Eastspring’s 2017 Investment Outlook

Asia

Investments Heads from Prudential’s asset manager in Asia, Eastspring Investments, share their views on the outlook for 2017 and find that the biggest risk is not taking on enough of it. The foreword to the report, by Eastspring Global Strategist Robert Rountree, is below and you can find the full report here.

Investors dip their toes in the higher risk pool

Whichever way you slice it, 2017 is shaping up to be an interesting year. Investors, throughout 2016, began jettisoning the caution that characterised many of their dealings throughout 2015. They took on more risk! They seem poised to extend this move as we enter 2017.

There was not a whole-hearted dive into risk, of course. Investors remained wary, shuffling their way towards higher return, higher risk investments but always keeping an eye on the return and risk balance.

High yield bonds offered a comforting return risk ratio

The first stirrings of an attitude change were evident in early 2016 as investors nibbled (sometimes grasping) at high yield bonds (both US and Asian).

Given these bonds possess both bond-like and equity-like characteristics (refer to Fig.1), such an initial move towards more risk made eminent sense, especially if those bonds held good value.

This, we argue (and not just with the benefit of hindsight), they did. The 2015 sell-off in US high yields on falling oil price fears was always excessive, we thought, as the bond prices of lower oil price beneficiaries (e.g. the airlines) and bonds on which oil prices should have little impact (e.g. the banks) sold off as well.

This pricing “contagion” suggested to us across-the-board panic, which often exposes value, deep value. This interplay, incidentally, provides a good example of the herd mentality we like to exploit in our investment process.

Fig 1: High Yielding and Asian Bonds offer attractive yields (even if the Fed does nudge US rates higher)

Fig 1: High Yielding and Asian Bonds offer attractive yields (even if the Fed does nudge US rates higher)

Discovering “thematic” investing provides a “safer” way of taking on risk

While the “risk on” mode was evident, it was also apparent that investors were only prepared to do so if there was the right balance between return and risk. Thematic investments across markets in global low volatility stocks, (i.e. equities that exhibit bond-like characteristics), for example, proved highly popular.

Low volatility was not the only theme to emerge; Real Estate Investment Trusts and high dividend investing also received increasing attention. High dividend investing has been popular in recent years as investors sought to augment returns via higher dividends.

That many of today’s highest dividends are found in the cyclical stocks (given their exposure to growth) adds “spice” to their attraction, but more on this soon.

Investors really threw caution to the wind, however, when it came to the emerging markets. For several years, they had shunned these markets; valuations were driven down towards attractive levels as growth and profit fears prevailed.

2016 saw a sea change. Investors had been too pessimistic; the deep value they identified more than compensated for the perceived risks. Within Asia, the Philippines and Thailand soared. Emerging markets as a whole outperformed the developed markets.

What messages does 2016 hold for 2017?

So where are we going with this? Why have we spent so much time going over what happened in 2016?

Simply, many of the assets investors ran to in 2016 still look attractive. Some look very attractive. The game is not over. The momentum towards risk seems poised to wash into 2017.

Deep value can be spotted not only at the market (refer to Fig. 2) and stock level, but also across many of the “themes” (refer to Fig. 3) that appealed in 2016.

Fig 2: Good value is evident in the “shunned” equity markets.

Fig 2: Good value is evident in the “shunned” equity markets

Fig 3: Asia’s cheap cyclical stocks clawed back lost ground in 2016. There is still a long way to go.

Fig 3: Asia’s cheap cyclical stocks clawed back lost ground in 2016. There is still a long way to go.

In the report’s articles, three of our Investment Heads not only highlight the value they see in their respective areas but also spotlight the dynamics at play in pricing that value out.

Ooi Boon Peng (CIO for Fixed Income) has made the case for slow but stable US growth, low inflation and moderate rises in US interest rates in 2017.

That suggests the conditions for a further move to risk in both bonds and equities seems more than likely. Indeed he sees good yield value in Asian bonds, but is remaining nimble nevertheless.

A common thread running through both Kevin Gibson’s (CIO for Equities) and Nick Ferres’ (Head of Multi Asset Solutions) articles is the extent to which mispricing occurred as investors fled the growth related cyclical stocks (e.g. the banks, industrials and consumer discretionary) towards the “safer” stocks (i.e. those stocks less impacted by slow growth such as utilities, telecommunication services and consumer staples).

Kevin sees this in Asia, the emerging markets and Japan. Nick sees it throughout the global markets. Both are overweighting the cyclical stocks, particularly the banks, as a result.

The paradox is that today, in many instances those shunned cyclical stocks not only often offer the better value but also the higher dividends.

It is very easy to make the case for high dividend stocks, particularly within Asia, but this has been the case for several years.

If Kevin and Nick are correct, the cheap cyclicals - especially those offering high dividends - could well be the next asset class to rally and to price out a glaring valuation anomaly.

To spell it out, the cyclicals could be next in line, hot on the heels of high yield bonds, low volatility and then emerging market equities.

Will this occur in 2017? Are investors ready to take the plunge in 2017 having tentatively dipped their toes in the waters of 2016’s higher risk lake?

It is shaping up like it. And all three of our Investment Heads are ready to “spice up” their portfolios.

To read the articles by the Investment Heads, access the full report available here.

Important Information

This foreword is solely for information purposes and does not constitute an offer or solicitation to anyone to invest in investment products. Past performance is not necessarily indicative of future performance. Any view, opinion, projection, or forecast on the economy, securities markets or the economic trends of the markets is not necessarily indicative of the future performance of Eastspring Investments or any funds managed by Eastspring Investments. An investment is subject to investment risks, including the possible loss of the principal amount invested. Whilst we have taken all reasonable care to ensure that the information contained here is not untrue or misleading at the time of publication, we cannot guarantee its accuracy or completeness. Any opinion or estimate contained here is subject to change without notice.