Dispelling the myth: Volatility can be positive for returns

In 2017, the global economy transitioned from a period of sluggish, US-dominated growth, to a more synchronised global recovery. With inflation still well behaved, corporate earnings grew strongly, buoying both equity and credit markets and suppressing volatility, which reached historically low levels.  So far, 2018 has proved more challenging for some investors. Volatility spiked in the first quarter, driven by the unwinding of US volatility products and then compounded by an increase in global trade tensions and profit taking in US technology stocks. Unanticipated volatility spikes generally hurt in the near term, but they can also offer opportunities. Although generally short lived, the fear of loss among investors drives risk appetite downwards, and derivatives markets become dominated by those looking to hedge against downside risk. As a result, risk premia in option pricing can become elevated and this can create greater opportunity for alternative, option-based strategies to deliver positive returns.

Steve Waddington – portfolio manager. Insight Investment, a BNY Mellon company

 

In 2017, the global economy transitioned from a period of sluggish, US-dominated growth, to a more synchronised global recovery. With inflation still well behaved, corporate earnings grew strongly, buoying both equity and credit markets and suppressing volatility, which reached historically low levels.  So far, 2018 has proved more challenging for some investors. Volatility spiked in the first quarter, driven by … read more

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Weaning China off credit addiction

The Chinese authorities are galvanised to lower the dependence on credit of its economic model so that less credit is needed to generate an increment of GDP growth. Notwithstanding recent efforts to infuse more durable liquidity in to the banking system, going forward, heightened financial oversight of the on- and off-balance sheet usage of credit and further state owned enterprise restructuring will be the norm. This is already achieving some headway. The share of bank deposits as a percentage of Chinese GDP and that of aggregate total social finance (a proxy for on- as well as off-balance sheet lending) have already begun to decline. This development highlights the effectiveness of financial tightening as well as the regulatory crackdown on shadow banking.

Aninda Mitra – Senior Sovereign Analyst. BNY Mellon Asset Management North America

The Chinese authorities are galvanised to lower the dependence on credit of its economic model so that less credit is needed to generate an increment of GDP growth. Notwithstanding recent efforts to infuse more durable liquidity in to the banking system, going forward, heightened financial oversight of the on- and off-balance sheet usage of credit and further state owned enterprise … read more

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Horror on the high street: ‘Experiences over things’ revs up retail apocalypse

Increasingly we are seeing a trend towards consumers valuing ‘experiences over things’ and this is having an impact on the performance of certain sectors. There have been a string of high street casualties in recent weeks, with a number of household names falling into administration. Other brands have been forced to seek help through Company Voluntary Agreements – arrangements with their creditors usually to try and improve lease terms on stores.

Restaurants are not immune to the squeeze in consumer discretionary spending, so while the growth in the sector may seem counterintuitive compared with headlines seen in recent months, it is in particular mid-market chains that are shrinking. We see greater consumer appetite for healthier eating, informal and experiential dining and an increased focus on food provenance and sustainability.

These trends are not unique to the UK, in the US footwear and apparel sales are also lagging other sectors. We believe these trends will materialise at different paces in different countries but for now the ‘experiences over things’ idea remains very much a developed market phenomenon.

Anna Martinez – fixed income analyst. Newton, a BNY Mellon company

Increasingly we are seeing a trend towards consumers valuing ‘experiences over things’ and this is having an impact on the performance of certain sectors. There have been a string of high street casualties in recent weeks, with a number of household names falling into administration. Other brands have been forced to seek help through Company Voluntary Agreements – arrangements with … read more

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The revolution set to save industries $421bn per year

Industry 4.0 – our name for the fourth Industrial Revolution – uses smart technology to enhance manufacturing processes, making them more efficient and more easily adaptable to customer needs. It promises the integration of automation, data, analytics and manufacturing to deliver new business and operating models. Computers and robotics will come together in an entirely new way in ‘smart factories’. Robots will be connected remotely to digital systems equipped with machine learning algorithms. These systems will analyse information coming from the shop floor and control the production line, making decisions with minimal input from human beings.

Future production lines will employ a fraction of the people currently needed, so the impetus for production to happen in low-wage locations may become less important. There may also be a greater need for software engineers who can monitor increasingly complex systems on-site and less need for manual labour.

For these reasons, Industry 4.0 could mean greater investment in production within Europe and the US. As a consequence, the production shift in the late 20th and early 21st centuries to low-wage economies, such as Mexico and Bangladesh, may be reversed. Inevitably, a revolution on this scale will likely shift economic distribution, both from country to country as well as from labour to capital. This could be the most material long-term consequence of Industry 4.0.

Walter Scott Global Equities team

Industry 4.0 – our name for the fourth Industrial Revolution – uses smart technology to enhance manufacturing processes, making them more efficient and more easily adaptable to customer needs. It promises the integration of automation, data, analytics and manufacturing to deliver new business and operating models. Computers and robotics will come together in an entirely new way in ‘smart factories’. … read more

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The risk business: towards a new paradigm?

Geopolitical analysis is an essential piece of investment management that many firms currently neglect. We think markets are not fairly pricing the level of current and potential global geopolitical risk due to distortions such as central bank liquidity. Another explanation for the recent complacency toward geopolitical risk is the rise of exchange-traded funds (ETFs), which has distorted capital flows into equities. However, recent price action of political risk-off assets including gold, the Swiss franc, the Japanese yen and the “Defence” Index (Dow Jones US Select Aerospace & Defence Index) is becoming more acute in response to the most recent geopolitical events. In short, geopolitical risk is starting to get noticed, and we believe active equity asset managers are well positioned to capture the benefits and avoid the pitfalls.

Jim Lydotes – portfolio manager and Richard Bullock – senior analyst. BNY Mellon Asset Management North America

Geopolitical analysis is an essential piece of investment management that many firms currently neglect. We think markets are not fairly pricing the level of current and potential global geopolitical risk due to distortions such as central bank liquidity. Another explanation for the recent complacency toward geopolitical risk is the rise of exchange-traded funds (ETFs), which has distorted capital flows into … read more

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Who wins a trade war?

Trade wars are not won by anyone. Of course, the exporting country loses from a trade war, but so too does the importing one. The reason why there are no winners in a trade war is because it normally leads to the substitution of more expensive goods for cheaper ones. In effect, a trade war denies consumers the efficiency gains that have been realised through the expansion of global supply chains and one only has to go back as recently as 2002, the last time steel tariffs were enacted, to see the potential for damage. Following a spate of mill closures and surging imports, President Bush implemented tariffs on certain steel products. The net effect on employment in the steel industry was minimal, but the businesses that used steel products as inputs shed approximately 200,000 jobs (compared to the 180,000 employed in US steel production at the time).[1]. As a result of these tariffs, US manufacturing firms, in particular smaller companies, were subjected to higher input prices which eroded profitability. Unable to increase prices, once profitable companies were forced to cut production and with it their labour forces, so while the intention of tariffs and trade barriers is to repatriate jobs seen to have been lost overseas, the outcome is often higher prices and jobs losses at home.

Brendan Mulhern – Global Strategist. Newton, a BNY Mellon company

[1]Trade Partnership Worldwide study. The Unintended Consequences of U.S. Steel Import Tariffs: A Quantification of the Impact During 2002 07 February 2003.

Trade wars are not won by anyone. Of course, the exporting country loses from a trade war, but so too does the importing one. The reason why there are no winners in a trade war is because it normally leads to the substitution of more expensive goods for cheaper ones. In effect, a trade war denies consumers the efficiency gains … read more

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Is Spain becoming semi-core?

From a pure economic perspective, we argue Spain has moved from the periphery to a semi-core member of the eurozone. The IMF estimates Spain’s potential growth to have improved from 0% in 2014 to 1.5% this year. In this sense, the structural reforms put in place starting in 2009 have contributed to a fair degree of competitiveness gains and higher potential growth.

More importantly, the market is likely to trade Spain favourably in the coming year. A potential catalyst is likely the S&P’s review of Spain, currently BBB+ with positive outlook, on 23 March 2018.

The growth outlook remains robust, and the Catalonia-Madrid tensions have dwindled; we believe the macro risks have receded sufficiently for the agency to upgrade Spain to A-. With two rating agencies in A-range (Fitch upgraded Spain to A- on 19 January), we believe the market is likely to price Spain as an A credit.

Rebecca Braeu – head of Sovereign Credit and strategy, BNY Mellon Asset Management North America 

From a pure economic perspective, we argue Spain has moved from the periphery to a semi-core member of the eurozone. The IMF estimates Spain’s potential growth to have improved from 0% in 2014 to 1.5% this year. In this sense, the structural reforms put in place starting in 2009 have contributed to a fair degree of competitiveness gains and higher … read more

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CPI, RPI and the true cost of clothing

Have UK clothes prices gone up or down over the last 10 years? Most people would assume that the answer to this would be simple, just look at inflation. But not all inflation calculations are the same, they can use different formulas to calculate price changes and, as a result come to different conclusions.

Most people know that the UK’s Retail Price Index (RPI) differs from the Consumer Price Index (CPI), as RPI includes housing costs in the form of council tax and mortgage interest payments, but the differences between the two indices are deeper than this. For example when you compare clothing and footwear prices over the last twenty years, both CPI and RPI show prices declining during the first ten years, but for the second ten years a clear divergence appears.

The reason for this disparity comes down to calculation method. RPI uses the ‘Carli’ formula for around 30% of the prices it measures (including clothing and footwear), a measure that has previously been criticised for introducing an upward bias to inflation data. But even the initial decline is questionable! The Bank of England (BoE) have stated that annual CPI inflation may have been underestimated by up to 0.3% a year between 1997 and 2009 as a result of seasonal sales for clothing and footwear which saw discounts being captured by the data, but not the recovery back to normal prices as the sales ended. This led to a change in methodology being introduced at the start of 2010.

With inflation at the top of the BoE’s tolerance threshold, the Monetary Policy Committee will need to make a judgement on how quickly they need to raise interest rates. Understanding these intricacies of inflation measurement is a critical part of their role.

David Hooker – portfolio manager. Insight Investment, a BNY Mellon company

Have UK clothes prices gone up or down over the last 10 years? Most people would assume that the answer to this would be simple, just look at inflation. But not all inflation calculations are the same, they can use different formulas to calculate price changes and, as a result come to different conclusions. Most people know that the UK’s … read more

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Flying high: the rise of the drones

Until recently, drones or unmanned aerial vehicles (UAVs) were most commonly recognised for their military application and, in small scale, as children’s toys. Now, via new technologies, they have uses in areas such as farming, industrial inspection, mapping and search and rescue. Commercial drones are fast becoming big business.

Many drones now carry infrared sensors, which allow them to “see” heat at great distances. For search and rescue and first responders, the technology could make rescue efforts faster and more efficient. UAVs can also cross sector verticals and have applications throughout nearly every industry, aided in part by new sensors like infrared. Energy companies can use them to inspect pipelines and solar farms to prevent leaks and boost efficiencies and transportation and infrastructure companies can test ageing infrastructure to improve safety. Agricultural and mining applications can boost yields and lower costs with improved mapping techniques.

The increasing sophistication and application of drones presents exciting potential to both businesses and tech-savvy investors. Autonomous drones, capable of operating independently, are also in development and could be a reality in the next three to five years. UAVs offer the potential to boost productivity via higher efficiency and resource utilisation as well as lower costs. UAVs may reduce environmental accidents by identifying looming risks. The sky really may be the only limit.

Robert Zeuthen – senior equity analyst, BNY Mellon Asset Management North America.

Until recently, drones or unmanned aerial vehicles (UAVs) were most commonly recognised for their military application and, in small scale, as children’s toys. Now, via new technologies, they have uses in areas such as farming, industrial inspection, mapping and search and rescue. Commercial drones are fast becoming big business. Many drones now carry infrared sensors, which allow them to “see” … read more

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Tech stocks: Have we returned to ’99?

Over the 12 months to 31 December the FANG[1] stocks rose on average some 50% in US dollar terms, while the broader S&P 500 rose just 23%. Asia too has its own tech leaders, colloquially known as the BAT stocks (Baidu, Alibaba and Tencent) and they, like FANGs, experienced spectacular returns in 2017 (up on average c80% in US dollars over the same time frame).

Without these ‘Dracula’ stocks (the FANGs and BATs combined), markets like the S&P 500 would certainly have been less exuberant over the past year.

The last tech bubble came at the close of the millennium. In our view, investors in the current crop of technology stocks have partied like it’s 1999 all over again. While this is fine in theory we prefer to take a less short-term view. To paraphrase the immortal words of Prince Rogers Nelson: “Life is a party but parties weren’t meant to last”. [2]

Nick Clay – portfolio manager. Newton, a BNY Mellon company

[1] The term FANG stocks refers to Facebook, Amazon, Netflix and Google (subsequently renamed as alphabet)

[2] From the song 1999 by Prince, released 24 September 1982, re-released 3 November 1998

Over the 12 months to 31 December the FANG[1] stocks rose on average some 50% in US dollar terms, while the broader S&P 500 rose just 23%. Asia too has its own tech leaders, colloquially known as the BAT stocks (Baidu, Alibaba and Tencent) and they, like FANGs, experienced spectacular returns in 2017 (up on average c80% in US dollars … read more

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