In equity markets, the descent can be more hazardous than the ascent

A correction at the end of January has ushered in a period of relatively heightened volatility through 2018, as markets have come to focus more on potential headwinds and attention has started to swing away from growth-orientated stocks, to ones with more defensive qualities, better able to operate through more challenging market-cycle conditions. In our view, while markets have regained some poise over recent weeks, further market falls are possible against the volatile backdrop. Is it best to keep chasing momentum and growth or to hunker down and invest in companies with more defensive qualities?

In attempting to answer this question, it is informative to look at 40 years of data from the S&P 500 index of US equities and the asymmetry between the effect of falling markets and rising markets on investors’ overall returns. Put simply, it has been far better for investors to miss out on the 10 worst market days over the past four decades, than to have missed out on the 10 best days.

To draw on a mountaineering analogy, many more climbers die on the way down from the summit than on the way up. Much of this could be down to the fact that a climber will use up the majority of their resources on the way up, and will be more tired physically and mentally on the descent when many of their supplies have been exhausted.

Similarly, the asset inflation driven by loose central-bank monetary policy and the abundance of cheap debt has helped propel markets to historic highs, but as resources are increasingly withdrawn, there is far less left in the tank to sustain the markets’ upward trajectory.

To us, using the mountaineering analogy again, the message seems clear: it is more important to acclimatise, prepare properly and manage resources prudently to boost your chances of surviving the descent. In the case of equity markets, we think one way to achieve this could be to invest in companies with strong balance sheets and visible, recurring cash flows that can be captured in the form of dividend income, to help augment returns when markets are volatile or on their way down.

Nick Clay – portfolio manager, Newton Investment Management.

A correction at the end of January has ushered in a period of relatively heightened volatility through 2018, as markets have come to focus more on potential headwinds and attention has started to swing away from growth-orientated stocks, to ones with more defensive qualities, better able to operate through more challenging market-cycle conditions. In our view, while markets have regained … read more

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Roll out the barrel: positive signs ahead for global beer brewers?

The beer market is highly concentrated with the top five brewers producing about 50% of global volumes and controlling 65% of industry profits.  Volume growth has slowed and has been broadly flat in recent years due to both macro and more structural issues.  A recovery in emerging markets where per capita consumption of beer is still relatively low should see the category back to growth, but more structural volume headwinds particularly in developed markets persist.  In many developed markets demographics are less favourable, per capita consumption is mature and younger generations of consumers are drinking less alcohol than their parents and grandparents.  However, it is not all doom and gloom in developed markets.  While volume growth has stagnated, consumers aspire to “drink better” trading up to more expensive craft beers, low/no alcohol beers and flavoured malt beverages.  Emerging markets have also seen increasing demand for premium products, and the roll out of higher-priced global brands has accelerated.   Premiumisation in both developed and emerging markets has driven category value higher even as volume has remained stable.

Paul Flood – multi-asset manager, Newton Investment Management

The beer market is highly concentrated with the top five brewers producing about 50% of global volumes and controlling 65% of industry profits.  Volume growth has slowed and has been broadly flat in recent years due to both macro and more structural issues.  A recovery in emerging markets where per capita consumption of beer is still relatively low should see … read more

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Japan: Bridging the productivity gap

As Japanese society ages it will need to rely ever more on automation and new technology to bridge the productivity gap. That creates a requirement for robots to start taking on the jobs that people used to do. Employment data and labour force projections underline the point.

The Japanese jobs-to applicants ratio has soared while the unemployment rate has plummeted as the economy recovers from 20 years of stagnation and deflation during which the nominal GDP actually contracted.

Meanwhile, even though more women are entering the workforce, the number of people in work will plateau at best in the next decade. Together, the combination of a tight labour market and the structural trend of an ageing population create a real need for an automated future.

Miyuki Kashima – head of Japanese equity investments. BNY Mellon Japan

As Japanese society ages it will need to rely ever more on automation and new technology to bridge the productivity gap. That creates a requirement for robots to start taking on the jobs that people used to do. Employment data and labour force projections underline the point. The Japanese jobs-to applicants ratio has soared while the unemployment rate has plummeted … read more

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Turkey: The canary in the coal mine?

Should the recent financial turmoil in Turkey be considered an isolated event or is it one of those financial canaries in a coal mine? On the one hand, it is clear that local policy and president Erdoğan’s bellicose handling of foreign relations have both contributed to the slide in Turkish assets. Those who believe such factors have been the main driver of the sell-off argue that Turkey is going bust for idiosyncratic reasons, and so maintain that a relatively risk-on stance is appropriate.

To us, there is little doubt that the protracted nature of Turkey’s bubble has ensured a deep structural maladjustment, misallocated capital and financial excesses. The risk is that, should the market continue to command higher yields on Turkish assets in order to provide compensation for increased risks, those financial excesses may prove unsustainable. Should Erdoğan adopt a more market-friendly approach to international relations and a more orthodox approach to domestic fiscal policy, perhaps Turkish yields will decline to a level where financing costs are consistent with sustaining the status quo.

However, the other school of thought is to view Turkey as merely the symptom of a wider liquidity malaise globally. The evidence increasingly suggests that the environment of self-reinforcing expanding liquidity, indiscriminate buying of financial assets (speculation) and rising asset prices/bullish trends has come to an end. In this context, declines in Turkish asset prices are met with selling rather than being regarded by many as a dip to be bought. Moreover, while Turkey is the most conspicuous example of this pattern to date, we believe it is one that is becoming increasingly widespread, marking a departure from market dynamics in 2017.

Brendan Mulhern, global strategist. Newton Investment Management, a BNY Mellon company

Should the recent financial turmoil in Turkey be considered an isolated event or is it one of those financial canaries in a coal mine? On the one hand, it is clear that local policy and president Erdoğan’s bellicose handling of foreign relations have both contributed to the slide in Turkish assets. Those who believe such factors have been the main … read more

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Gearing up for a 5G revolution?

The last transition we had in the market was from 3G service to 4G which was largely about increasing the speed of online communication. But 5G is a more complex cellular technology which will enable completely new types of application, allowing users access to new wireless spectrum that was previously unusable with earlier technologies.

Lower latency – or responsiveness of 5G – opens up scope for new millisecond time applications such as controlled drones, autonomous vehicles and a host of other applications. 5G is really going to be about the internet of things and there will be a lot more machine to machine communication happening over its wireless networks.

A lot of operators have spent the last couple of years deploying fibre and today are now the owners of those fibre assets. While they have spent money on this infrastructure in many cases it is underutilised. As we move closer towards an interconnected world, we expect the market to put a higher value on those fibre infrastructure assets and for there to be opportunities to profit there. In the final analysis, smart cities could encompass a million applications which we haven’t even thought of yet, though you do have to enable it first.

Matthew Griffin, senior research analyst. The Boston Company, BNY Mellon Asset Management North America Corporation

The last transition we had in the market was from 3G service to 4G which was largely about increasing the speed of online communication. But 5G is a more complex cellular technology which will enable completely new types of application, allowing users access to new wireless spectrum that was previously unusable with earlier technologies. Lower latency – or responsiveness of … read more

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Mind the gap: why gender diversity matters.

Gender equality has proved a high profile media topic in the past year, with the #MeToo and #TimesUp campaigns garnering global support and attention. Recent UK pay-gap figures have also revealed the stark pay inequalities that still exist between the sexes in most industries and companies. Many such conversations centre around the possible social impact of supporting gender equality in the workplace. However, research shows that along with having a positive social impact, increasing the number of women in the workplace (and supporting them once they’re there), carries a host of potential macroeconomic benefits. This suggests working to achieve gender parity should be on the agenda of all investors, not just those with a social impact focus.

Research shows that global educational attainment is essentially very equal. For example, Saudi Arabia, where women have only recently been allowed to drive and enter sports stadiums, has a marginally higher proportion of women than men enrolling in primary education than Iceland – a notably progressive country in gender parity terms. However, despite accounting for 50% of the global working-age population, women only generate 37% of global GDP, suggesting they are a seriously under-utilised economic resource given their comparable levels of education.

Much of this discrepancy can be explained by two key factors. Firstly the lack of women in leadership positions, both professional and political, and secondly the huge amounts of unpaid care work being done by women compared to men. There are three primary benefits of increasing equality in female participation in the workforce – not just in terms of the numbers of women in work but also by improving equality in senior positions and across the sectors.

Lottie Meggitt – Responsible investment analyst. Newton Investment Management, a BNY Mellon company

Gender equality has proved a high profile media topic in the past year, with the #MeToo and #TimesUp campaigns garnering global support and attention. Recent UK pay-gap figures have also revealed the stark pay inequalities that still exist between the sexes in most industries and companies. Many such conversations centre around the possible social impact of supporting gender equality in … read more

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Ready to unwind? Telling the time in bond markets

Our current macro view is that bond markets are in the middle of a transition year. This is owing to the gradual US monetary tightening process currently underway, which has a negative impact on different sectors of the bond market at different stages in the economic cycle.

First to feel the negative impact of the tightening were developed-world government bonds, followed by emerging-market sovereign bonds. Finally, the effects ripple out into the real economy and thus to high-yield corporate bonds. To help map out how this process plays out, we have put together the clock below, to show which parts of the bond market are affected, and at what ‘time’ in the market cycle.

Prior to 2016, we were at midday on the clock – the growth stage – when economic growth was strong and monetary policy was loose. Then the US Treasury market started to react to the US Federal Reserve’s (Fed) decision to raise rates and talk of reducing its balance sheet, which sparked a sell-off in US Treasuries in the second half of 2016. This period equates to 4pm on the clock above.

We have been experiencing stage three – the unwinding of US monetary policy (8pm on the clock) – since the beginning of this year, as the tightening of US-dollar liquidity causes stress in emerging-market countries exposed to US borrowing. Stage four, at 9pm on the clock, is the point at which US Treasuries rally and credit sells off as the economic outlook deteriorates. At this stage, we think high-yield bonds (and probably equity markets) are likely to be in decline on the negative outlook.

Our best guess is that this could occur in the fourth quarter of 2018 as the market becomes concerned about 2019 economic growth forecasts, and is able to make an educated guess as to when the Fed will stop raising rates. As the clock shows, the tightening cycle is gradual, but eventually there will be a price to pay for assets that have run ahead of growth.

Paul Brain – head of fixed income. Newton Investment Management, a BNY Mellon company

Our current macro view is that bond markets are in the middle of a transition year. This is owing to the gradual US monetary tightening process currently underway, which has a negative impact on different sectors of the bond market at different stages in the economic cycle. First to feel the negative impact of the tightening were developed-world government bonds, … read more

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Taking charge: How battery technology advances could fuel a new boom in electric transport

As the electric and autonomous vehicles markets evolve, significant advances are being made in battery technology and the race is now on to build battery packs that can compete on cost with the internal combustion engine.

There is a lot of debate about how much battery packs of the future will cost with a target of US$100 per kilowatt-hour often held up as the figure which will make them competitive with conventional petrol and diesel fuelled engines. Given recent technological advances, that could be achievable by 2022-23.

Battery costs have already been dropping at about 15% per year over the past decade. Scale manufacturing and adjustments in the way chemicals and technology are applied in battery construction are also helping to improve battery energy density and the range they allow electric vehicles to travel.

Major tyre manufacturers are also addressing the challenges set by the weight of EVs by developing better tyres specifically designed for them. Because of the sheer weight and the higher torque of electric battery driven vehicles, their wheels do need stronger tyres with lower rolling resistance. Tyres will need to improve over time to support this market.

Frank Goguen and Barry Mills, senior research analysts. The Boston Company, a brand of BNY Mellon Asset Management North America Corporation

As the electric and autonomous vehicles markets evolve, significant advances are being made in battery technology and the race is now on to build battery packs that can compete on cost with the internal combustion engine. There is a lot of debate about how much battery packs of the future will cost with a target of US$100 per kilowatt-hour often … read more

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The BBB conundrum: an accident waiting to happen?

The composition of the US corporate investment grade (IG) market has undergone a dramatic transformation over the last decade. A boom in debt-fuelled M&A and share repurchase activity has contributed to an increase in leverage and an explosion in BBB-rated US IG corporate debt. There are signs that while downgrades have happened, credit rating agencies have been arguably too lenient in some cases, placing too much faith in the ability/desire of companies to de-lever within a target timeframe.

However, the general trend of increased leverage is consistent with a strengthening economic backdrop. The US economy remains in the midst of a protracted economic expansion that began almost a decade ago and, should it continue into summer 2019, will become the longest expansion in its history. Along with the recent tax reforms, this presents a very favourable environment for corporate America. The tax reforms should lead to an improvement in corporates’ free cash flow, which would enable them to manage higher leverage burdens; and the now higher after-tax cost of debt makes it less attractive from an issuer’s perspective. This should pour some cold water on opportunistic debt issuance. Along with still-easy monetary policy, an economy at full employment and the Federal Reserve’s preferred measure of inflation hitting 2% for the first time in six years, and the increase in corporate leverage makes more sense.

We would also note that valuations of BBB-rated debt still appear attractive in the context of historical loss rates. That said, if the credit cycle turns and companies do not sufficiently delever, rating agencies may be forced to downgrade some of these large-cap companies to high yield. We therefore believe security selection has become ever-more important.

Peter Bentley – head of UK and global credit. Insight Investment, a BNY Mellon company

The composition of the US corporate investment grade (IG) market has undergone a dramatic transformation over the last decade. A boom in debt-fuelled M&A and share repurchase activity has contributed to an increase in leverage and an explosion in BBB-rated US IG corporate debt. There are signs that while downgrades have happened, credit rating agencies have been arguably too lenient … read more

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Emerging market sell-off: an untimely exit?

There is no doubt emerging markets have had a rough run since the start of the year, and it is easy to understand why investors are skittish. Events, such as Italian politics and Trump’s future behaviour on trade, could create negative shocks and are tough to measure or anticipate. However, we think the move away from EM may be premature; our global macro outlook actually supports the asset class.

We expect the main external drivers lead to a reversal of recent trends and bolster EM assets such as local currency debt. While US rates will likely continue moving a bit higher, the bulk of expected Federal Reserve hikes are already priced in forward curves. A relative healthy global growth outlook continues to support commodity prices, an obvious boon to many commodity exporters. Finally, we believe some fundamental drivers for US dollar depreciation remain intact. We also think the dollar is expensive, particularly when considering mounting twin external and fiscal deficits. As the dollar begins to slide, which we expect, it will create a tailwind for the asset class. While we may have to be more patient, we think the asset class will recover and likely post notable returns.

Federico Garcia Zamora – portfolio manager. Standish, BNY Mellon Asset Management North America

There is no doubt emerging markets have had a rough run since the start of the year, and it is easy to understand why investors are skittish. Events, such as Italian politics and Trump’s future behaviour on trade, could create negative shocks and are tough to measure or anticipate. However, we think the move away from EM may be premature; … read more

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