.2 and 1.3 per cent y/y, respectively), only topped by the slump of 0.5pp in the Italian index (to 0.7 per cent y/y). Meanwhile, Spanish HICP has recovered 0.5pp from the large drop in the previous month. We expect HICP to recover, starting in March, but remain below the ECB’s 2 per cent target throughout 2018. Our view is supported by our in-house euro area inflation model.

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Figure 15: CPI vs. import price index per cent YoY (RHS)


On the monetary policy front, recent communication has provided little news as to the ECB’s thinking on quantitative easing. Despite the recent falls in the inflation index, Mario Draghi stated that inflation was much stronger than the ECB had expected. In line with this, the ECB has dropped its QE easing bias from its communication in March – a first step towards normalisation. While these developments were clearly hawkish, Mario Draghi’s commentary remained overall very dovish. He reiterated that the sequencing of QE and future rate hikes remains “cast in stone”, leaving no doubt that we won’t see rates rise until 2019/2020. However, our attention is drawn to the ECB’s discussion about the degree of slack in the economy. The minutes state that the “degree of slack in euro area labour markets might be greater than assumed in the staff projections, which would imply a slower path for wages than that expected in the projections”. We see this as a dovish comment, which implies that potential growth might be higher than currently estimated and therefore inflation might need longer in order to return to target. Were this to be the case, a longer period of accommodative monetary policy would be justified.

Elsewhere, good news came from Germany, where after almost six months of political uncertainty, Angela Merkel was finally able to form a government under the renewal of the grand coalition. We expect the government to ease the fiscal belt in the next few quarters, cutting taxes and increasing investment. Yet, the political debate in Europe is drawn toward the recently enacted US import tariffs and the EU’s possible retaliatory response. Generally, the EU with its large current account surplus, and in particularly Germany, has a lot to lose from a trade war. We therefore do not expect any aggressive retaliatory measures from the EU. Instead, the EU is likely to try to find an agreement with the US for as long as possible until passing, if anything, only small measures in case no agreement can be found.

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United States of America

The US economy performed strongly in Q4 with the details of the GDP breakdown indicating that the healthy growth momentum is likely be carried over into 2018.

US real GDP growth disappointed slightly in Q4, printing at 2.5 per cent q/q (saar), 0.7pp lower than in the previous quarter. Although the headline printed below expectations, the details of the national accounts show strong performance across productive components.

Figure 16: GDP growth per cent QoQ (saar) and contributions (percentage points)


Fixed investment growth quadrupled in the last quarter of the year, surging 8.1 per cent q/q with equipment outlays, one of the most important components for industrial production, jumping 11.4 per cent. Adding to this, private consumption growth, the backbone of the US economy, has accelerated significantly, growing at the fastest rate since Q2 2016 (3.8 per cent q/q (saar)). In line with this, imports expanded 14 per cent q/q – at the fastest rate since 2010. However, although exports growth was also remarkably strong, exports grew at only half the pace of imports (7.1 per cent q/q), leaving us with a sizable negative contribution in net trade (-1.1pp). Going into 2018, we expect a somewhat weaker reading in Q1, partly due to residual seasonality and mean reversion in US growth rates, followed by an acceleration in Q2 and Q3.

Figure 17: US real GDP growth, Dolfin forecast

(%, sa) Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q2-18

Real GDP growth 1.2 3.1 3.2 2.5

Private consumption 1.9 3.3 2.2 3.8

Investment 8.1 3.2 2.4 8.1

Net trade (pp) 0.2 0.2 0.4 -1.1


Turning to the sectors, industrial output has rebounded in Q4, as we had expected. Production grew 2.0 per cent q/q with manufacturing up 1.6 per cent q/q. Furthermore, strong performance in utilities and mining output has provided a tailwind to the overall sector. Going into the new year, we have seen some

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weakness in January which was more than compensated for by February output, bringing IP 0.8 per cent higher than at year end. Looking ahead, we expect strong growth in production in the first half of 2018 and a healthy overall performance for the whole of year.

Figure 18: ISM manufacturing PMI vs. industrial production (RHS)


Our view is supported by forward-looking indicators with the ISM manufacturing PMI standing at the highest level since January 2004, pointing to strong expansion ahead. Adding to this, the three-month moving average of durable goods orders, a reliable forward-looking indicator for industrial output, increased to a 40-month high (9.0) in January, after orders expanded 4.0 per cent q/q in Q4. The positive sentiment in the manufacturing sector together with full order books should translate into higher output volumes in the coming quarters.

Figure 19: Durable goods orders vs. industrial production growth (RHS)


Turning to the services sector, retails sales were buoyant in Q4 with volumes expanding 2.2 per cent q/q – the fastest quarterly expansion since Q2 2014. The strong performance was driven by a jump in auto sales. Going into 2018, however, retail sales disappointed in January and February, falling 0.1 per cent m/m in each of the months. Moreover, December sales were also revised down somewhat, pointing to weaker consumption growth momentum than previously estimated. However, forward looking indicators remain at elevated levels. The University of Michigan Consumer sentiment index has

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further improved, surpassing its October peak in March and the ISM non-manufacturing index declined from its more-than a decade high in January. We therefore expect a rebound in the sector in Q2, after a weak reading in Q1 2018.

Figure 20: Consumer sentiment vs. retail sales (RHS)


The service sector remains supported by a very strong labour market as non-farm payrolls grew strongly in Q4, adding 220,000 new jobs on average. Moreover, non-farm payrolls jumped in February, expanding by 313,000. With this, the 12-month moving average has moved to 190,000 – well above the growth of 150,000 monthly jobs the Fed expects in the medium term, supporting our view that the underlying trend in the labour market remains strong.

Figure 21: Non-farm payrolls (thousands)


Turning to inflation, price pressures have increased over Q4, averaging 2.1per cent in the quarter, up from 1.9 per cent in Q3. Going into the new year, the picture changed very little from December. Both CPI and core CPI remained unchanged from the previous month at 2.1 and 1.8 per cent y/y while producer prices inched up 0.1pp to 2.7 per cent y/y. With the latter standing above CPI inflation, upward pressure on consumer prices should increase. In line with this, the Fed’s preferred inflation gauge, the PCE index, has trended upwards since the summer. It increased from an average of 1.5 per cent in Q3

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to 1.7 per cent in Q4. Excluding the volatile components, underlying price pressures also accelerated with the core PCE rising to 1.5 per cent in Q4 (+0.1pp).

Figure 22: PCE, CPI and PPI inflation indices (%, YoY)


Higher inflation is good news for the central bank as the acceleration in inflation pressures supports the current tightening policy stance. A further increase in prices is supported by the recently signed fiscal package, the buoyant US economy and depreciation of the US dollar. Indeed, the currency dropped from a peak of 1.04 in January 2017 to a low of 1.24 against the EUR in mid-March 2018 – an 19 per cent decline. This exchange rate development makes imported products more expensive for domestic US consumers, pushing consumer prices higher and in turn supporting a more restrictive monetary policy stance in the future.

Adding to this, average hourly earnings jumped in January by 0.2pp to 2.9 per cent - well above market expectations. Higher wages increase the purchasing power of consumers and have played to the recent market fears of a faster than expected pick-up in inflation and interest rates.

Figure 23: Average hourly earnings (ell employees)


The recent price data has provided enough argument for the Fed to hike rates by 25bp to 1.5-1.75 per cent in March, as widely anticipated. Fed Chair Janet Yellen stepped down in February, making way for

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the new Chair Jerome Powell, who held his first FOMC meeting in March. He appeared somewhat more hawkish than Yellen, similarly to his first public appearance as Fed Chair at the semi-annual testimony before Congress. In line with this, Fed officials have revised up their GDP forecast for 2018 and 2019 (+0.2 and +0.3pp, respectively) and revised down their short-term outlook for unemployment. However long-term projections remained untouched, underlying that the Fed expects transitional effects from the fiscal package to dissipate in the longer term. Most importantly, the dot-plot profile has become somewhat more hawkish: albeit the medium 2018 estimate remained at three hikes, it was only one vote short of moving to four. With the large fiscal package at a time when unemployment is very low, wages are increasing and global demand is strong, we expect inflation to accelerate somewhat stronger over the current year.

On the political front, President Trump has announced tariffs of 25 per cent on steel and 10 per cent on aluminium imports to take effect in March, after having already introduced tariffs on solar panels and washing machines in January. However, after two weeks of negotiations with several trading partners, the administration has approved exceptions for Canada, Mexico, Australia, Korea, Brazil and the EU. The latter was a sigh of relief for many observers as countries have pledged to introduce retaliatory measures on their part and we have moved closer to the edge of a trade war. It seems, however, that Trump’s main target will remain China, where he recently announced tariffs on 50bn value of Chinese imports, additionally to the aluminium and steel products. The development around trade is of particular worry to us as a significant increase in protectionist measures poses a downside risk not only to the sectors affected but to the overall global economy.


Japan

Japan’s economy has ended the year on a strong footing with annual 2017 real GDP expanding at the fastest pace in four years.

Real GDP expanded by 0.4 per cent q/q (1.6 per cent y/y) in the fourth quarter of the year as private consumption rebounded (+0.5 per cent q/q) and business investment expanded by a healthy 1.0 per cent q/q. The latter is consistent with the strong business sentiment and at the same time tight labour market, making capacity expansion necessary through investment into machinery and equipment. Meanwhile, net trade was a small drag to GDP as imports grew stronger than exports. The strong growth in imports is consistent with the rise in domestic demand, reflected by private consumption. Nevertheless, exports expanded by a buoyant 2.4 per cent q/q as the world trade environment remained supportive. Going forward, we expect the Japanese growth momentum to hold up well into 2018 as business sentiment remains favourable.

Figure 24: Japan real GDP growth (%, QoQ)


Forward looking indicators such as the Tankan survey paint a positive picture in the business sector. Business investment has expanded faster than expected as continued strong exports activity and labour shortages require more investment into machines and equipment. Adding to this, Japan is preparing for the 2020 Olympic Games in Tokyo, which is a strong growth driver for construction investment. We therefore expect investment activity to remain firm in the coming quarters and consistent with strong growth seen last year (3.0 per cent y/y).

In the industrial sector, production has decelerated somewhat at the beginning of the year, rising 2.7 per cent y/y in January, down from 4.4 per cent in December. The slowdown was led by a fall in the more volatile vehicle production index (-3.8 per cent y/y), dragging the overall index lower.

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Figure 25: Industrial production vs. vehicle production growth (%, YoY)


However, soft indicators remain buoyant, signalling that this weakness is likely of a temporary nature. The manufacturing PMI has declined somewhat in February (-0.7pp) but this decline comes from highly elevated levels and the indicator remains well in expansionary territory (54.1), pointing to further growth in industrial output. In addition, we do not expect to see any pronounced consequences from the US tariffs on aluminium and steel as these have constituted only a small fraction in Japan’s export activity.

Figure 26: Purchasing Manager Index


The picture in the consumer sector has improved with an acceleration in domestic demand in Q4, as we had expected. Going into 2018, consumer sentiment remains at elevated levels and the services PMI continues in expansionary territory, pointing to an increase in activity ahead. Moreover, employment has continued to grow strongly, printing 1.5 per cent y/y in January and supporting household budgets. The main risk to the consumer spending outlook remains sluggish wage growth and a simultaneous rise in inflation, eroding real income growth. Wages growth averaged 0.4 per cent y/y in 2017 and despite the acceleration towards year end, it has only printed at 0.7 per cent in January 2018. It appears, that the tight labour market conditions do not seem to have translated into higher incomes.

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Turning to inflation, headline prices have jumped in January (+0.4pp to 1.4 per cent y/y), mainly on a surge in fresh food prices. However, excluding the volatile components of food and energy, underlying price pressures have remained subdued. The Bank of Japan’s core-core inflation index (ex. food and energy) has only inched up to 0.4 per cent y/y (+0.1pp) in January, well below the Bank’s 2 per cent target. Yet, this is higher than both the average of Q3 and Q4 readings at 0 per cent and 0.1 per cent, respectively. Our expectation is for this moderate inflationary trend to continue into Q2 as wage growth remains sluggish. However, despite the recent upward movement in prices, we do not see enough inflation acceleration over the course of the year to hit the central bank’s target.

Figure 27: Wage growth vs. core CPI (ex. food) (%, YoY)


With underlying inflationary pressures remaining close to zero and volatile components likely to fade later in the year, we expect the BoJ to stick to its ~0 per cent yield control target on ten-year government bonds in 2018. In its January outlook for economic activity and prices, the Bank has left its GDP and price projections more or less unchanged. It reiterated that “medium- to long-term inflation expectations are projected to rise as firms' stances gradually shifts toward raising wages and prices with an improvement in the output gap continuing”. Interestingly, Governor Kuroda has commented that the BoJ will discuss an exit policy around FY 2019, giving rise to speculation around a change in forward guidance. However, his comments are based upon the assumption of inflation reaching the central bank’s 2 per cent target in 2019, which we meet sceptically, especially should wage growth continue to disappoint.

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China

In the beginning of 2018, China’s economy continues to be fuelled by strong global trade momentum.

Chinese real GDP grew by 6.8 per cent y/y in Q4, in line with the previous quarter’s performance. This bring overall 2017 GDP growth to 6.9 per cent y/y (+0.2pp) – the first acceleration since 2010 and above the government’s GDP target of 6.5 per cent. The pick-up in growth was driven by stronger trade data while investment growth slowed, and consumption remained robust. China continues to reap over-proportionate benefits from upbeat global trade momentum with an impressive jump in nominal exports in February (+44.5 per cent y/y) after a weaker January reading, bringing the two-month average to a strong 24.2 per cent y/y. Imports have also expanded strongly, rising sharply in January but slowing in the following month. While monthly volatility in the data is significant, overall import volumes have increased at a stronger pace than in the previous quarter.

Figure 28: Exports and imports growth (3-mma, % YoY)


Elsewhere, investment has slowed over Q4 in both the private and public sector. However, February data suggests that private fixed assets investment (FAI) rebounded in February, indicating that a stronger Q1 outturn is likely to support GDP growth. The rise is largely due to stronger-than-expected real estate activity in China. Overall, we expect China’s GDP growth to expand at a similar, if not stronger, pace in Q1 before slowing gradually towards year-end, consistent with the government’s GDP growth target of 6.5 per cent y/y.

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Figure 29: Public, private and total fixed assets investment (%, YoY)


Despite strong exports growth, weakening signs come from the industrial sector, where industrial production has fallen to 6.2 per cent in Q4 (-0.4pp), amid cuts in heavy industry production to contain pollution. Moreover, the recently enacted US import tariffs on steel and aluminium add a dampening effect on the sector. However, the tariffs should not exert a major drag on industrial production as only about 1 per cent of China’s steel exports go to the USA, which is indeed negligible given its large export volumes. Going into Q4, manufacturing PMIs have remained broadly unchanged since year-end 2017. The index stood at 51.6 in February – above the 50 threshold of expansion. However, strong exports growth in February suggest that industrial production should experience some tailwinds from external demand. On the other hand, the government’s efforts to slim down capacity in heavy industry and the tightening of environmental standards is likely to weigh on overall production, leading output lower over the course of 2018.

Moreover, major risks to the industry stem from increased trade frictions with the US. China has been on Trump’s radar since his election campaign and Congress looks likely to take aim at the large current account deficit the US runs with China. Whilst we do not expect the Trump administration to move into a full-fledged trade war with China, the country is one of the top import sources for US companies across a range of product groups and any additional tariffs could upset Chinese exports growth significantly. As for now, the newly announced tariffs on $50bn worth of imports from China have not taken effect and the list of products targeted is yet to be defined. However, this broader package, if indeed introduced, will affect just under 10 per cent of Chinese exports to the US. Moreover, China has pledged to retaliate, stating its willingness to step into trade a war, which has shaken markets considerably. Over the next weeks, the governments will meet to negotiate and we still see some likelihood that the rhetoric (and possibly measures) will be softened. We believe, it is yet too early to draw conclusions but we will be watching developments closely.

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Figure 30: Caixin Composite, Services and Manufacturing PMI


On the consumer side, we have seen a slowdown in retail sales over Q4, expanding only 8.4 per cent y/y in December, having constantly declined from 9.7 per cent in July 2017. This comes despite the robust labour market and strong wage growth, leading to a further improvement in consumers’ overall disposable income. However, the services PMI has remained well in expansionary territory, only inching down from its January peak to 54.2 in February, pointing to strong momentum in the sector. The services sector becomes increasingly important as China rebalances from an export and manufacturing oriented economy to a more domestically demand-driven market, due to an improvement in living standards of households. Indeed, in 2017, services accounted for more than half of China’s economic output (52 per cent). We believe that the sector will therefore continue supporting growth.

Looking at prices, consumer price inflation jumped in February to 2.9 per cent y/y from 1.5 per cent in January on higher food prices. The 1.4pp move reflects a distortion in the index due to calendar effects in connection with the Chinese New Year celebrations and we therefore expect a moderation in March. Meanwhile, producer price inflation has eased further to 3.7 per cent in February, falling for four months in a row, as real estate momentum softened. Overall, we expect CPI inflation to remain below the People’s Bank of China’s 3 per cent-target in 2018 as GDP growth slows.

Figure 31: China CPI YoY vs. PPI YoY (RHS)


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Despite below target inflation, the PBoC maintained a tightening bias in its monetary policy stance. With the new PBoC governor generally regarded as market friendly, we expect continuation in the current monetary policy stance. Meanwhile, the Chinese government continues to worry about financial stability as non-financial corporate debt remains high. The planned regulatory tightening as well as higher US interest rates should excerpt upward pressure on Chinese Interbank Rates. However, with inflation to likely remain below 3 per cent we do not expect the central bank to move benchmark rates higher.

Turning to politics, in March, Prime Minister Li Keqiang presented the Government Work Report, identifying priorities for 2018. The government reaffirmed its commitment to balance growth with reform and deleveraging while battling against poverty, pollution and potential risk. Overall, the emphasis is on quality, leaving the GDP growth target with somewhat less importance. The government continues to make efforts to contain leverage through regulatory tightening but highlighted that growth of credit should be maintained at a reasonable level. We therefore do not expect an abrupt and growth threatening tightening in credit growth, but a gradual slowdown.


India

India’s economy has surprised to the upside at the end of 2017, rebounding faster than was generally expected.

India’s real GDP growth climbed a strong 7.2 per cent y/y in Q4. Together with a third quarter revision of +0.2pp to 6.5 per cent this brings overall 2017 GDP to 6.4 per cent. GDP growth was mainly driven by investment (12 per cent y/y), which was helped by a strong increase in government spending. Meanwhile, private consumption has declined somewhat further, printing at its weakest growth rate since Q2 2015 (5.6 per cent y/y), possibly still mirroring Goods and Service Tax (GST) adjustment effects. On a sectoral level, growth was balanced with all industry, services and agriculture accelerating from the previous quarter. On the negative side, net trade somewhat subtracted from growth as exports growth decelerated to its slowest reading in five quarters (2.5 per cent y/y). Looking ahead, the buoyant Q4 outcome suggests strong carry-over effects for 2018 and we are looking for a strengthening in GDP growth in the first half of 2018.

Figure 32: Private consumption growth (%, YoY)


Industrial production had an impressive run over the past three months with the overall Q4 reading coming in at a strong 7.1 per cent q/q. In January IP expanded another 7.5 per cent y/y, bringing the three-month moving average to 7.8 per cent and indicating strong momentum in the sector. The manufacturing PMI declined somewhat in February from its December peak but remained at elevated levels (52.1), pointing to further expansion ahead. We therefore expect to see a similarly strong IP print in Q1, boosting GDP growth.

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Figure 33: Real GDP growth YoY vs. Industrial production YoY (RHS)


Turning to domestic demand, private consumption growth has disappointed in the past two quarters, failing to reaccelerate after it was hit by the demonetisation policy of the government earlier in 2017. This is also reflected in the services PMI survey which has once again dipped into contractionary territory at 47.8 in February. However, domestic auto sales have held up in positive territory with a pronounced jump in two-wheelers, indicating strong rural demand. We therefore do not expect a further drop in private consumption going into 2018 and we are looking for a gradual recovery in the index. However, it remains unclear whether private consumption will pick up in Q1. We therefore expect consumption to remain at current levels, pending further macroeconomic data.

Figure 34: Manufacturing, services and composite purchasing manager indices


Turning to prices, we have seen a pronounced acceleration in inflation starting mid-2017. The CPI index had bottomed in June at a remarkably low 1.5 per cent y/y and has since overshot the Reserve Bank of India’s target range of 2.0-4.0 per cent, ending the year at 5.2 per cent y/y. This mainly reflected a pronounced pick-up in food price inflation, but fuel and core inflation also picked up. Going into 2018, we have seen a slowdown in price pressures with CPI standing at 4.4 per cent y/y in February. However, as price pressure appear now to have broadened and the economy is reaccelerating, we do not expect CPI to fall below the upper limit of the inflation range target for much of 2018.

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Figure 35: Consumer price inflation YoY vs. RBI repurchasing rate (RHS)


Despite above target inflation, the RBI has stayed on the side-lines in February, leaving the repurchase rate unchanged at 6 per cent and maintaining a broadly neutral stance. However, as GDP growth accelerates, together with an increase in government spending and no sign of declining oil prices, we expect the RBI to turn more hawkish in Q2 2018. Should next month’s inflation readings print consistently above target, the RBI is likely to hike rates by the end of next quarter.

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Russia

The economic recovery continues at a slow-but-steady pace as Putin is re-elected for another six-year term.

First estimates show 2017 GDP at 1.5 per cent y/y, somewhat less than markets had anticipated. While the GDP breakdown is not yet available, monthly indicators point to growth being driven by private spending. Preliminary results show continues growth momentum in the retail sector with the three-months moving average in retail sales growing at 3 per cent in Q4, marking a third consecutive quarter of positive momentum after 10 quarters of contraction. The retail sector remains supported by record low inflation and strong real wage growth as real monthly wages increased by an impressive 6.2 per cent y/y in January, boosting consumer’s purchasing power. This is in line with an improvement in consumer sentiment over the past six months.

Figure 36: GDP growth (%, YoY) vs. retail sales growth (%, YoY)


Meanwhile, industrial production has remained weak at the end of the year with average output growth at a mere 0.1 per cent y/y in Q4. However, January industrial production printed at 2.3 per cent y/y with manufacturing up 4.7 per cent y/y – a noteworthy jump in the index, which we see as a positive signal for 2018 growth. However, looking ahead, the manufacturing PMI has been moving sideward for more than three quarters, leaving us with little reason for cheer. Nevertheless, it remained in slightly positive territory and with easing of non-price lending conditions and nominal interest rates prices, we believe the industrial sector should rebound in the next few quarters, moving GDP growth rates higher.

Possible risks to the industrial sector outlook stem from the global trade environment, but the recently enacted tariffs on aluminium and steel should only have a marginal negative effect on the Russian industry. Russia has only a small exposure to US trade with bilateral steel exports amounting to a mere 6 per cent of Russian output, and aluminium, although more widely exported, representing only 2 per cent of Russia’s overall exports.

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Figure 37: Manufacturing PMI (3-mma) vs. Industrial Production YoY (3-mma)


Overall, PMI numbers point to improved growth momentum at the beginning of 2018. The composite PMI index has increased to a strong 58.2 – well into expansionary territory. This is largely due to improved sentiment in the services sector (56.5), in line with recent positive performance in retail sales.

Figure 38: Composite, services and manufacturing PMIs


The Russian economy remains highly reliant on the oil sector with roughly 60 per cent of Russia’s exports and 30 per cent of its GDP linked to energy commodities. However, with Brent crude trading at around $65 per barrel, the Ministry of Finance continues to have a comfortable degree of flexibility given the budget is currently managed at a level of $40 p/b. In 2017, Russia’ s budget deficit has declined to its lowest level in five years, closing the year below at 1.5 per cent of GDP, lower than the Finance ministry’s earlier expectation of 2 per cent. Going into 2018, we expect the budget deficit to widen slightly, as we do not think that the strong revenue growth of 2017 (+8.7 per cent) will be repeated.

On the prices front, consumer price inflation has continued declining below the Central Bank of Russia’s target rate of 4 per cent to 2.2 per cent y/y in February - a new historical low since the breakdown of the Soviet Union. The core index has dropped to a mere 1.9 per cent y/y, indicating a further broadening of disinflationary pressures. Nevertheless, we expect inflationary pressures to pick up in the coming quarters as labour market conditions remain relatively tight and wages are growing at a fast pace,

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increasing the purchasing power of consumers. However, the increase in prices is likely to be gradual and we expect headline inflation to remain below target throughout 2018.

Figure 39: CPI inflation (%, YoY) vs CBR key rate (%)


With price developments in mind, the CBR has cut rates by 25 bp to 7.50 per cent, after a cut of 50bp in December. The central bank noted that “this year annual inflation is much less likely to exceed 4 per cent” and therefore the CBR will continue reducing the key rate with the monetary policy stance turning from moderately tight to neutral this year. The statement is more dovish that that we have seen in past meetings. With well below target inflation and a sluggish economic recovery we believe the CBR has plenty of room to cut rates more aggressively this year.

The CPI is typically influenced by the level of the oil price in local currency, however, this link seems to have weakened in 2017. In the past 12 months, we have seen a price increase of nearly 20 per cent in the Russian Rouble-denominated oil price, while inflation has continued falling at the same time due to a drag from other components such as food prices. Against this, on a trade weighted basis, the currency has depreciated by only 7 per cent over the same period. As the CBR continues cutting interest rates and economic growth remains below expectations, the rouble is likely to see more down- than upside pressure, which in turn should push CPI higher.

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Figure 40: CPI (%, YoY) vs Brent crude (RUB, RHS)


On the political front, President Putin was re-elected for another 6-year term, as expected, ensuring continuation in his policy agenda. Elsewhere, political tensions with the EU and in particularly the UK continue to escalate as several countries have send Russian diplomats home, following the poisoning of an UK ex-spy and his daughter in the UK in March. While the developments are worrying, countries have not pledged to introduce new economic sanctions on Russia, leaving consequences in the political sphere uncertain for now.

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Brazil

Brazil’s GDP growth has taken a breather in Q4 but the cyclical economic recovery remains well underway.

Brazil’s real GDP growth report was mixed at year end: Q4 GDP disappointed market expectations significantly, growing at a mere 0.1per cent q/q. At the same time, the previous quarter result was revised up to 0.2 per cent (+0.1pp), bringing the overall 2017 GDP expansion to 1 per cent y/y. We take note that each of the first three quarters of 2017 had been revised up from the initial estimates, and we do not exclude an upward revision of Q4 accounts later this year, as monthly data would have suggested a stronger growth print in the last quarter.

Looking at the details, we note that growth was driven primarily by fixed investment, which has accelerated for a third quarter, rising 2 per cent q/q and adding 0.3pp to overall growth. It is indeed good news as Q4 was the first quarter where we observed a positive year-over-year growth rate (3.8per cent y/y), after almost four years of contraction. This bodes well for future industrial activity and growth, as capital investment has a positive effect on productivity and production output increases. Adding to this, private consumption also expanded (0.1per cent q/q), albeit at a much slower pace than previously. On the negative side, the main drag came from strong imports and at the same time contracting exports, shaving off 0.3pp from overall growth. For 2018, we expect Brazil to continue recovering and picking up pace from the past year’s expansion.

Figure 41: Q4 GDP growth contributions (in percentage points)


The rise in investment is in line with industrial production activity, which has grown at an average pace of 4.5 per cent y/y in Q4, up from 2.6 per cent in the previous quarter. Forward looking indicators such as manufacturing PMI (53.2 in March) and the industry survey underpin the positive momentum, displaying increasingly positive sentiment in the industry.

A key risk to the industrial sector stems from an upset in international trade. The tariffs on aluminium (10 per cent) and steel (25 per cent) imports1, recently enacted by the US government, are targeting important sectors of Brazil’s industry. As for aluminium, Brazil’s production has heavily focused on the

1 Brazil is currently in negotiations to receive an exemption from the tariffs.

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local market with aluminium exports recently falling to a 20-year low in 2017 and taking thus a negligible share in its overall exports. For steel, however, Brazil is the second largest exporter to the US after Canada, which will be exempt of the tariffs. It is hence the single country, which should be affected the most by the tariffs. In 2016, Brazil exported around 40 per cent of domestic production of which 35 per cent were shipped to the US. An increase in the price of Brazil’s steel for US importers thanks to the new tariffs, is likely to reduce this share noticeably. Fortunately, however, steel production makes up only 10 per cent of Brazil’s manufacturing or 1.2 per cent of overall GDP, which is very little on a large scale. Therefore, while steel producers will feel the heat of the recent US policies, we do not expect a major negative impact on the overall industrial sector or on Brazil’s GDP growth. With the increase in capital investment, low interest rates and positive survey indicators, we therefore expect recovery in the industrial sector to continue and extend well into 2018.

Figure 42: Industrial production and industry survey (RHS)


Meanwhile, the weakness in private consumption growth is likely due to a reversing situation in the labour market. Until Q4, we had seen strong improvements in employment and a fall in unemployment, correlated with strong growth in consumption. In Q4, however, unemployment rose slightly, ending the quarter at 12.2 per cent and the employment ratio also somewhat fell. Given the overarching recovery situation of the economy we do, however, believe that this weakness is temporary and we expect the labour market to improve in the next quarters.

Figure 43: Employment ratio vs. unemployment rate (%, RHS)


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Adding to this, retail sales have rebounded in January, expanding 0.9 per cent m/m, after having declined slightly in Q4. Moreover, the services PMI has pointed to improved sentiment in 2018, printing at 52.7 in March, in expansionary territory. Overall soft indicators, point to a strengthening of momentum in the economy, leaving us unworried about the soft patch in Q4.

Figure 44: Services, manufacturing and composite PMIs


Turning to prices, inflation has fallen back to November levels of 2.8 per cent y/y in February, after having risen to 3 per cent at the end of last year. The fall was mostly due to low price pressures in the food and beverages component, where prices fell 0.33 per cent on the month. Looking ahead, we expect inflation to rise moderately over the next few quarters, but to remain below target over the course of the current year.

With the exceptionally weak price pressures in mind, the Monetary Policy Committee (Copom) had lowered the interest rate by 25bp to 6.75 per cent at its last meeting in February. The lower rates environment should make the deleveraging process in all sectors less painful and provide support for investment growth and household consumption. The Copom has noted that the baseline inflation scenario has broadly played out as expected and that the balance of risks was balanced. With the information available at the time of the meeting it therefore viewed an “interruption of the monetary easing process as more appropriate”. However, with inflation comfortably below the central bank’s inflation target of 4.5 per cent and disappointing economic growth in Q4, we believe there is more space for the central bank to cut rates this year. A further 25bp rate cut in H1 2018 now looks increasingly likely, in our view.

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Figure 45: Selic target rate vs. CPI


Overall, Brazil seems to continue on a solid, albeit, gradual recovery path. Taking together the positive signals from survey indicators, the nascent recovery in investment and the improvement in the industrial sector, we believe the economic expansion is likely to continue and accelerate going into 2018.

On the politics side, the main event in 2018 will be the election in October. So far, Brazil’s political crisis has delayed important reforms which are urgently needed to decrease Brazil’s debt to GDP ratio. With the approval of the 20-year budget freeze, the government needs to urgently reform the pension system. The election will be a vital step to resolving the political crisis and to step up reform efforts.

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Macro view: Asset classes Fixed income

With rates going higher, we look to carry collection as a means of compensating for any potential losses.

The first quarter vindicated both our negative stance on government bonds and more neutral stance on investment grade bonds. The US 10-year Treasury (with a yield of 2.8 per cent) now sits 35bps wider than at the start of the year whilst the UK 10-year Gilt is 17bp wider and the German Bund 18bp wider. Having peaked in mid-February, government bonds have moved lower over the course of March but we retain the belief that we will once again test higher yields from here. Relative monetary policy should continue to drive global rates higher, with further normalisation from the Fed, gradual tightening from the Bank of England and a path towards ‘tapering’ of quantitative easing by 2019 by the European Central Bank. Looking ahead, we keep our medium-term view of higher rates, supported by continuation of the reduction in stimulus from central banks, based on an improving inflation outlook.

Within the fixed income world, investors of any asset class would have noticed that the LIBOR-OIS spread has widened in Q1 2018 and now stands at levels (58bps) not seen since the European sovereign crisis. LIBOR-OIS is typically seen as a potential warning signal about the global banking system. However, this time around the widening is more technical is nature (like the unwind of VIX higher) and driven by the financing shifts following the US tax reforms. Whilst this spread may continue at this elevated level (or even go higher) this will be a drag for credits and can be viewed by the market as a temporary form of tightening of liquidity conditions. As such this tempers our ability to go positive on IG credit (especially in the US) despite the recent back up in yields.

Turning first to the US, for fixed income investors there are numerous headwinds ahead, but unexpected US inflation remains of greatest concern. As in other developed economies, such as the UK and Japan, the US is close to full employment, which shall likely intensify price and wage pressures. Whilst undoubtedly a welcome development, as economies return to normal rates of inflation

consistent with ‘price stability’, the fear is that inflation may overshoot, particularly given the added stimulus of US tax breaks, a weaker dollar and higher oil prices. In such an environment, markets will likely oscillate between viewing inflation as a benign outcome and viewing it as an overshooting risk. In the latter case, the Fed shall have to move more quickly, and less predictably, to prevent genuine overheating. As such, the flattening of the US curve (both 2-10s and 2-30s) may have room to go, with inflation not feeding into long term expectations but the front-end being especially sensitive to the rate hikes and / or stronger-than-expected prints.

In Europe, the ECB expressed a more hawkish outlook in its March meeting, dropping its QE easing bias as a first step towards policy normalisation. While undoubtedly a slow process, the ECB is expected to withdraw monetary stimulus and end QE by December 2018.

With the ECB unlikely to ‘rock the boat’ for European government debt, maintaining a gentle pace of tapering, drivers of the segment shall remain global rates (especially the US) and inflation. With rates only 10bps higher than at the start of Q1, the risk / reward is still skewed in favour of higher rates and we maintain a negative view on the price movement of the Bund. In Europe, steepening is the ‘only game in town’ and irrespective of QE, the short-end is firmly anchored. We do not expect the ECB to act any time soon in raising the refinancing rate and any announcement around ‘tapering’, would take place either in June or July, leaving most of the next quarter without a strong ECB catalyst.

After delivering its first rate hike in a decade in November 2017, the Bank of England’s March meeting confirmed that the trajectory of rates in the UK is upwards, with two hawkish dissenters voting for hikes - the next hike is expected in May. Whilst Brexit remains a headwind for the central bank, with a transition now agreed


upon, near-term uncertainty has faded. We expect gilt yields to grind higher from here (and over the course of Q2). From a cross-market perspective, UK Gilts look rich against US Treasuries and we note that the 30-year UK Gilt is at a spread of 1.3 per cent compared to the 30-year Treasury, one of the widest levels seen historically.

Given growing market uncertainty, we take a more measured approach to selecting emerging market fixed income in Q2, focusing on a select few countries. The prospect of a US trade war could damage emerging markets more broadly, but we view protectionist rhetoric more political at this stage (ahead of US mid-term elections) with the main target likely to be China. We expect higher yields to be a crucial factor for EM bond performance going forward, given their cushion in absorbing rate pressures. Noting these rate pressures, we hold a preference for short-dated bonds in local currencies, where the country fundamentals are solid and there is potential scope for positive FX moves – we highlight Brazil, Russia, Turkey and South Africa as top picks.

The importance of an absolute level of yield offered by credit was highlighted to investors back in our Q1 2018 publication. Both US sovereigns (-1.2 per cent total return) and US investment grade bonds (-2.5 per cent total return) underperformed the US high yield market (-0.9 per cent total return), where the extra carry on high yield was able to offer partial compensation for the market volatility and turmoil experienced. Economic and credit fundamentals remain supportive, and periods of weakness, as we saw in Q1, provide an opportunity for selective carry collection. Despite credit spreads having widened out in Q1, we remain neutral on IG as a whole, preferring credit exposure within EM and HY bonds.

Within credit, 2018 is likely to be a story of recurring volatility and lower overall returns. Investors will have to focus increasingly on capital preservation and on forms of portfolio construction, which tend to minimise drawdown risk. As such, investors should be selective on issuers to identify value, but more importantly select those corporates with robust balance sheets at this late stage of the credit cycle. We continue to favour financials as a sector (globally) and make the case for AT1s once more, where fundamental factors (larger CET1 cushions, rising net interest margins) continue to be supportive and the yields on offer make this a preferred part of the credit space. As we did in the first quarter, we maintain a degree of

caution for sectors such as retail, where we note structural challenges. Retail, in particular, is of particular risk and S&P (the ratings agency) have noted that defaults in this space could match or exceed last year's record levels, identifying 20 retailers at risk of defaulting this year.

In the US, IG has widened, recording the worst quarterly start to a year since 2008. In spread terms, it remains expensive but with the recent rise in yields, we expect an element of stabilisation in Q2 as investors, hungry for yield, are encouraged to invest in IG once more. We also note that there could be a lack of potential IG issuance over the coming quarters on the back of tax reform, which should stimulate cash repatriation in the US (and thus reducing the need for companies to issue in the bond market). We favour a neutral stance on US IG bonds and reiterate that duration remains a key consideration. We continue to hold a preference for short duration and quality credit.

GBP investment grade faces the headwind of the rate cycle having turned in the UK, offsetting any short-term support from recent (positive) political developments. Our playbook for GBP follows that of US IG, where we look to maintain a short duration bias in portfolios.

Elsewhere, we remain cautious on EUR investment grade; spreads are wide (especially within industrials and utilities) and we expect negative ramifications as the ECB begins to unwind their bond purchases (for example, corporates have seen a 12 per cent drop in average monthly purchases in 2018 compared to the amount bought monthly between April and December 2017). From a relative standpoint, financials still look best placed to perform in the current context, on a lower sensitivity to ECB bond-buying and improving fundamentals. AT1s (with an emphasis on Spanish names) can be considered as attractive from a carry standpoint.

For high yield globally, the importance of carry remains a primary factor. We would be selective on issuers where we continue to see solid company fundamentals. Concerns over equity market valuations will be a consideration in the coming quarter (and for 2018) and investors in the space should consider stress-testing the potential rating of HY bonds to determine those which may have the highest sensitivity to the equity/credit relationship that was developed by Merton and look to avoid these names. In our opinion, the gentle rates normalisation process will allow carry to compensate investors and the recent weakness


in equity markets has been absorbed by the HY space. We continue to like earning carry and uncorrelated price-upside through selected single-name stories and non-rated issuers in this space.

The EUR high yield market remains expensive in comparison to the US (and other markets) – the segment trades 73bps inside US HY (on a spread basis) and 112bps inside UK HY. Looking at valuations from a different angle, the EUR aggregate yield is still below 3 per cent, in comparison with US HY, which stands at over 6 per cent. Whereas we don’t foresee a sharp

move lower in price, with yields so low, we take a neutral stance on EUR HY. Instead, we favour US and UK HY (a market which offers an average yield of 5 per cent) on a relative basis, although the smaller size and limited scope of the UK market offers fewer opportunities.

Equities

With the ‘goldilocks scenario’ seemingly a thing of the past, we take a more cautious approach to equities going into the second quarter.

The first quarter was a ‘tale of two halves’ with January delivering some of the best equity returns seen over that month in 40 years, quickly superseded by a correction in February (with equity markets down 10 per cent for the first time since 2015). The sharp move lower from the January highs looked like a ‘technical’ correction in some respects, but also looks likely to have ushered in a new era for equity markets in the current cycle. The ‘goldilocks trade’ appears to be coming to an end – whilst synchronous global growth remains broadly on track, rates (in the US) and volatility are rising. We take a more neutral view on equity markets going into the second quarter and ultimately expect more moderate returns across regions, particularly in the US.

Turning first to the US, equities finished the quarter down (-0.8 per cent YTD), almost 10 per cent off the highs reached in January, and ending the straight run of positive quarters, we have seen for the past two years.

In some respects, this comes as a surprise; data remains broadly positive with leading indicators supporting a rosy picture. Manufacturing PMI data, for example, reached 60.8 in February, the highest level since 2004, whilst the NFIB Small Business Optimism Index (a gauge of small business confidence) is at levels not seen for over 30 years.

Supporting the forward-looking data (and robust ‘hard’ data), tax reform, signed into law back in December, has yet to fully benefit corporate America and should also act as a support from here. We would expect this to have a positive impact on earnings over the course of the next few quarters, particularly for domestically-

orientated companies or those considering repatriating their offshore earnings to the US.

However, the biggest risk to the asset class remains Trump’s proposed trade tariffs, which came into effect in March (on steel and aluminium imports) and threaten to extend to other goods. Aside from the more direct ramifications, the tariffs also show the Trump administration’s willingness to ‘rock the boat’ of global trade dynamics, which has knocked sentiment and threatens to derail growth (and equity returns).

With a steady succession of rate hikes and thus higher bond yields from hereon in for the US the case to invest in the region is now more uncertain. As such, we take a neutral view at an index level for the second quarter.

From a valuation perspective, the US remains rich, albeit the broad index has cheapened somewhat compared to the previous quarter; the S&P trades at a forward Price to Earnings of c.15x (versus 18.9x in Q118). The dividend yield (at an index level) is 1.6 per cent, the lowest yield amongst developed market equity indices.

Within sectors, we favour the Financial, Industrial and Materials sectors. The financial sector should be a beneficiary in a rising rate environment and gain from any loosening of regulations, a topic we discuss within the investment ideas section. The industrial and materials sectors are positively geared to GDP growth and inflation and should also benefit in an ‘America first’ scenario, whereby US industry is favoured.

Turning to Europe, equities once again disappointed in the first quarter, delivering


negative returns (the Euro Stoxx returned -3.7 per cent in Q118), with major European indices shaken by the correction in early February and unable to fully recover. Yet, the negative picture for the broad index hid some regional disparities; whilst the German index closed the quarter down 6.4 per cent (certainly not helped by trade war fears), the Italian index delivered 2.8 per cent year-to-date as political risk dissipated following the election.

Whilst equity performance was decidedly mixed, the fundamental picture in Europe is healthy. GDP figures show broad-based strength, unemployment continues to fall and consumer strength remains apparent (albeit, it has weakened since the beginning of the year). Importantly, ‘forward looking’ PMI numbers point to further growth and we expect the European economy to remain a bright spot for the second quarter.

This bodes well for corporate earnings over the coming months and despite weakness in Q1, we maintain a cautiously positive outlook on the asset class for Q2, especially given the EUR has pared back from the highs (versus the dollar) seen at the end of January.

From a political standpoint, the situation (across Europe) looks more certain; despite the lack of government in Italy, elsewhere we sense a renewed vigour to European relations, spearheaded by a Merkel-Macron alliance. Whilst plans have yet to be agreed upon, we expect greater focus on fiscal policy (with a larger investment budget) – we do not think that investors are pricing this in and believe that this could act as a support to equity prices for the coming quarters.

The biggest challenge for European markets, particularly Germany, is the prospect of greater trade tariffs from the US, which is a key export market. This could continue to weigh on the index for the coming months, tempering our positive view and we express some concern that Europe has failed to ‘bounce back’ in a similar fashion to the US following the February correction, which does not bode well for sentiment.

Valuations for European equities have pared back from the upper end they reached in Q1; the Euro Stoxx 50 currently trades at a 12.2x forward P/E level (compared to 14.9x a quarter previously).

From a sector level, we maintain a preference towards the Consumer sectors, where stocks should continue to benefit from the improving macro story (as they did in Q1). We like

Financials, which should benefit from incremental rate rises and the improving balance-sheet story and we also like Industrials, which are positively correlated to GDP growth.

Looking at the UK, equity markets have suffered in the first quarter, delivering -7.2 per cent at an index level and marking the worst start to the year for almost 10 years.

In some respects, we find this surprising; the bulk of FTSE 100 revenues (70 per cent) are derived from revenues outside of the UK, and with global growth broadly healthy, UK companies stand to benefit.

However, the UK has seen a turn in sentiment, owing to the long-winded Brexit negotiations and, the ever-fragile nature of the current UK government. Anecdotally, we find that investors are increasingly assigning greater concern to the prospect of a Corbyn-led Labour government. The environment is also not helped by the prospect of rising rates (with a hike likely in May); with the highest dividend yields across developed markets (at an index level), any move higher in rates results historically has had a knock-on impact for UK stocks.

Although mindful of the challenges to the UK economy, we do see some room for optimism. The economy has not collapsed amidst Brexit uncertainty, unemployment remains low and wages are finally tracking higher, supporting the consumer sector, which has been challenged in recent quarters.

Whilst Brexit negotiations remain ongoing, we continue to hold a cautiously optimistic outlook on the process and that agreement shall be met – this will likely be favourable to UK plc and underlies our neutral-to-positive outlook for UK equities going into the second quarter.

From a P/E basis, the FTSE 100 now stands at 12.7x on a forward-looking basis, which is a considerable discount (relative to its recent history). It is also worth mentioning that the dividend yield now stands at 4.4 per cent (versus 2.9 per cent in the first quarter), highlighting the discount investors now attach to the asset class.

At a sector level, we continue to favour Financials given banks continue to improve their balance sheets (and should benefit in a rising rate scenario). We also like Materials, which should benefit from global growth trends and we take a contrarian view on the Consumer Discretionary sector – whilst sentiment is poor in the segment, we believe this is now fully


priced in and valuations are now attractive in certain cases.

Moving around the world, within emerging markets, we express greater caution given the dual threat of protectionism and rising rates in the US. Yet, there remains bright spots and we highlight several ‘growth’ stories, namely

Malaysia and Vietnam, which should benefit should global trade remain healthy. We also see an opportunity in countries undergoing political and/or social change, namely Saudi Arabia and South Africa.


Investment ideas Fixed income

US investment grade: Smart beta bond portfolio

Implementation Buy a basket of single bonds using our smart beta investment tool

Investment horizon 3-6 months

Expected return (p.a.) 2-4% (charges and fees can have a material impact on performance)

Risk grade 2 (where 1=lowest and 5=highest)

Rationale We find that the investment grade asset class currently presents limited value at an index level and as such we seek to help our clients requiring high-quality USD-denominated ideas by proposing a basket of single names within the segment. We acknowledge the significant yield differentials between core US, EUR and GBP IG markets, although a large chunk of the excess yield available in the USD market (for example) is due to the currency. We employ a smart beta approach to single-line name selection.

To construct our basket of US IG bonds, we focus on value at an issuer level and momentum and curve dynamics at the issue level. Also, we consider how well our selection performs against similar securities by rating, maturity and sector. Our list of names presents itself with an average yield of 3.8 per cent and an average duration of 4.8, which compares to the US IG corporate benchmark yielding 3.8 per cent with an associated duration of 7.1 reflecting our defensive stance.

Selection

ISIN Issuer name Short name Gross yield*

Duration S&P rating

Country Issue size Sector

USU37818AS70 GLENCORE

FUNDING LLC GLENLN 3 10/27/22

3.7 4.2 BBB US 500,000,000 Basic

materials

USU24652AL09 HARLEY-

DAVIDSON FINL SER

HOG

2.55 06/09/22

3.4 3.9 A- US 400,000,000 Consumer,

cyclical

USU3455QAA14 ALLERGAN SALES LLC

AGN

5 12/15/21 3.4 3.1 BBB US 1,200,000,000

Consumer,

non-cyclical

USU62472AF96 MYLAN INC MYL 3 1/8 01/15/23

3.8 4.4 BBB- US 750,000,000 Consumer,

non-cyclical

USH3698DBM59 CREDIT SUISSE

GROUP CS 3.869 01/12/29

4.4 8.1 BBB+ CH 2,000,000,000 Financials

Source: Bloomberg, Dolfin *Assuming yield-to-worst for callable bonds


Sector breakdown

Source: Bloomberg, Dolfin (March 2018)

Rating breakdown


Idea specific risks

- Credit risk: Our chosen bonds are not immune from a general risk-off tone in credit markets.

- Security risk: Idiosyncratic risks for the specific issuers.

20%

20%

40%

20%

Basic Materials Consumer, Cyclical Consumer, Non-cyclical

20%

20%

20%

40%

A- BBB+ BBB BBB-


Global high yield momentum

Implementation Buy a basket of single high yield bonds using our proprietary momentum tool




Rationale Whilst we are cognisant of the somewhat stretched levels of valuations in global high yield at an index level, we continue to see value in selected high yield bonds. In a cautiously ‘risk-on’ environment, the case for earning carry from the segment remains intact for now. Furthermore, we would expect the asset class to remain supportive should equities remain on an upward path, which is our base case in Q2 2018. Demand for new issuance remains strong and refinancing concerns are limited in such a context. We remain conscious of increasing shareholder-friendly activity and late-cycle behaviour, particularly in the US.

To determine our list of bonds within this segment, we employ quantitative momentum-based selection process, using the previous six months performance to help enlist 3 EUR bonds, 3 GBP bonds and 4 USD bonds that have favourable price-trend dynamics for the coming periods. With non-USD bond yields swapped into USD, the basket has a yield of 6.0 per cent and a duration of 4.2.

Selection

ISIN Issuer name Short name

Currency Gross yield*

Duration S&P/Fitch

rating Country Issue size Sector

XS1496337236 AVIS BUDGET FINANCE PLC

CAR 4 1/8

11/15/24 EUR 3.5 4.1 BB- JERSEY 300,000,000

Consumer, Non-

cyclical

XS1577957837 GLOBALWORT

H REAL ESTATE

GWILN 2 7/8

06/20/22 EUR 2.1 3.9 BB+

GUERNSEY

550,000,000 Financial

XS0552915943 BOMBARDIER

INC

BBDBCN 6 1/8

05/15/21 EUR 6.0 2.8 CCC+ CANADA 780,000,000 Industrial

XS1514268165 LADBROKES GROUP FIN

PLC

LADLN 5 1/8

09/08/23 GBP 3.5 4.5 BB BRITAIN 400,000,000

Consumer, Cyclical

XS1577956516 MCLAREN

FINANCE PLC

MCLAUT 5

08/01/22 GBP 5.2 3.8 B BRITAIN 370,000,000

Consumer, Cyclical

XS1120937617 HEATHROW

FINANCE PLC

HTHROW 5 3/4 03/03/25

GBP 4.0 5.7 #N/A N/A BRITAIN 250,000,000 Industrial

USU7586LAB37

REGIONALCARE HOSPITAL

PR

RGCARE 8 1/4

05/01/23 USD 6.9 3.4 B

UNITED STATES

800,000,000 Consumer,

Non-cyclical

USU92279AK18

VECTOR GROUP LTD

VGR 6 1/8

02/01/25 USD 5.9 3.3 BB-

UNITED STATES

850,000,000 Consumer,

Non-cyclical

USG90073AA86

TRANSOCEAN INC

RIG 9 07/15/23

USD 7.1 3.5 BB CAYMAN ISLANDS

1,250,000,000 Energy

Source: Bloomberg, Dolfin


Sector breakdown


Rating breakdown


Idea specific risks



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40%

10%

10%

20%

Consumer, Cyclical Consumer, Non-cyclical Energy Financial Industrial

30%

20%20%

10%

10%

10%

B B+ BB BB- BB+ CCC+


Emerging market sovereign bonds

Implementation Buy select sovereign bonds of emerging market issuers

Investment horizon 12 months



Rationale We highlight several countries with favourable risk / reward dynamics, with a potential benefit not only from yield-compression but also from favourable currency moves.

Our recommendation would be to consider a basket of:

- Russia (OFZ) 2.0% 03/2019, indicative 6.2% yield (in RUB)

- Brazil (BLTN) 0% 7/2018, indicative yield of 6.3% (in BRL)

- Turkey 8.8% 07/2018, indicative 13.0% yield (in TRY)

- South Africa (SAGB) 12/2018, indicative yield of 6.6% (in ZAR)

Select emerging markets: FX forecast

Currency Spot Q2 18 forecast Gain/loss from FX

Total annualised potential return (at maturity)

USDTRY 3.972 3.9 1.81% 14.76%

USDRUB 57.2 57.11 0.16% 6.34%

USDBRL 3.31 3.2 3.32% 9.62%

USDZAR 11.63 11.4 1.98% 8.56%


The Russian economy rebounded in 2017, expanding 1.5 per cent y/y, supported by buoyant domestic demand and rising exports. At the beginning of 2018, we see strong economic momentum, backed by a robust fiscal framework and record-low inflation (2.2 per cent y/y in February) providing tailwinds to growth. Moreover, Moody’s recent upgrade to Russia’s credit outlook (to positive), supports our positive view on Russian sovereign rates.

Turning to Brazil, we note that the country has emerged from the doldrums of a painful recession in 2017, with GDP growth of 1.0 per cent y/y. Despite easing monetary policy, inflation has surprised to the downside, remaining firmly below target. The central bank has indicated a further rate cut in Q2 as inflation risks remain tilted to the downside. With high real yields, low inflation and an improving economy, we take a positive view on local rates.

In Turkey, the economy expanded rapidly in 2017 (c.11 per cent y/y), backed by a large fiscal stimulus from the government, resulting in a widening of the current account deficit (>5 per cent/GDP). As stimulus measures run out this year, growth should moderate, but nevertheless relatively strong, especially at the start of the year. At the same time, inflation has started to moderate, albeit it remains well above the 5 per cent target. Given the deterioration in fundamentals has already been priced in, we do not expect material downside in the short-term, leaving us positive on the short-dated rates space.

Finally, in South Africa, we see a considerable improvement in its economic outlook with GDP up 1.3 per cent in 2017. The change in the presidency was followed by an improvement in business and consumer sentiment, which should support stronger investment and consumption growth going forward. Meanwhile, inflation remained below target for ten months running, leaving scope for a supportive monetary policy stance.


For our chosen bonds, we believe that the local currency yield provides an ample buffer to any deterioration in the currency.

Idea specific risks

- Political risk: Price movements in EM sovereign bonds are closely tied to political developments in these countries, which remain relatively fragile.

- Currency risk: Although the health of our chosen credits could remain positive, should the underlying currency fall by more than the offered yield, investors should expect a loss.


Revisiting additional tier 1 bonds

Implementation Buy a basket of single bonds within the AT1 segment




Rationale We revisit Additional tier 1 bonds, which we previously recommended at the start of 2017.

Additional tier 1 bonds are a type of debt issued by European / UK financial institutions that sit above equity in a bank’s capital structure but below other forms of debt. In a financial crisis environment, AT1s would become loss-absorbing (to avoid a repeat of the bailouts that scarred taxpayers during the financial crisis) - to compensate for the additional risks, these bonds typically offer a higher level of return for investors.

Since we first recommended AT1s, we note there has been positive performance, both from a spread and price perspective. However, mirroring weakness in equity markets earlier this year, the segment has softened year-to-date, which we believe presents a favourable entry point.

AT1s are closely aligned with the overarching macroeconomic environment – given our constructive view on European equities for the coming quarter, we thus see a positive knock-on effect for the AT1 segment. The relationship can be seen in the below chart, which shows an AT1 index (as a proxy for our basket of single bonds) against Eurozone composite PMI. The two variables are closely aligned and given we expect a rebound in European activity in the second quarter, we expect the AT1 segment to remain supported from here.

USD-denominated AT1s vs. Eurozone composite PMI (RHS)


Macroeconomics aside, we also maintain a favourable view on the financial sector, particularly within Europe. Alongside balance sheet rehabilitation, European financials are finally benefiting from a recovery in both EPS and loan growth, which should act as a support for the AT1 segment.

Furthermore, whilst this year the capital requirements for many European banks is set to increase (bringing the rest of Europe more closely in line with Sweden and Norway), we do not expect a material impact for the AT1 segment, with management and regulators likely to remain supportive of AT1

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AT1 Index (USD) Eurozone composite PMI (RHS)


payments, given skittishness in equity markets, most recently, as well as crossover in the investor base between AT1s and ‘seniors’.

Whilst we allocate to one UK-issued AT1, given the more uncertain UK backdrop (both politically and economically), we hold a preference for European-issued AT1s.

Selection


Currency Gross yield*

Duration S&P/Fitch

rating Country Issue size

XS1793250041 BANCO

SANTANDER SA

SANTAN 4 3/4 PERP

EUR 4.7 5.9 - SPAIN 1,500,000,000

XS1658012023 BARCLAYS

PLC

BACR 5 7/8

PERP GBP 6.0 5.3 B+ BRITAIN 1,250,000,000

USF22797RT78 CREDIT

AGRICOLE SA

ACAFP 7 7/8

PERP USD 6.1 4.6 BB+ FRANCE 1,750,000,000

XS1548475968 INTESA

SANPAOLO SPA

ISPIM 7 3/4

PERP EUR 4.7 6.5 BB- ITALY 1,250,000,000

CH0400441280 UBS GROUP

FUNDING SWITZE

UBS 5 PERP

USD 6.6 4.1 BB SWITZERLAND 2,000,000,000

Source: Bloomberg, Dolfin (March 2018) *yield is shown in local-currency terms and assumes yield to worst for callable bonds

Idea specific risks

- Equity risk: AT1s have a close correlation to equity markets – should equities fall, we would expect some impact within the AT1 segment.

- Coupon risk: In the case of a ‘credit event’ or should an issuing banks’ capital fall below a certain level, AT1s would not be compelled to pay a coupon – the security could be written off or converted to equity.

- Perpetual risk: AT1s are perpetual but typically callable to 5 years. However, issuer banks do not have to call the bond and regulators could restrict banks from ‘calling’ if they would then need to issue new bonds at a higher cost.


US miners revival

Implementation Basket of bonds from US miners and coal producers




Rationale The US North American coal sector has encountered numerous headwinds over the past several years, including environmental regulatory pressures and a shift towards renewable energy. In turn, this has resulted in structural decline in coal production and led coal miners including Peabody Energy, Arch Coal and Contura Energy to both enter and then re-emerge from Chapter 11 bankruptcy.

However, armed with an ‘America first’ agenda and an awareness of the importance of (coal-producing) swing-states such as Pennsylvania, Trump is looking to revive the US coal industry – the most prominent example of this was exemplified by his steps to remove the restrictive provisions of the Paris Climate Agreement in 2017. Whilst production has been declining over the past 10 years, 2017 saw witness to the largest increase in production since 2001.

US coal production, 2007-2017

Source: IEA (February 2018)

Bearing in mind the recent tariffs on foreign steel, we would expect both higher demand for US steel and for coal (a key component in steelmaking) from here. This supports the case for owning bonds issued by coal miners.

The outlook is not all rosy, and the recent release by the International Energy Agency forecasts global demand to remain flat between 2017 and 2022, largely driven by the fall in coal demand in China, the European Union and the United States. There are also fears for coal’s future as its share of overall energy generation, particularly in the US, diminished. Yet, we believe a lot of bad news is now well known and (importantly) priced in; with restructuring of the industry (post-chapter 11) and Trump’s keenness to promote US coal, we expect a more stable environment for producers over the next 12-18 months.

We note that the coal sector is still rated poorly by the agencies, despite, for comparison sake, the Bloomberg DRSK model implying a higher credit rating (based on their equity price). Whilst certain credits remain a risk (over a 12-month time horizon), we find value in the FELP 11.25 23s (callable in 2020) which has a yield of 16.7 per cent and is considered just below IG rating (according to the DRSK

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2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

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model) as well as the NRP 10.5 22 (callable in 2019) which yields 7.7 per cent. We note that an equal-weighted basket of these names would yield us 12.2 per cent. Were we to provide more diversification, we could add the Peabody bond, which would result in a 3-name basket that still yields 9.8 per cent.

Selection

ISIN Issuer name Short name Gross yield*

Duration S&P rating

Country 1-year Risk of

default**

5-year Risk of

default** Issue size

USU34550AE00 FORESIGHT

ENERGY/FINANCE

FELP 11 1/2

04/01/23 16.7 3.5 CCC US 0.9 4.6 425,000,000

US63901HAB69 NATURAL RESRCE

PART LP NRP 10 1/2

03/15/22 7.7 1.7 B- US 0.0. 1.0 345,638,000

USU7049LAA62 PEABODY ENERGY

CORP BTU 6

03/31/22 5.0 2.7 BB US 0.0 0.0 500,000,000

Source: Bloomberg, Dolfin (March 2018) *assuming yield-to-worst for callable bonds

**according to Bloomberg DRSK model

Idea specific risks

- Economic risk: Coal sector remains under pressure in the US. Should the environment worsen, we would expect sentiment to weigh on bond prices over the coming quarters.

- Credit risk: Restructuring within the industry remains ongoing and issuer default risk on certain names remains elevated.


Fallen angels

Implementation Selection of ‘fallen angel’ bonds




Rationale A ‘fallen angel’ is the name given to a bond that has historically held investment-grade status but has since been reduced to junk bond status (i.e. high yield) owing to the perceived weakening financial condition of the issuer.

These fallen angels make up 10 per cent of the broad US high yield bond market, but can offer a superior value proposition vis-à-vis the wider high yield universe – historically, names have included Dell, Nokia and Arcelor Mittal

From a performance perspective, fallen angels have outperformed the broader high yield index year-to-date as well as over a longer time-frame; in 2017, the index delivered over 10 per cent compared to 7 per cent for the broader ICE Bank of America High Yield Index.

Fallen angels: Relative price performance


Performance aside, fallen angels have typically demonstrated lower levels of default than the broader high yield index, a trend which is likely explained by the fact that fallen angels are closer to investment grade issuers on some metrics. We also note that management of these fallen angels often see a re-upgrade to IG as a future goal, which is typically supportive for ongoing credit metrics.

The table below shows that since 2007, issuers classified as ‘fallen angels’ enjoyed a lower level of defaults over the 12-month period than that of the issuers who were originally rated at high yield (speculative grade) from the outset. For example, the default rate in 2016 for fallen angels was 1.41 per cent and far lower than the 5.48 per cent of defaults seen by bonds where the issuers started at high yield upon issuance. This lower default probability for a fallen angel whilst achieving similar yields to issues of similar rating, provides us with a better risk/reward ratio when holding the bond.

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07 08 09 10 11 12 13 14 15 16 17 18

Index

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US High Yield US Fallen Angels S&P 500


Fallen angels: Relative defaults

Year 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Fallen angel 0.86 3.07 8.07 1.76 3.36 4.7 0.63 0.79 2.8 1.41

Original issue speculative grade

1 4.34 11.89 3.43 1.96 2.5 3.22 2.66 2.68 5.48

All speculative grade

0.97 4.02 10.93 3.27 1.98 2.59 2.1 1.52 2.77 5.1


A final characteristic of the fallen angels’ segment, is that price action ahead of an expected downgrade to high yield status means that investors will typically reduce their exposure to issues (given mandate constraints) whilst at the same time, high yield buyers hold back until there has been full confirmation that the issuer shall become a HY name. This leads to a temporary price distortion, which can be capitalised upon.

We have constructed a portfolio of bonds, screened against the Fallen Angel index (BofA Fallen Angel High Yield Index) to determine those names based on the Bloomberg default risk model, which would be rated A- or better (IG7) and could potentially benefit from an issuer companies’ desire to regain investment grade status once more. This basket of USD-denominated bonds (shown below) offers a yield of 6.3 per cent with a duration of 7.9, which we view as favourable given the quality of the credit.

Selection


Gross yield*

Duration S&P rating

Country Issue size Sector

US86210MAC01 STORA ENSO

OYJ

STERV 7 1/4

04/15/36 5.2 10.6 BB+ Finland 300,000,000 Basic materials

US654902AC90 NOKIA OYJ NOKIA 6

5/8 05/15/39

6.1 11.3 BB+ Finland 500,000,000 Communications

US05330KAA34 AUTO METRO

PUERTO RICO

AMETPR 6 3/4

06/30/35 8.6 6.8 BBB-

Puerto Rico

435,000,000 Consumer, non-cyclical

US881575AC87 TESCO PLC TSCOLN

6.15 11/15/37

5.7 11.3 BB+ UK 1,150,000,000 Consumer, non-cyclical

USU24019AG38 DCP

MIDSTREAM OPERATING

DCP 5.85 05/21/43

6.9 4.2 B+ US 550,000,000 Energy

USU67523AA57 OCH-ZIFF

FINANCE CO LLC

OZM 4 1/2 11/20/19

5.7 1.5 BB- US 400,000,000 Financial

US81211KAK60 SEALED AIR

CORP SEE 6 7/8 07/15/33

5.5 9.7 BB+ US 450,000,000 Industrial

Source: Bloomberg, Dolfin (March 2018) *assuming yield-to-worst for callable bonds

Idea specific risks




Long US / Short German 10-year rates

Implementation Futures




Rationale The spread between the German bund and the US Treasury 10-year yield went from -35bps in the aftermath of the financial crisis to -220bps mainly because the US economy was leading its G7 peers in terms of economic recovery, inflation outlook and monetary policy normalisation. On a 9 to 12-month investment horizon, we expect the spread to start moving higher.

Looking at the currency implications in the first chart, we see the co-movement of the German-US 10yr spread, simply called the “spread” hereafter, against EURUSD. The positive correlation exists mainly because FX dynamics are reflected on rates and vice versa (monetary policy and trade transmission mechanism). However, since 2017, while the EUR was recovering strongly on the back of a strong European economy, the ECB remained committed to accommodative policy and quantitative easing. This resulted in bund yields pegged at all-time lows, creating an interesting divergence in views reflected by the FX and rates markets. Holding a neutral view on the EURUSD for the coming quarters we expect the spread to move higher.

Germany-US 10-year spread vs. EURUSD (RHS)


Similarly, the early start of hikes by the Fed has caused the interest rate differentials on the front end of the curve to follow a similar path as the spread (see the below second chart). However, even after considering three hikes by the Fed, we see the spread moving higher, especially as we approach Q3 and Q4 when the ECB is expected to conclude its tapering (i.e. paring back of bond purchases).

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GE-US 10-year spread EURUSD (RHS)


Germany-US 10-year spread vs. GE-US 12m Euribor-Libor spread (taking into account 3 hikes) (RHS)


Finally, looking at the 10-year breakeven spread between Germany and the US we observe the clear divergence in terms of inflation expectations and long-term rates differential. With both economies growing strong, the markets are pricing in higher long-term inflation for Germany vs the US, which is not reflected in the current bund yield.

Finally, it is important to highlight the dominance of the ECB and its buying program as well as the reduced supply of bunds that have been keeping bund yields at artificially low levels.

Germany-US 10-year spread vs. GE-US 10yr breakeven spread (RHS)


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Idea specific risks

- Economic risk: Export-orientated eurozone will get more hurt in an increasingly protectionist world.

- Inflation risk: Inflation expectations in the eurozone remain subdued while US benefits from rates normalisation and fiscal stimulus.


CDS warrant decompression trade

Implementation Optimal CDS for both legs or CLN vs CDS warrant




Rationale With rates rising globally, we have seen a more supportive environment for financial-related credits and underlies our general preference for the sector. In the credit space, this has resulted in outperformance of subordinated debt against senior debt. At the start of 2017, the differential between the iTraxx Europe Subordinated Financial Index and the iTraxx Europe Senior Financial Index stood at 128bp whereas today, it stands at 58bp. Going forward, any stress in the market may lead to a “decompression” of this spread differential, which we would expect to be led by the subordinated index.

Subordinated: Senior spread


The spread Dv01 (i.e. the amount that can be made on a 1bp move) for the two instruments is similar at 479.5 (for senior) and 462 (for subordinated) when considering a EUR 1m position. This means that a 10bp widening or tightening would make a gain or loss of EUR 4,700. Our expectation would be for 42bp widening, bringing us back to a differential of 100bp and resulting in a PnL of EUR +19,740. The position has a negative carry of 58bp per annum for each EUR 1m exposure (equating to EUR -5,840.7 for 12 months).

The trade should optimally be executed as a pure CDS trade to take advantage of the potential leverage available. Taking the 1m available capital, a 5x leverage (which is not extreme) would result in a return of EUR 98,700 should our target be met (equating to between 7-9 per cent per year). This would fall to 69,500 from the negative carry over a 12-month period should our view not play out.

For those without the sufficient capital to deploy on the senior financial leg of the trade making the trade viable, one possibility would be to buy the CDS warrant on the subordinated debt and use the available capital to purchase an AT1 (as an alternative to a leveraged CDS position on the Senior) to pay for the yearly cost. For example, the DB 6 per cent Perpetual AT1 (callable in 2022) has a yield to call of 5.4 per cent which means that for a 1m exposure to this perpetual bond, we are able to fund a 4.2m equivalent position in the subordinated index.

NB: If client opts for structured product, there is a EUR 1 million minimum.

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Idea specific risks

- Economic risk: Rising yields and continued economic growth results in a more positive outlook for financials with subordinated credits outperforming senior as a result.

- Leverage risk: Any moves potential gains or losses are magnified when leverage is applied.


Structured product: Fixed income funds

Implementation Capital protected auto-callable structured product based on three credit funds

Investment horizon 3 years

Expected return (p.a.) 7% (charges and fees can have a material impact on performance)


Rationale Having enjoyed a tailwind of favourable conditions over many years, and with rates rising across markets, we note a changing dynamic within fixed income, which threatens to ruin the party. The ability to generate positive performance thus becomes more challenging. Providing a case in point, since the start of 2018, we have seen both US and EU investment grade post negative returns (-2.4 per cent and -0.27 per cent for US and Europe respectively).

We do not expect this to change in the coming quarter; whilst economic fundamentals remain solid, valuations are rich and sentiment has now turned.

With these concerns in mind, we consider a USD-denominated capital protected structured product, with an auto-call feature, which offers insulation from any losses within the fixed income space, whilst still providing a potential return. The product is based on three fixed income funds (Pimco Income Fund, Jupiter Dynamic Bond Fund and Carmignac Securities Fund). Should all three of these funds trade above par (i.e. 100) at any of the annual review dates, you would receive 100 per cent of the nominal as well as 7 per cent for each year it has been held (up to a maximum of 21 per cent if this occurs in the final third year). The note has a memory feature, which means that in a scenario whereby any of the funds is below par at an annual review date, but moves above par at the next annual review date, both coupons shall be paid out.

The funds in question are well-capitalised and long-standing. They have also generated strong returns over the course of several years – this is shown in the below table

Characteristics

AUM (EUR m) Performance (%) Duration YTM

Fund 2017 2016 2015 2014 2013

Carmignac Securities 13,059 0.4 2.3 0.7 1.9 2.7 -0.1 0.9%

PIMCO Funds Global Investors Series plc - Income Fund

61,400 4.3 5.8 1.7 6.2 3.6 2.8 5.1%

Jupiter Dynamic Bond 10,425 0.3 4.2 -0.4 7.4 8.0 4.9 3.8%


We consider this product to be attractive in the current environment given.

- Should all three fixed income funds fall at maturity, you will still receive back 100 per cent of the nominal.

- In a positive scenario, whereby the funds are above par, the note offers a 7 per cent return per annum, which far exceeds the return we expect in most years for investment grade.

Note: Proposed trade is subject to USD 100,000 minimum.


Idea specific risks

- Issuer risk: In trading a structured product, you are taking inherent issuer risk. Should an issuer of a structured product default, investors may not return see a return on their capital.

- Liquidity risk: The potential liquidity risk is three years on this note, whereby investors may be able to return their capital.


Equities

European income

Implementation A basket of single stocks




Rationale With rates still supressed across much of the developed world, there remains a natural demand for dividend-paying stocks as a means of complimenting fixed income. This is particularly true of European stocks (euro area & UK), where dividend pay-outs are elevated.

We have constructed a portfolio of European income stocks (euro area and UK) with several criteria in mind:

- Stable net income and cash-flow from operations

- Positive free cash flow and lower leverage than peers

- High, but sustainable, dividend yield

- Stable dividend payments throughout the last five years

- Positive fundamental outlook

Our portfolio offers an indicative portfolio yield of 4.9 per cent, with approximately 63 per cent in eurozone stocks and 27 per cent in UK stocks. Notwithstanding that we envisage there could be some element of capital gain in our chosen stocks, we note that the yield is favourable compare to 12-month Libor and Euribor rates in both regions (1.0 per cent and –0.19 per cent respectively).

For US dollar investors, we would suggest an unhedged position, given our expectation of upside in both the euro and the British pound versus the dollar.

The funds in question are well-capitalised and long-standing. They have also generated strong returns over the course of several years – this is shown in the table below.

Illustrative stock selection

Name Price YTD change Market cap Operating

margin

Return on invested capital

Dividend yield

Sector Country

DE'LONGHI SPA 23.86 -2.1% 3,693 12.4% 14.6% 4.0% Consumer

discretionary Italy

KONINKLIJKE AHOLD DELHAIZE N

19.60 7.2% 24,505 3.5% 8.7% 3.2% Consumer

staples Netherlands

TOTAL SA 45.68 5.6% 128,070 6.5% 4.7% 5.1% Energy France

SAMPO OYJ-A SHS 44.58 -2.6% 24,769 16.0% 27.1% 5.8% Financials Finland

RANDSTAD HOLDING NV

54.20 6.0% 9,953 3.7% 12.7% 3.8% Industrials Netherlands

NAVIGATOR CO SA/THE

4.73 11.4% 3,398 15.6% 10.9% 5.0% Materials Portugal

RUBIS 59.25 0.5% 5,626 10.0% 8.4% 2.5% Utilities France

CREST NICHOLSON HOLDINGS

462.00 -12.5% 1,225 20.3% 18.6% 6.9% Consumer

discretionary UK

BP PLC 467.20 -4.2% 99,964 2.6% 2.1% 5.7% Energy UK

RIO TINTO PLC 3,565.00 -9.6% 64,132 35.2% 15.0% 6.0% Materials UK

PLUS500 LTD 1,100.00 42.9% 1,422 59.1% 112.8% 6.1% Financials Israel



Sector breakdown


Idea specific risks

- Stock-specific risk: Our chosen stocks may underperform the broader European index.

- Market risk: Our chosen stocks are not immune from the broader market downturn.

- Rate risk: Should rates move sharply higher, we would expect dividend-payers to be materially impacted.

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Consumer Discretionary Consumer Staples Energy

Financials Industrials Materials

Utilities


European stocks: Preferred sectors





Rationale We have constructed a European equity portfolio, which aligns with our macroeconomic forecasts for the region.

Our view is that the region shall continue to benefit from higher GDP growth, as we saw in the previous quarter, at a time when inflation remains subdued. Furthermore, we anticipate that the Euro shall remain in a rangebound pattern (versus the dollar) and short-term rates shall remain pinned down.

Macroeconomic views:

- GDP: Positive

- Inflation: Neutral to negative

- Euro: Neutral

- Short-term rates (Euribor): Neutral

With these views in mind, we have compared the historical correlation of various economic factors (such as CPI, GDP growth, and EURUSD) to European sectors to reach a shortlist of sectors. Namely we focus on consumer discretionary and financials sectors, complimented with a smaller allocation to the industrial sector.

We have then screened European stocks (from within these sectors) using our smart-beta methodology to construct a portfolio of 10 stocks. This approach compares stocks against fundamental metrics, including value (e.g. dividend pay-out and earnings yield), quality (e.g. gross profit margin and EV / EBITDA) and momentum.

We have then applied a discretionary overlay to provide the final output of stocks.


Name Price (EUR)

YTD change

Market cap

(million)

Operating margin


Dividend yield

Sector Country

JUMBO SA 14.84 -0.4% 2,019 25.2% 12.6% 2.4% Consumer

discretionary Greece

KERING 416.70 6.0% 52,621 17.5% 10.4% 1.4% Consumer

discretionary France

LVMH MOET HENNESSY LOUIS VUI

263.25 7.3% 133,473 19.0% 14.0% 1.9% Consumer

discretionary France

STROEER SE & CO KGAA

57.15 -7.2% 3,185 9.1% 7.8% 2.3% Consumer

discretionary Germany

KERRY GROUP PLC-A

85.25 -8.8% 15,027 10.6% 12.3% 0.7% Consumer

staples Ireland

BANCO SANTANDER SA

5.36 -2.1% 86,522 23.8% 3.5% 3.3% Financials Spain

BPER BANCA 4.66 10.7% 2,243 8.7% 1.9% 2.4% Financials Italy

NATIXIS 6.60 0.1% 20,713 27.2% 0.7% 5.6% Financials France

KINGSPAN GROUP PLC

34.64 -4.8% 6,222 9.9% 13.4% 1.1% Industrials Ireland

VINCI SA 80.22 -5.8% 47,485 10.8% 7.4% 3.1% Industrials France



Sector breakdown


Idea specific risks

- Macroeconomic risk: Should our ‘base case’ for the European economy not occur, our chosen stocks could underperform.

- Political risk: Political uncertainty both domestically (e.g. Italy, Greece) and internationally (e.g. in US) could impact our chosen sectors, particularly within the industrials sector.



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US stocks: Preferred sectors





Rationale We have constructed a US equity portfolio, which aligns with our macroeconomic forecasts for the region.

Our view is that the US will continue to deliver neutral-to-positive GDP growth, in line with previous quarters as well as higher inflation. We also expect Libor to increase from here, owing to the expected hikes this year.


- GDP: Neutral-to-positive

- Inflation: Positive

- Dollar: Neutral

- Short-term rates (Libor): Positive

With these views in mind, we have compared the historical correlation of various economic factors (CPI, GDP growth, Dollar index etc.) to US sectors to reach a shortlist of sectors. Namely we focus on Financials, Industrial and Materials sectors.

We have then screened US stocks (from within these sectors) using our smart-beta methodology to construct a portfolio of 10 stocks. This approach compares stocks against fundamental metrics, including Value (e.g. dividend pay-out and earnings yield), Quality (e.g. gross profit margin and EV / EBITDA) and Momentum.



Name Price (USD)

YTD change

Market cap

(million)

Operating margin


Dividend yield

Next year PE

Sector

DISCOVER FINANCIAL SERVICES

72.13 -6.2% 25,502 35.7% 12.0% 2.0% 8.4x Financials

INTERCONTINENTAL EXCHANGE IN

72.53 2.8% 42,138 51.4% 9.7% 1.3% 18.2x Financials

SEI INVESTMENTS COMPANY

74.63 3.9% 11,738 26.0% 19.7% 0.8% 21.0x Financials

CRANE CO 93.02 4.3% 5,564 14.4% 9.2% 1.5% 15.0x Industrials

DELTA AIR LINES INC

54.21 -3.2% 38,322 14.8% 18.0% 2.3% 7.6x Industrials

INGERSOLL-RAND PLC

85.87 -3.7% 21,458 11.7% 13.8% 2.1% 14.7x Industrials

TETRA TECH INC 50.20 4.3% 2,804 9.0% 10.3% 0.8% 18.2x Industrials

BERRY GLOBAL GROUP INC

55.18 -5.9% 7,236 10.3% 10.8% - 13.7x Materials

SHERWIN-WILLIAMS CO/THE

396.82 -3.2% 37,341 11.8% 20.0% 0.9% 18.1x Materials

TRINSEO SA 74.20 2.2% 3,211 12.1% 24.0% 1.9% 7.8x Materials



Sector breakdown


Idea specific risks



- NB: Our chosen stocks are geared towards global demand – should global growth fall or the dollar materially strengthen, we would expect our chosen stocks to likely be impacted.

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UK stocks: Preferred sectors





Rationale We have constructed a UK equity portfolio, which aligns with our macroeconomic forecasts for the region.

Our view is that the UK shall continue to experience neutral-to-positive economic growth, with GDP moving sideways and inflation also not moving higher from here. We also expect Sterling to move higher from current levels.


- GDP: Neutral

- Inflation: Neutral-to-negative

- Sterling: Positive

- Short-term rates (Libor): Neutral

With these views in mind, we have compared the historical correlation of various economic factors (CPI, GDP growth, GBPUSD etc.) to UK sectors to reach a shortlist of sectors. Namely we focus on financials and materials sectors, with a smaller allocation portioned to the consumer discretionary sector.

We have then screened UK stocks (from within these sectors) using our smart-beta methodology to construct a portfolio of 10 stocks. This approach compares stocks against fundamental metrics, including value (e.g. dividend pay-out and earnings yield), quality (e.g. gross profit margin and EV / EBITDA) and momentum.



Name Price (USD)

YTD change

Market cap

(million)

Operating margin


Dividend yield

Next year PE

Sector

ASOS PLC 7004.00 4.3% 5,857 4.2% 27.6% - 57.6x Consumer

discretionary

CARNIVAL PLC 4632.00 -5.3% 33,245 16.0% 8.5% 2.8% 12.9x Consumer

discretionary

INFORMA PLC 719.60 -0.3% 5,930 19.9% 9.5% 2.8% 14.4x Consumer

discretionary

BARCLAYS PLC 211.15 4.0% 36,110 14.3% 1.3% 1.4% 9.0x Financials

LLOYDS BANKING GROUP PLC

66.53 -2.2% 47,990 26.3% 2.5% 4.6% 8.9x Financials

ANGLO AMERICAN PLC

1633.40 5.4% 21,111 21.1% 9.7% 4.6% 10.8x Materials

GLENCORE PLC 353.45 -9.4% 50,984 3.1% 5.7% 4.0% 11.4x Materials

KAZ MINERALS PLC

872.80 -2.4% 3,900 43.0% 12.0% - 7.8x Materials

MONDI PLC 1918.50 -0.6% 9,312 13.5% 13.5% 2.9% 12.9x Materials

SYNTHOMER PLC

485.20 -1.3% 1,649 6.4% 12.5% 2.5% 13.9x Materials



Sector breakdown


Idea specific risks

- Political risk: UK stocks (particularly those that are domestically-focused) are subject to political risk – should sentiment worsen surrounding the British political situation, this may impact our chosen stocks.

- Stock-specific risk: Our chosen stocks may underperform the broader UK index.


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Thematic: US small and mid-cap financials





Rationale On the campaign trail, Donald Trump vowed to pare back financial regulations, which he warned was stymieing banks’ ability to support growth in the world’s largest economy. Over a year since taking office, and with mid-term elections looming, Trump looks set to come good on his promise, with Republicans gathering behind the most significant scaling bank of regulations since 2008.

The deregulation drive is focused on the Dodd-Frank Act, which was signed into law in 2010 as a response to the financial crisis. When enacted, the reform impacted virtually all US financial institutions, regardless of size and encompassing greater consumer protections, banning of risky trading and higher capital provisions, amongst other reforms.

Eight years on, proposed regulatory overhaul is likely to exempt small-to-medium sized banks from key swathes of reform. Furthermore, it looks likely that the proposed reform shall define the structure through which further de-regulation can occur. In its current guise, the proposed bill shall benefit those banks with assets under $250bn, which shall no longer be tied to the Federal Reserve’s strictest supervisory requirements. In effect, this would suggest a lower regulatory burden (and expense), which should allow for greater focus on growth and return of capital to shareholders. We have identified several banks within the small & mid-sized segment, which should benefit from potential reform.

Furthermore, we foresee a scenario whereby M&A activity picks-up within this space, following several years of lacklustre activity (as is evidenced in the below chart). With a far higher hurdle by which an institution becomes ‘systematically important’ (and thus more heavily regulated), the opportunities for less-painful corporate activity are magnified – we would thus expect greater activity to this extent, which should be accretive to equity prices.

Annual M&A Volume by Total Target Assets

Source: SNL Financial, Morgan Stanley (as of 16 March 2018)

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Our portfolio of stocks focuses on those companies with assets below $250bn and thus most likely to benefit from the proposed de-regulation drive.


Name Price (USD)

YTD change

Market cap

(million)

Operating margin


Dividend yield

Price/ book

Next year PE

BANK OF THE OZARKS

48.58 0.3% 6,247 61.7% 13.2% 1.6% 1.8x 11.3x

CATHAY GENERAL BANCORP

40.17 -4.7% 3,258 56.1% 6.4% 2.4% 1.6x 12.0x

FIRST INTERSTATE BANCSYS-A

40.35 0.7% 2,288 31.9% 6.0% 2.8% 1.6x 12.7x

FNB CORP 13.56 -1.9% 4,388 32.4% 3.5% 3.6% 1.0x 10.9x

SIGNATURE BANK 140.15 2.1% 7,707 45.2% 7.9% - 1.9x 11.7x

ZIONS BANCORPORATION

52.89 4.1% 10,394 35.9% 5.4% 1.5% 1.5x 13.1x


Idea specific risks

- Political risk: Regulations are yet to be signed into law and the risk remains that de-regulation is altered or weakened prior to being signed off.

- Economic risk: Small and mid-cap banks are not immune from the macroeconomic environment. Should the economy falter, we would expect the sector to be negatively impacted.


Select emerging markets: ‘Growth & change’

Implementation A basket of ETFs




Rationale With broadening global growth dynamics, a persistently weaker US dollar and some recovery in external balances, international capital flows have flowed into emerging markets year-to-date, supporting emerging market equities. Whilst the segment was not immune from the ‘correction’ in February, (partial) recovery was swift and the index has returned 2.5 per cent+ year-to-date.

For the second quarter, we remain cautiously optimistic that growth in EM equities can continue, noting that growth shall remain resilient in most economies and the US dollar shows no sign of moving higher (a key driver for EM equities).

However, risks have picked up, particularly given the prospect of a ‘tit for tat’ trade war sparked by the Trump administration. Amidst this heightened uncertainty, we recommend markets benefiting from outsized economic growth and / or external catalysts, which could support their equity markets from here. Namely we focus on ‘growth’ candidates, Malaysia, Vietnam and ‘political change’ candidates; Saudi Arabia and South Africa.

Looking first to intermarket relationships, we note that our chosen four markets (constructed as a portfolio of ETFs), has a high correlation to global growth. In the below two charts, we show the ‘portfolio’ against US GDP (year-on-year) and a combination of US & Chinese PMI data. Our base case remains that both the US and China should continue to grow in line with expectations over the next few quarters, which should be supportive for our chosen EM countries and allow them to perform well.

Growth & Change portfolio vs. US GDP (YoY) (RHS)


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Growth & Change portfolio vs. US & China PMI (RHS)


Further to this, we note the close relationship between our ‘portfolio’ and inflation (using a combination of US & Chinese CPI as a proxy). Again, given our base case of higher inflation from here, we view this as supportive of our chosen markets.

Growth & Change portfolio vs. US & China CPI (RHS)


Aside from the intermarket relationships, we highlight the domestic support for our chosen markets. For Malaysia & Vietnam, we highlight growth as a potential catalyst. In Malaysia, the economy has been especially supported by a structural upswing in the electronics sector (a primary export). The country has also seen growth in its consumer sector; with unemployment at just 3.3 per cent, spending is elevated, which bodes well for future GDP growth. In Vietnam, manufacturing has also been bolstered by consumer strength owing to the growth in wages supporting the prominence in the middle class – providing one anecdotal point, the number of outbound tourists over Chinese New Year (in 2018) has doubled in less than 6 years.

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For our ‘change’ candidates, we have chosen countries undergoing political / social change, which should bolster growth over the medium term. Looking first to South Africa, which was a country we highlighted for inclusion in the previous quarter, we continue to see the benefits of a changing political landscape – following decades of rule un Jacob Zuma, Cyril Ramaphosa took power (peacefully and without violence). Ramaphosa has outlined many pro-growth priorities, since coming to power, including mining reform, manufacturing revival and a focus on tourism. Given his recent sweeping changes to the ANC cabinet, sacking one third of ministers, we expect change to move quickly, which should pave the way for further growth (and support sentiment).

In the short-term, we are comforted by the fact the economy expanded 1.3 per cent in 2017, the first time in four years that the country avoided recession.

For Saudi Arabia, ‘change’ is subtler and driven by the ambitions of the country’s de facto new ruler and heir apparent, Muhammad Bin Salman (MBS). MBS has highlighted his plans to diversify the country away from oil over the longer-term. However, for now, we note that the country is taking up fiscal expansion this year, with higher spending on infrastructure, export financing and housing. Social change should also benefit growth, particularly the recent reversal on the ban of women drivers, which should increase labour force participation. Whilst there remain concerns that MBS shall struggle to drive through reform (which may have negative effects on Saudi equities), with a young workforce and supportive oil price, the country should remain on solid footing.

Idea specific risks

- Trade risk: Our chosen countries (particularly Malaysia and Vietnam) are exposed to trade risk, notably with the USA – should Trump expand protectionist measures, we would expect these countries (and their equities to be impacted).

- Political risk: Emerging market equities pose additional political risk, which can result in significant volatility.

- Dollar strength: Should we see high levels of appreciation in the US dollar (not our base case), this would likely result in a sell-off in our chosen markets.

- Market risk: A sharp market fall, could result in outflows from EM.

- Commodity risk: Our chosen markets express some correlation to commodity markets (notably South Africa and Saudi Arabia). Should we see a sell-off in these markets, our chosen equities may underperform.


Cloud computing



Expected return (p.a.) 10%+ (charges and fees can have a material impact on performance)


Rationale Cloud computing has emerged as one of the most exciting areas of the technology ecosystem in recent years and we expect to see a continuation of the secular shift towards cloud computing over the coming decade.

Cloud computing enables the delivery of computing services (such as servers, databases, storage, software, analytics) over the internet (i.e. the ‘cloud’). Such technology enables corporations (amongst others) to drive meaningful efficiencies (in terms of speed, scale and productivity). Furthermore, moving to a cloud-based system will typically deliver considerable cost-savings, also driving the adoption of cloud computing. Providing just one example, we have shown the potential cost of ownership of an ‘on-premise’ computing system versus a cloud-based one. As can be seen, the cost-savings are considerable, which supports further transition to cloud-based systems.

Cost of ownership: On premise vs. cloud ($ per core per month)

Source: Bloomberg Intelligence (April 2017)

Given the obvious benefits, it comes as no surprise to see that spending on cloud solutions is expected to increase 66 per cent over the next three years. This has been echoed, more recently, by business leaders. In their recent CIO survey, Morgan Stanley highlighted how software (particularly related to cloud computing) remains at the top of business leader’s priority lists for the coming year. Perhaps more importantly, the same survey suggests that cloud adoption has reached >20 per cent this year (21 per cent in 2018), a number the bank believes signals critical mass for new technologies.

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Oracle Cloud

Facilities Cost Hardware Cost Software Cost Ongoing Maintenance Cost (People)


Public IT cloud spending ($ billions)

Source: Bloomberg Intelligence (April 2017)

Our chosen stocks can be found across the cloud computing spectrum, albeit we prefer companies related to the public cloud, which we expect to drive growth in the segment. As opposed to private cloud systems (which ring-fence the pool of underlying computing resources), public cloud systems tend to be both cheaper and more flexible systems for a company to adopt. Furthermore, public cloud systems tend to offer greater security than private cloud systems, given a superior framework – public cloud IT infrastructure is typically spread across data centres, making it less vulnerable to hackers.

Within our proposed portfolio (within the cloud computing segment), we have allocated across cloud providers (Microsoft, Google, Amazon), software (Adobe), hardware (Wistron) and IT consulting (Capgemini, Cognizant). Whilst this provides diversification within the theme, we would expect to see synergies across segments, which should prove beneficial.


Name Price YTD

change

Market cap

(USD million)

Operating margin


Dividend yield

Country Sub-sector

ADOBE SYSTEMS INC

223.54 27.6% 109,712 29.7% 19.1% - US Application

software

AMAZON.COM INC

1451.75 24.1% 699,148 2.3% 6.0% - US Internet & direct

marketing

ALPHABET INC-CL A

1032.64 -2.0% 714,445 23.6% 8.1% - US Internet software

& services

CAPGEMINI SE 102.55 3.7% 21,240 9.2% 10.6% 1.7% France IT consulting & other services

COGNIZANT TECH SOLUTIONS-A

80.92 13.9% 47,097 16.8% 12.5% 1.0% US IT consulting & other services

ASPEED TECHNOLOGY INC

842.00 17.3% 977 34.2% 23.1% 1.8% Taiwan Semiconductors

MICROSOFT CORP

92.38 8.0% 708,843 30.1% 8.0% 1.8% US Systems software

ORACLE CORP 45.96 -2.8% 185,664 33.7% 3.9% 1.7% US Systems software

WISTRON CORP 24.00 0.2% 2,254 0.7% 3.0% 5.0% Taiwan Technology hardware, &

storage


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2015 2016 2017 2019 2020

$B

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ns


Idea specific risks

- Stock-specific risk: Our chosen stocks could underperform the broader universe.

- Market risk: Stocks are not immune from any broad market downturn.

- Technology risk: There remains a risk that a new technology supersedes cloud computing, which could have a material impact on our chosen stocks.


Augmented reality





Rationale ‘Simply put, we believe augmented reality is going to change the way we use technology forever’ – Tim Cook, Apple CEO, November 2017

Back in Summer 2016, Nintendo (supported by US-based software developer Niantic) launched augmented-reality mobile game Pokémon GO. Within a few weeks, the game had shattered all previous records for most profitable and most downloaded app (across all platforms). In total the game would be downloaded over 650 million times and was the first case of mass mobile augmented reality (AR) adoption.

AR, as a technology, blurs the line between real world and digitally generated images by superimposing computer-generated images onto a user’s smartphone screen. Whilst the technology has previously been limited to games, many believe the technology is vertical in its application, spanning education, health, entertainment, and commercial segments. To give a couple of examples, Amazon and Ikea both have AR functions within their smartphone apps, which allows customers to visualise its products in the real world. Car companies such as Ford and Volvo are using the technology in their design process: instead of having to build a physical clay model of every car, a design can be visualised using AR.

Whilst the technology has existed for some time, its application on the smartphone is more recent and the new Apple iPhone X sets a precedent for the technology with its 3D sensors and ‘ARKit’, within the latest iOS 11 operating system. Early reports suggest that other smartphone makers are also incorporating 3D AR technology into their phones and analysts are bullish that AR (as a technology) will take off over the next few years. According to recent projections, AR (and to a lesser extent VR) technology will grow exponentially to a market size of $150bn by 2020.

Augmented and virtual reality: Projected growth

Source: Digi-Capital (January 2018)

In constructing a portfolio of AR-exposed stocks, we have screened the universe for those with considerable revenues derived from the technology. Given the theme is still emerging, we have focused on component producers (such as Apple, Samsung and Sony) but compliment this exposure with software producers (such as Electronic Arts).

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Augmented Reality Virtual Reality



Name Price YTD

change

Market cap

(USD million)

Operating margin

Return on

invested capital

Dividend yield

Country Sub-sector

LUMENTUM HOLDINGS INC

60.50 23.7% 3,736 4.8% 17.4% - US Communications

equipment

SONY CORP 5,205.00 2.4% 61,480 3.8% 11.5% 0.5% Japan Consumer electronics

TONG HSING ELECTRONIC INDUST

120.00 -11.1% 678 15.0% 8.1% 5.0% Taiwan Electronic

components

CHROMA ATE INC

170.00 4.9% 2,392 20.4% 15.8% 2.6% Taiwan Electronic

equipment & instruments

ELECTRONIC ARTS INC

121.23 15.4% 36,945 25.3% 20.9% - US Home

entertainment software

SK HYNIX INC 80,300.00 5.0% 54,727 45.6% 32.1% 1.2% South Korea

Semiconductors

APPLE INC 172.80 2.1% 871,96

9 26.8% 20.1% 1.5% US

Technology hardware, &

storage

SAMSUNG ELECTRONICS CO LTD

2,420,000.00

-5.0% 290,86

1 22.4% 17.5% 1.8%

South Korea

Technology hardware, &

storage


Idea specific risks

- Technology risk: Mass-market adoption of AR technology may simply not happen, or a new technology may appear and supersede AR.




World Cup





Rationale On 14 June, Russia will host the 21st FIFA World Cup. The World Cup remains the most widely viewed sporting event in the world. In 2014 it reached an in-home television audience of 3.2 billion people (according to FIFA). With such a large audience, the corporate opportunities for global brands is huge.

Despite media reports suggesting that FIFA has struggled to find sponsors for the upcoming World Cup (many brands are wary of association with FIFA following the corruption scandal back in 2015), with a global audience larger than ever, we expect there to be ‘winners’ from the event.

We have selected a portfolio of stocks that incorporate both corporate sponsors of the event, but also those brands we would expect to benefit from differing consumer patterns. To provide an indication of the changing demand around the world cup in the below chart, we show beer volumes and how they have historically spiked over the course of the world cup, both in the host country and more broadly (the only anomaly being Germany, which has a consistently high beer consumption level).

World Cup: Beer volume growth


We have focused on stocks across sportswear, beverages and food and allocate to those names more exposed (both internally and externally) to the World Cup. Importantly, we have highlighted stocks where we have conviction in the fundamentals, regardless of the World Cup in June. Whilst the event is expected to offer support to the stocks, providing a ‘safety net’ in a more negative, ‘risk-off’ environment, we expect relative outperformance (versus the broader market) irrespectively.

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Gro

wth

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France (1998) Germany (2006) South Africa (2010) Brazil (2014)



Name Price YTD

change

Market cap

(USD million)

Operating margin

Return on

invested capital

Dividend yield

Sector Country

ADIDAS AG 190.60 14.0% 52,514 9.8% 18.1% 1.3% Consumer

discretionary Germany

NIKE INC -CL B

66.17 5.8% 111,373 13.8% 12.3% 1.2% Consumer

discretionary US

DOMINO'S PIZZA INC

231.58 22.6% 10,088 18.7% 101.7% 0.9% Consumer

discretionary US

HEINEKEN NV

85.60 -1.5% 63,770 15.3% 8.2% 1.6% Consumer

staples Netherlands

ANHEUSER-BUSCH INBEV SA/NV

87.10 -6.5% 221,496 30.4% 6.6% 4.0% Consumer

staples Belgium

COCA-COLA EUROPEAN PARTNERS

40.55 1.8% 20,231 11.4% 5.0% 3.1% Consumer

staples UK


Idea specific risks




Pair trade: Puts on wage-sensitive stocks vs. S&P 500

Implementation Listed options

Investment horizon 12 months+



Rationale Wage inflation has been a key missing component in the recovery post financial crisis. Yet, with the labour market now almost at levels not seen since 2000 (in the US unemployment stands at 4.1 per cent), wage pressures are starting to build. In the US, the Federal Reserve has met its labour objectives and with employees scarcer, we would expect employers to continue to raise compensation - both to recruit new staff and to retain existing employees. Such a dynamic creates risks for those companies with high labour costs. As such, we suggest investors consider taking a negative position (using ATM puts) on a portfolio of companies with the combination of: i) the highest labour sensitivity; and ii) the lowest relative margins. We highlight the negative correlation between these two variables and would ultimately expect these businesses to underperform as compensation costs rise.

We have screened the US equity universe for a basket of names where the cost of goods sold (which comprises labour and material costs) represents a high proportion of revenue (>85 per cent). On top of this, we have screened for companies where the pre-tax margin reports by these companies is 5 per cent or less, and thus their financial slack is limited.


Name Price YTD

change

Market cap

(USD million)

Cost of goods/

revenue

Pre-tax margin

Implied volatility

Sector Country

FORD MOTOR CO

11.33 -8.57 43,031 89.6% 5.2% 26.19 Consumer

discretionary US

PHILLIPS 66 62.94 -3.70 44,632 90.9% 4.0% 25.85 Energy US

EXPRESS SCRIPTS HOLDING CO

95.99 -7.86 39,494 91.2% 4.9% 21.95 Healthcare US

CARDINAL HEALTH INC

70.04 2.86 19,266 95.0% 1.5% 25.28 Healthcare US


We have determined the cost of an ATM listed put option for each of the stocks in the table.

'Wage-sensitive' stocks – option pricing

Name Price Strike % of strike Maturity Cost of premium

FORD MOTOR CO

11.33 10.87 96% 21/09/2018 5.56%

PHILLIPS 66 62.94 62.50 99% 21/09/2018 7.95%

EXPRESS SCRIPTS HOLDING CO

95.99 95.00 99% 17/08/2018 5.21%

CARDINAL HEALTH INC

70.04 70.00 100% 17/08/2018 7.14%

Average 6.47%


We note that the cost of the strategy can be cheapened by selling a S&P 500 ATM put, which would bring in 4.53 per cent, or indeed using put spreads (or selling calls) on the chosen stocks.


Idea specific risks


- Inflation risk: Wage inflation fails to gain traction and company margins are not affected by rising wages.


Puts on highly-levered companies with high dividends

Implementation Listed options




Rationale The low cost of debt has benefitted many companies, allowing them to issue cheap debt to support a share buyback programme or dividend growth. Furthermore, those stocks paying high dividends have become ‘bond proxies’ within a low-rate world.

With rates now on the rise, not only has the benefit of holding these bond proxies diminished, but the ability to maintain capital pay-outs has fallen, owing to the high cost of debt. The policy of using the bond market to support dividends is not sustainable and we see dividends (in some cases) as under threat.

A Fed study released late last year2 noted that an increase in the federal funds rate from 1.25 per cent to 3 per cent by 2019 (as implied by current projections) would translate into an increase in interest payments of $2bn in 2017, $15bn in 2018, and $37bn in 2019, relative to a scenario in which the Federal Funds rate remains at 1.25 per cent. Were rates to rise by this extent, this would imply that the interest coverage ratio (EBIT to interest expense) would decline to 4.1 by 2019 from 4.6 today. This increase in interest payments will constrain the ability of companies to perform buybacks and maintain their dividend growth.

If the debt of ‘bond proxy stocks’ starts to be refinanced, against a backdrop of rising bond yields, it will become more expensive to service. In turn, this will make their capital return policies, which have propped up stock prices, harder to justify. At the same time, if investors are finding bond yields more attractive again, these stocks could face a double whammy.

The S&P 500 Dividend Aristocrats ETF (ticker is NOBL US), which tracks those large-cap companies that have increased their dividend pay-outs for 25 years or more, has a dividend yield of 2.34 per cent. This is just 0.1 per cent more than the 5-year US Treasury yield. Further to this, since the start of 2010, the Dividend Aristocrats ETF has outperformed the S&P 500 by 74 per cent (see the below chart) at the same time as net debt / EBITDA (across companies) has increased from 0.96x to 1.68x. We expect a reversal of this outperformance over the next few quarters.

2 (https://www.federalreserve.gov/econres/notes/feds-notes/potential-increase-in-corporate-debt-interest-rate-payments-from-changes-in-the-federal-funds-rate-20171115.htm)


Relative performance of NOBL vs. S&P 500 against net debt/EBITDA (RHS)


We note that is possible to buy a listed put on the ETF (NOBL US) with an expiry in October (2018) at a strike of 64 (100.4 per cent of current price) at a cost of 4.8 per cent. We could fund this put by selling a listed put on the S&P, with an expiry in September (2018) and a strike of 2725 (99.9 per cent of current price). Whilst we have a bearish slant on the dividend paying stocks, those with a more bullish view on the markets could also consider buying a call on S&P funded by selling a call on the NOBL US. We could trade this as a long / short equity pair.

Idea specific risks

- Rate risk: Were rates to fall from here, companies could continue refinance at lower levels and increase their leverage.

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DVD Aristocrats Performance vs. S&P 500 perf Net Debt / EBITDA (RHS)


Trade war escalation

Implementation Options

Investment horizon 12 months+ or quarterly rebalancing



Rationale Despite delays and opposition to his plans, Trump is slowly making ground on his election promises, most recently focusing on the US’s record-wide trade deficit. For China in particular - being the largest of the US’s trading partners (and noting their $375bn deficit with the US in 2017) - the stakes are high and bolstered by the recent reshuffling within the Trump White House whereby ‘China hawks’ such as Peter Navarro have moved into more influential roles, the prospect of a ‘tit for tat’ trade war has intensified.

Balance of trade with USA by product group (USDbn, 2016)

Balance of trade with USA by product group (bn USD, 2016) China France Germany Italy Japan Spain Total

Machinery and transport equipment -153.0 -9.4 -51.8 -14.9 -82.9 -2.3 -440.0

Miscellaneous manufactured articles -117.2 -0.8 -3.6 -6.2 0.3 -0.4 -167.2

Road vehicles -3.7 -0.1 -22.6 -4.0 -48.3 -0.6 -160.0

Motor vehicles for transport of persons, NES and motorcycles etc. 7.3 0.1 -16.7 -3.9 -39.8 -0.6 -117.8

Telecomm, sound equip etc. -53.7 0.4 -0.4 0.0 -1.0 0.1 -92.4

Manufactured goods classified chiefly by material -41.2 -0.8 -6.1 -3.6 -4.7 -1.2 -79.3

Clothing and accessories -33.0 -0.6 -0.1 -1.7 0.1 -0.4 -65.5

Office machines, ADP machines -49.0 0.0 0.3 0.0 -2.4 0.1 -53.8

Petroleum, petroleum product 0.2 1.3 0.0 0.3 0.2 -0.8 -47.1

Mineral fuels, lubricants and related materials 1.4 1.6 0.3 0.5 2.0 -0.6 -43.0

Elec machinery apparatus, parts, NES -26.0 -0.2 -5.6 -0.5 -7.3 -0.1 -42.1

Power generating machines -5.1 -3.5 -5.7 -1.4 -6.4 -0.9 -32.7

Other transport equipment -1.6 -5.0 -5.0 -3.1 -3.2 -0.2 -31.8

Furniture, bedding etc. -18.9 -0.3 -0.4 -1.0 0.0 -0.1 -30.8

Miscellaneous manufactured goods NES -36.3 0.8 -0.1 -1.0 1.4 0.1 -30.7

Aircraft, associated equipment -1.1 -3.6 -4.1 -0.9 -3.2 -0.2 -26.2

Parts, tractors, motor vehicles -7.5 -0.2 -5.3 -0.1 -7.5 0.0 -24.0

Medicinal, pharma products -0.1 -1.5 -10.8 2.3 2.3 0.9 -19.1

Footwear -12.1 -0.2 -0.2 -1.1 0.1 -0.2 -18.6

Other -3.8 11.1 -28.5 -13.0 14.2 2.3 139.0

Grand total -554.4 -10.7 -166.7 -53.1 -186.1 -5.1 -1383.2

Source: United Nations Commodity Trade Statistics Database (2017)

Trump’s first move was to impose steel and aluminium tariffs (in early March), and the President has since gone on to target products in high-tech and industrial sectors, where China has been accused of intellectual property theft. Given the latest front in a growing trade war, it seems likely that technology is most likely to be impacted should negotiations escalate from here.

Should the trade war escalate, we would expect global repercussions, the extent to which largely depends on China’s response. A full-blown trade war would impact countries such as Taiwan and South Korea, whose economies are dominated by tech exposure. We also envisage that Treasuries may come under pressure, given less Chinese support (who remain the largest holders) and would expect Gold to be a key beneficiary.

Taking these considerations into account, it may be prudent to purchase a contingent option to hedge against such a black swan scenario. For the contingent option, we would suggest an ATM put on Nasdaq, contingent on gold being above 105 per cent (5 per cent above the strike). A 12-month contingent put would cost 4.75 per cent, which is just over half the cost of an at-the-money Nasdaq put


(9 per cent). For those that prefer an outright position in Nasdaq (QQQ US), we would recommend a 3-month listed option maturing on 29/06/2018, where a 100 per cent/90 per cent put spread would indicatively cost 2.75 per cent, with an outright put costing 4.6 per cent.

Idea specific risks

- Political risk: Trade war does not materialise, leaving our options maturing worthless.

- Contingent option risk: Nasdaq falls, but gold fails to react.


Real estate

Implementation A basket of REITs and single-stocks




Rationale We maintain optimism in our outlook for European real estate going into the second quarter of 2018, despite the challenging start to the year. As a direct beneficiary of synchronous economic growth across the Eurozone, we expect the sector to benefit. Whilst UK property markets have largely held up (from a price and rent perspective), sentiment has kept UK stocks under pressure, a dynamic we expect to continue. As such, we focus on Eurozone stocks, where we have greater conviction. The relationship with economic health is highlighted in the chart below. It shows the European real estate index (as a proxy for our chosen stocks) against the Eurozone composite PMI. The same relationship can be found with retail sales, which are a sign of consumer strength. Both suggest support for the sector.

European real estate vs. eurozone composite PMI (RHS)


European real estate vs. eurozone retail sales YoY (RHS)


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European Real Estate Index Eurozone composite PMI (RHS)

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European Real Estate index Eurozone retail sales YoY (RHS)


There is the risk at this stage, that in a rising rate environment, bond-proxies, such as European real estate, may be impacted. However, given the pace of change at the central bank is likely to remain glacial, we expect the impact to be limited.

Furthermore, we note that real estate, as a sector, has already de-rated in anticipation of tighter monetary policy and thus we view valuations as reasonable.

In constructing a portfolio, we focus on German residential companies (Deutsche Wohnen, Leg Immobilien). The country has one of the cheapest global residential markets, despite prices rising fast, which suggests there remains upside in those companies operating in the segment.

Elsewhere, we ascribe some allocation to the commercial segment, both in France and Germany (Nexity, Alstria Office), whereby we expect healthy fundamental strength to continue to support the segment.


Name Price YTD

change

Market cap

(million)

Net income margin

Dividend yield

Next year PR

Sector Country

DEUTSCHE WOHNEN SE

36.95 1.3% 13,105 24.4% 2.2% 22.2x Real estate Germany

NEXITY 51.80 4.4% 2,908 5.7% 4.8% 13.5x Real estate France

GRAND CITY PROPERTIES

19.07 -3.0% 3,143 28.3% 3.8% 15.0x Real estate Luxembourg

LEG IMMOBILIEN AG 88.84 -6.8% 5,614 46.3% 3.4% 17.5x Real estate Germany

ALSTRIA OFFICE REIT-AG

12.38 -4.0% 2,102 57.5% 4.2% 16.5x Real estate Germany


Idea specific risks

- Rate risk: Should rates move sharply higher, we would expect a negative impact on yield-heavy real estate stocks.

- Economic risk: Our chosen stocks are geared to the health of the European economy.


Commodities

Pair trade: Long silver, short copper





Rationale Our proposed pair trade has both macroeconomic rationale whilst applying a more cautious approach, owing to its market-neutral structure. Supply for silver is contracting and demand likely to grow at a moderate pace over the coming years - the negative impact of higher interest rates is already priced and the combination of industrial and precious metal characteristics reveals an interesting entry level. Whilst the outlook for copper remains attractive owing to expected further supply tightness, the red metal is is closely linked to global economic growth and China. With renewed worries surrounding global trade wars and a more protectionist agenda, particularly in the US, we expect this to put a cap on upside in the metal currently.

Turning to macroeconomic factors, we identify US core inflation and the US 10-year yield as indicators as to the direction of this market-neutral trade.

We expect US core inflation (PCE) to remain at current levels or move higher on the back of an economy close to full capacity and a weak dollar. As the chart below shows, there is a discrepancy between the US PCE index and the silver/copper ratio – should inflation remain at current levels, we would expect a rise in the ratio.

Silver/copper ratio vs. US PCE YoY (RHS)


In our second chart, we depict the ratio against the inverse of the US 10-year yield. With the US economy still in somewhat of a “Goldilocks” scenario (but with significant risks ahead), the ratio has moved lower, discounting a significantly higher 10-year yield than current levels suggest. Any disappointing incoming US macro data or a change in tone in the Fed language should trigger a convergence of the two lines, resulting in the ratio moving higher.

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Silver / Copper ratio PCE YoY (RHS)


Silver/copper ratio vs. US 10-year yield (inverse) (RHS)


Idea specific risks

- Supply/demand risk: Should supply of our chosen commodities increase (or demand fall), prices would likely fall from here.

- NB: Sentiment (and positioning) could get more negative from here, which would be of detriment of our chosen commodities.

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Silver / Copper ratio US 10-year yield (inverse) (RHS)


Long agriculture





Rationale Year-to-date, many soft agricultural commodities (‘softs’) have performed well, owing to drought and failed crops, particularly in US and in Argentina, which had one of the driest February on record.

From here, we continue to favour an agriculture idea based on ‘softs’, which we would trade via an ETF (DBA), owing to macroeconomic concerns as opposed to supply/demand fundamentals. The agricultural commodities are usually the last segment of the commodities universe to outperform in a market cycle (typically after energy and metals). Given we believe we are nearing this point, it makes sense to allocate to the segment.

Aside from this, ‘softs’ (and other agricultural products) act as a robust hedge against inflation and in the first chart we show the performance of the proposed ETF against US CPI and PCE (both inflation indices). Given our view that inflation remain at current levels (or indeed moves higher), noting a likely weaker dollar, we expect agricultural commodities to catch up with inflationary pressures.

Agriculture vs. US inflation (RHS)


In our second chart, we compare our chosen ETF with the inverse relationship of the US dollar. The US currency’s recent slide was not accompanied by a rise in the agricultural spectrum, which leaves room for upside even in the case of a dollar bounce.

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Agriculture ETF (DBA) US PCE inflation (RHS) US CPI inflation (RHS)


Agriculture vs. US dollar (inverse) (RHS)


Idea specific risks

- Supply/demand risk: Should supply of our chosen commodities increase (or demand fall), prices would likely fall from here.

- NB: Sentiment (and positioning) could get more negative from here, which would be of detriment of our chosen commodities.

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Agriculture ETF (DBA) Dollar index (inverse) (RHS)


Precious metals

Implementation Futures and ETFs




Rationale Since the start of the year, the US dollar has continued its downward trajectory against major currencies. Whilst stabilising in recent weeks, this dynamic could remain in play for some time as the US faces twin deficits, more debt issuance and rating risk, and reserve diversification from the major central banks globally. Precious metals – including gold and silver – are key beneficiaries of this weakening dynamic; coupled with several other favourable tailwinds, we expect these metals (and the companies that mine them) to benefit over the coming quarters.

We propose a trade combining underlying exposure to the metals (via futures) – gold (25 per cent) and silver (25 per cent) - with an exposure to miners – gold miners (25 per cent) and silver miners (25 per cent).

The Trump administration has given several indications that it sees some benefit to a weaker dollar. At the Davos meeting earlier this year, Treasury Secretary Mnuchin echoed President Trump’s previous comments when he suggested that a weaker dollar is good for the US (and US trade). In doing so, he prompted a sharp move lower in the greenback, stoking fears of a future currency war. Owing to their pricing in US dollars, gold and silver typically benefit in a falling USD environment and have historically moved in lock-step with the currency (inverted) – this relationship can be seen below, where we compare the dollar index to our ‘metals and miners’ trade – even if we see do not see a further move in the currency, metals (and miners) are due some catch-up, assuming the negative correlation persists.

Metals and miners vs. USD (inverted) (RHS)


Closely linked to this, our chosen metals have typically prospered in an inflationary environment, with gold seen as a good hedge against rising prices. For the past two years, inflationary pressures have remained lacklustre with central banks left sitting on their hands as growth momentum has failed to materialise into higher prices. With labour markets increasingly tight and many commodities having risen considerably for much of 2017, this dynamic is waning. As the below chart shows, our chosen securities (metals and miners) have closely aligned with US inflation (as a proxy for global inflation).

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Metals & Miners USD (inverted) (RHS)


Metals and miners vs. US CPI Inflation YoY (RHS)


Aside from their inter-market relationships, gold and silver have ‘risk-off’ characteristics, which we view as favourable in the current market environment. This is especially the case, given the threat of a ‘tit for tat’ trade war - in a more negative environment for risk assets, gold and silver (and to an extent, gold and silver miners as derivatives of precious metals) should benefit.

Rather than focus solely on precious metals, we opt to combine with miners. Unsurprisingly, the miners have historically demonstrated a strong correlation to their respective precious metal (around 85 per cent) and benefit from any upside in their price, given the direct feed-through into earnings. However, we do note that the miners have lagged the precious metals since the beginning of the year, which we view as unwarranted (and underlies our rationale for seeking exposure alongside the metals themselves).

Idea specific risks

- Central bank risk: Hawkishness from the US Fed (and other central banks) reduces demand for precious metals.

- Futures risk: Although futures are not employed on a levered basis in this trade, an understanding of margin is needed.

- Supply/demand risk: Should supply of the precious metals increase, this could result in a fall in prices (of both precious metals and miners).

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Oil: Playing backwardation





Rationale Over the second half of 2017, the WTI oil curve inverted, a phenomenon commonly called backwardation – in effect, this is when the current price of oil is higher than the future cost of oil. The crude oil market will typically oscillate between periods of backwardation and contango (the opposite effect), but we have not seen backwardation since 2014 and the dynamic is an indication of strong demand and tight supplies.

Recent changes to oil futures curve


Driving this dynamic, we note that oil supply is being stymied by OPEC production controls. Whilst considerable oil supply has come back online in the US, OPEC has shown resolve in its production limits, which is supporting prices.

Ultimately, we expect a reversal of this trend over the medium term; market estimations put the average breakeven cost of US shale at approximately $50 per barrel – with the December 2019 futures now trading at $60, this indicates that Shale producers could lock in $5 of profit for the next 18 months - 2 years. In doing so, they could free up capital to be used for further capex growth and subsequently expand market supply. This dynamic has already stated to play out in recent months, with US rig counts expanding, but we expect it to continue to some extent. Should backwardation continue in the near-term we would expect US shale producers to expand production and resulting in a flattening of the curve and a subsequent move towards contango.

Taking advantage of this potential shift in the oil term structure, we have constructed a trade that takes a short futures position in the front month and a long position in the longer-dated future – our preference would be to combine a Short position in August 2018 position with a Long position in a combination of the December 2019 and December 2020 futures.

Idea specific risks

- Curve risk: Backwardation persists and widens more due to a supply shock.

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Alternatives

Short volatility strategy

Implementation Options – sell a basket of ATM straddles on a basket of securities




Rationale Volatility moved up considerably towards the end of 2017, a trend that extended into Q1 when the VIX spiked from the 10-region to over 50 by early February. This resulted in considerable pain for investors who have been selling volatility through products such as XIV or VXX. However, our strategy of selling straddles on selected indices has meant we were insulated from these moves to a degree, with indices such as the S&P 500 in directional terms only down 0.56 per cent.

The recent move up in volatility has meant that our proposed strategy will draw in more premium (allowing a greater cushion for our break-evens). For example, a 60-day ATM straddle on S&P is indicating 16.3 per cent volatility and would bring in a premium of 5.25 per cent, compared to 3.23 per cent when volatility was at a level of around 10.

To provide more detail, our proposed strategy is to sell straddles (short an ATM call and an ATM put) on our chosen securities (SPY, EWW & FXI) – in this case, our maximum profit (carry) would be the premium we receive from the options. Our breakeven would be the premium received from the shorts and therefore we would not want the underlying asset to move by more than this premium (which is a function of the implied volatility).

We have noted that by systematically selling a straddle on a 60-day basis and closing this out one week before option expiry, we can construct an overall profitable strategy. To illustrate this, we have looked at the implied 60-day volatility and worked out the implied move (in percentage terms). This is then compared to the actual 53-day move of the underlying. The trade is profitable if the ‘actual’ move falls within the ‘expected’ movement bands – in the below two charts, we show for the FXI (China ETF) and EWW (Mexico ETF).

EWW (Mexico ETF) implied vs. actual volatility


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FXI (China ETF) implied vs. actual volatility


We note that despite changing volatility regimes (e.g. as volatility increases, the next contract we roll into will incorporate this move), we see an overall higher percentage of winning trades (i.e. across our chosen securities) and currently selling volatility at least 1 standard deviation from its 2 year average.– this is evidenced in the below table.

Back-testing our short volatility strategy

Ticker Name %

winners %

losers

Current 60-day ATM

volatility

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min

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average

60-day volatility Zscore

SPY US Equity

SPY SPDR S&P 500 ETF Trust

75.00% 25.00% 17.01 23.34 7.62 10.09 2.67

FXI US Equity FXI - iShares China Large-Cap ETF

61.00% 39.00% 25.51 30.37 13.96 18.22 2.09

EWW US Equity

EWW - iShares MSCI Mexico ETFs

63.00% 37.00% 22.32 28.39 16.02 20.21 1.05


We bear in mind that returns (as shown in the table above) can be enhanced (given the strategy requires low margin), and it is possible to employ up to three times gross leverage on capital or invest the excess cash in other investments to capture additional yield.

Idea specific risks

- Large sudden moves in either direction will also lead to a move up in volatility and this will have a negative impact on the mark-to-market of the options that have been sold

- Should the chosen market or ETF price move more than the premium received in either direction, then there will be losses.

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More information Contact

Georgios Ercan Head of Sales

+44 7464 928 255 [email protected]

Authors

Vassilis Papaioannou Stuart Conroy Chief Investment Officer Equity Research Analyst

+44 20 3714 2275 +44 20 3883 1854 [email protected] [email protected]

Josh Jarvis Maksat Stamakunov Investment Advisor Financial Analyst

+44 20 3714 2288 +44 7526 168 260 [email protected] [email protected]

Olga Tschekassin Adrian van den Bok Global Economist Senior Portfolio Manager

+44 7935 504 103 +356 2014 5314 [email protected] [email protected]

About Dolfin

Dolfin is an independent provider of custody, execution and asset management to savvy financial advisers and their clients.

For more, email [email protected], visit dolfin.com, or follow us on Twitter @dolfinhq.

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Disclaimer This document is Investment Research issued by Dolfin Financial (UK) Ltd (“Dolfin”). It provides an analysis of an investment strategy, explicitly or implicitly, concerning one or several financial instruments or the issuers of financial instruments, and includes opinion as to the present or future value or price of such instruments. The information contained in this document does not constitute the provision of investment advice nor a recommendation, offer or solicitation to acquire, or dispose of, any of the financial instruments mentioned and will not form the basis, or a part of, any contract or commitment whatsoever. This Investment Research is independent, on the basis that Dolfin does not have any relationship or association with any party to which a financial instrument mentioned in this document relates, and which may impact on the ability of Dolfin to act objectively.

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