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Deutsche Bank Annual Outlook Wealth Management EMEA CIO Insights Reality check — 2018 The investment landscape ahead
CIO Insights
Letter to Investors
2
Letter to Investors
Reality check
Overall, 2017 turned out to be a good year for investors with
synchronized global growth translating into healthy returns for most
Christian Nolting
risky assets. Investors also became accustomed to low levels of
Global CIO
volatility.
Looking forward into 2018, Gross Domestic Product (GDP) growth
is likely to remain at similar levels to 2017, and there seems to
be room for some further price expansion in risky assets. But it
would be a mistake to assume that continued economic growth
will automatically translate into a similarly high level of investment
returns as in the year just ending or that these returns will be We expect
repeated again throughout the coming year. In short, we need an
investment “reality check”.
another year of
positive, if rather
We expect another year of positive, if generally rather lower,
investment returns. But as we discuss in our Ten Themes for 2018
(starting on page 5), this year will be subtly different from 2017. We
lower, investment
believe that you should be prepared for, at the least, higher levels
of volatility: as we put it, forewarned is forearmed (Theme 1). Our returns.
central macroeconomic scenario is that growth gazumps geopolitics
(Theme 2) but it is worth considering some alternative risk scenarios
and what they might mean, as we do on page 17: politics is not
the only threat here and we would keep an eye on inflation too, for
example.
A crucial focus will be the consequences of central banks in
transition (Theme 3). Efforts to return to a more traditional monetary
policy approach will continue. We think that they will proceed very
cautiously and that their approach will manage to avoid major
asset class reversals. But even the most gentle withdrawal of policy
support could blunt some asset class returns. For this reason, we
would suggest that you, for example, “flashlight” fixed income
(Theme 4): shine the light into each compartment of this asset class
and take a realistic view of what is possible.
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a
reliable indicator of future performance. Readers should refer to disclosures and risk warnings at
the end of this document. Produced in December 2017.CIO Insights
Letter to Investors
3
As we tread higher up the investment 8): economic and policy fundamentals
returns mountain, the journey will could be in conflict here with shorter-
I remain a strong become more tiring. Nonetheless, we term factors. Oil markets seem unlikely
think that there is still some oxygen for to be upset, however, and we expect a
believer in being equities (Theme 5). But, as they climb strong case of oil déjà vu (Theme 9) – we
higher, markets will need the support think that the potential for higher U.S.
invested and staying of solid earnings growth as we do not production will continue to keep a lid on oil
expect a further expansion in valuation prices, as it did in 2017. Finally, we look at
invested but we need to multiples. Within this asset class, we key selected longer-term portfolio drivers
see the potential for further gains in in tomorrow’s themes today (Theme 10)
be realistic about what the “new” emerging (EM) Asian equity and this year highlight smart mobility
market (Theme 6) where valuations are and artificial intelligence (AI) as likely
is achievable still attractive, and which should gain economic disruptors.
from the region’s increased exposure
to technology. But with returns in I remain a strong believer in being
conventional assets and asset classes invested and staying invested, but I think
probably lower on average than in 2017, that we all need to be realistic about what
and volatility higher, we think that it could is achievable and try at all times to avoid
be worthwhile to explore investment complacency - a potential danger in the
alternatives (Theme 7). coming year. 2018 will mark a decade
since the start of quantitative easing (QE)
During 2018, in an environment of slow by the Fed and I think that the process
but continuous change in monetary policy, of exiting it will be as interesting as QE
unexpected events could well lead to more was. This new and evolving political and
volatility than in 2017. Exchange rates are policy landscape will generate plenty of
usually an early echo of such uncertainty investment opportunities: watch out for
and we would expect dynamic foreign them.
exchange (FX) drivers in 2018 (Theme
Christian Nolting
Global CIO
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Contents
4
Contents
5 Ten Themes
24 Alternatives
Ten Themes Hedge funds
for 2018
16 Macroeconomics
25 Data tables
Growth without Macroeconomic
tears forecasts
18 Multi Asset
26 Data tables
Forward but Asset class
not so fast forecasts
Inside the cover
Looking forward into 2018, we can see a
fertile landscape for investment returns, 20 Equities
27 Glossary
but with sunlight sometimes interrupted
by clouds.
Room for more
29 Disclaimer
22 Fixed income and foreign exchange
34 Contacts
Compliments
of the chef
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
5
10 Themes
for 2018
Forward but not so fast
2017 was characterized by resilience, accelerating growth,
low volatility and earnings growth. With economic growth
accelerating around the globe in a synchronized manner, financial
markets notched up healthy returns. However, 2018 is likely to
be rather different. Our base case scenario is that GDP growth
remains close to current levels in most economies: global growth
is put at 3.8% in 2018 after 3.7% in 2017. However, continued
growth does not necessarily lead down a one-way path of
positive returns. Elevated valuation levels across most asset
classes suggest that markets have anticipated this revival of
economic strength. So as not to extrapolate the performance
of 2017, we believe a “reality check” is in order, which is the
backdrop of our Ten Themes for 2018.
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
6
01
180
160
140
120
100
80
Forewarned 60
is forearmed
40
20
0
VIX VSTOXX MOVE Oil Gold
95% of Historical Range Average Spread Level Current Spread
Figure 1:
Volatility is at abnormally low levels
Source: FactSet, Deutsche Bank Wealth Management. Data as of November 28, 2017.
95% of historical range is between the 2.5% and 97.5% percentiles.
Volatility is not just depressed in the asset classes priced close to perfection
equity market, but is near record lows in (in other words, on the assumption that
almost all asset classes. To put it another everything goes right), they could be
way, the S&P 500 looks like it could vulnerable to short-term reversals.
complete 2017 without a pullback of 5%
or more – for the first time since 1995. Investment implications
But this is not the time to be complacent: This is the time to start thinking about
low levels of volatility are unlikely to be reconfiguring portfolios. Being realistic
sustained through 2018. There are plenty is key. Selectivity, active management,
of potential political risks out there, for risk management (perhaps through risk
example in U.S. politics (run-up to the return engineering and option overlays)
mid-term elections, Trump legislative and tactical positioning are likely to be
agenda), European politics (Brexit, Italian important drivers of performance.
elections) or geopolitical events featuring
Saudi Arabia or North Korea. With many
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
7
02
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
Growth gazumps
geopolitics 0.5%
0.0%
-0.5%
-1.0%
Nov 82 Nov 87 Nov 92 Nov 97 Nov 02 Nov 07 Nov 12 Nov 17
U.S. 10-year minus 2-year yields U.S. recessions
Figure 2:
U.S. yield curve inversion historically precedes recessions – but with a gap
Source: Thomson Reuters, Deutsche Bank Wealth Management. Data as of November 17, 2017.
While geopolitical and domestic political rising unemployment) that may tell us if
concerns will continue, we expect growth the U.S. economic expansion is set to hit
momentum in the major developed and an inflection point or continue its upward
emerging market economies to come trajectory. But history suggests that
out on top. Consumer demand will likely even if we get a U.S. yield curve inversion
be the key driver of global growth as the (which still appears some way off), then
probability of recession remains fairly low we still could be many months away from
over the course of the year in all major the start of recession.
economies. Individual and corporate
tax cuts remain a catalyst for better Investment implications
U.S. growth. While the positioning of Continued growth should help risky
individual countries within the business assets, and will probably favour equities
cycle can be debated, the reality is that over bonds. Strong domestic demand
the major driver and determinant for growth could aid certain market
financial markets will be the U.S., which segments, for example small cap equities
is in a late phase of the economic cycle. in the U.S. and European small/mid cap
As a result, we will look out for key equities.
indicators (e.g. U.S. yield curve inverting,
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
8
03
USD bn Peak QE:
200 March 2017
Forecast
150
100
50
Central banks 0
in transition
-50
08 09 10 11 12 13 14 15 16 17 18 19
BoE Fed BoJ ECB Total
Figure 3:
Central bank bond purchases are starting to slow
Source: Deutsche Bank Global Markets, Deutsche Bank Wealth Management. ECB and Fed data
is for six month moving averages; others are 12 month moving averages. Assumptions are that
the Fed will redeem maturing assets as per the announced cap during their September 2017
decision. We assume that the ECB will cut buying to €30bn per month from January 2018 to
September 2018 and then to €10bn a month in October, November and December 2018, and
then to zero for 2019.
Global central banks are likely to remain Investment implications
accommodative even as some slowly Generally accommodative central banks
begin the normalization of their balance will favour risky assets overall. Further
sheets. The Fed could prove to be slightly Fed tightening could also strengthen
more hawkish in 2018 than in 2017, but the U.S. dollar, at least early in the
the broad thrust of policy will continue, year, with implications for investment
as the ECB and BoJ move only slowly returns – it would, for example, benefit
to reduce asset purchases. However, the total return of U.S. bonds relative to
changes in the U.S. Federal Open Market Europeans. In the bond sector, we would
Committee (FOMC) composition will favour active management and also be
add to uncertainty, and markets will also cautious on European core government
be thinking about future changes in the bonds – short and long duration – but
leadership of the European Central Bank we stay positive on emerging markets
(ECB) and Bank of Japan (BoJ). Inflation hard currency bonds. Floating rate bonds
could start to become more of an issue – could be useful as the shorter end of the
perhaps due to growing upwards wage yield curve moves higher.
pressure - but won’t derail the current
policy trajectory.
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
9
04
bps
1000
900
800
700
600
500
400
"Flashlight" 300
fixed income
200
100
0
U.S. High Yield EUR High Yield U.S. Investment Grade EUR Investment Grade EM Bonds
95% of Historical Range Average Spread Level Current Spread
Figure 4:
Corporate spreads are close to the bottom of their historical range
Source: FactSet, Deutsche Bank Wealth Management. Data as of November 28, 2017. 95% of
the historical range is between the 2.5% and 97.5% percentiles. High yield spreads are truncated
on the upside (U.S. = 1455, EUR = 1836).
The authenticity of the thirty year plus struggle in 2018. There will continue
bull market in bonds in recent years has to be high quality carry opportunities,
been challenged by the unprecedented but the overall picture suggests that
non-traditional, quantitative easing (QE) the return profile in credit will be less
policy of global central banks. In fact, attractive than in 2017.
the Federal Reserve estimates that their
massive bond buying has depressed Investment implications
10-year Treasury yields by ~100 bps. In Many sovereign bonds could have
fact, due to QE, around 17% of all bonds negative performance in 2018 as policy
outstanding (sovereign and credit) trade normalization continues. Within the
with negative interest rates. As investors main credit space, you will need to be
have moved into more risky fixed income selective. Emerging markets are still
sectors in the search for yield, this has likely to provide opportunities, with our
compressed yields significantly – to forecasts suggesting that emerging
the extent that European high yield market sovereigns could offer the highest
has recently been yielding less than total returns in the fixed income space in
the 10-year U.S. Treasury. Against this 2018.
background, government bonds will likely
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
10
05 2008
39.9%
36.4%
io n
10
2011 ea
rs
pe
-Y
rA
v e ra g e D is
37.0%
2012
27.5%
2009 2013 2016
52.8% 31.6% 30.1%
Still some oxygen
for equities 2015
31.2%
2014 2017
2010
36.8% 48.6%
24.8%
S&P 500 Sector Dispersion
Figure 5:
Equities sector dispersion is growing again
Source: FactSet, Deutsche Bank Wealth Management. Data as of November 29, 2017.
Global equity markets have hit multiple strong. Emerging markets could slightly
record highs in 2017, but there is room outperform developed markets over the
for further, probably smaller, gains on the next 12 months and our focus here is
back of continued economic growth. The on Asia (see next theme), but selectivity
truth is that earnings will need to be the will be important. At a sectoral level, we
driver of equity performance as valuation would suggest following earnings growth
multiples are likely to contract slightly. (e.g. technology and financials) and we
Selectivity is going to be critical as sector have tactical global overweights on both
dispersion will probably continue to grow. these sectors and healthcare. We have
an underweight on telecoms and utilities.
Investment implications Intra-sector correlations are notably
At a geographic level, there are lower now than a year ago and this trend
arguments to favour Europe and Japan may continue into 2018, providing a
over the U.S., but regional differentiation further argument for stock selection.
within the developed markets may not be
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
11
06
20.4% 18.0% 21.2% 20.7%
2007 2008 2009 2010
17.4% 17.2% 18.4% 18.6%
23.9% 26.3%
20.5% 22.3%
2011 2012 2013 2014
The "New" EM 18.8% 16.6% 14.5% 12.3%
Asia equity market 32.8%
38.9%
26.3%
2015 2016 2017
10.6% 10.4% 10.1%
Info Tech Weight Commodities Weight (Energy and Materials)
Figure 6:
Importance of Tech in MSCI Asia ex-Japan has risen sharply
Source: FactSet, Deutsche Bank Wealth Management. Data as of November 28, 2017.
The outperformance of emerging equities is their increasing exposure
markets in 2017 had its foundations in to the tech sector, one of our favourite
above-average earnings growth and sectors. Whereas commodities (energy
substantial upward revisions to earnings and materials) had the largest weighting
estimates through the year. We expect in the MSCI Asia ex-Japan 10 years ago,
that environment to continue, particularly tech now leads the rankings with a 39%
for Asian emerging markets where solid share.
economic growth is encouraging double
digit earnings growth; upwards revisions Investment implications
made to expected 2018 earnings are Favour Asia within emerging markets.
also the strongest in any region. Despite Active management could be important,
this, Asia still has attractive valuations, with tech becoming a bigger story in
for example relative to the MSCI AC Asian emerging markets.
World Index. Another important dynamic
driving our preference for Asian EM
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
12
07
7.7% 8.1%
6.9% 6.5% 6.2%
4.8%
Australia China Japan
4.2%
6.2% 5.4%
7.0% 6.6% 6.5%
8.4% 8.1%
5.6% 6.1%
5.3% 5.8%
France Germany Italy
3.8%
Explore investment 5.3% 4.9% 6.0% 4.2%
7.1%
alternatives 7.7% 9.0%
5.7% 5.6% 6.6%
6.2%
Spain UK U.S.
5.3% 5.4% 5.3%
6.3%
7.6% 7.6%
Industrials Office Retail Total
Figure 7:
Forecast real estate returns on a 5-year annualized basis
Source: Deutsche Asset Management, Deutsche Bank Wealth Management. Data as of
September 2017.
Expectations of slimmer pickings Investment implications
in equities and fixed income should Hedge funds and some other alternatives
encourage exploration of investment may in some cases be able to mitigate
alternatives (which does not necessarily downside risk, but this will depend on
mean alternative investments). One the type of hedge fund strategy used.
time-honoured use of different sorts Other specific areas such as hybrids,
of investment is diversification: over convertibles, and floating rate bonds
the long-term, non-traditional asset could be interesting, but be selective on
classes such as real estate, hedge funds, real estate (by type or geography). Look
convertibles and floating rate bonds can also at new, non-traditional alternative
provide a different mix of return levels vs. approaches such as factor investing and
variability of returns and thus help “plug big data. But please note that alternative
the gaps” in a portfolio. investments are not suitable for and may
not be available to all investors.
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
13
08
145 0%
143 5%
141 10%
139 15%
137 20%
135 25%
Dynamic 133 30%
FX drivers 131 35%
129 40%
127 45%
125 50%
14 15 16 17
Euro Trade Weighted Index Sentix Euro Break-Up Index (rhs, inverted)
Figure 8:
Italian election could pose a euro risk
Source: Bloomberg Finance LP, Sentix, Deutsche Bank Wealth Management. Data as of
December 2, 2017. Break-Up index measures probability given by investors to a break-up of the
Eurozone in the next 12 months.
Multiple factors will drive exchange rates markets looking for clues from a wide
in 2018. During 2017 the relationship range of political, policy and economic
between the U.S. dollar and the euro indicators, currencies could be more
drifted apart from that between U.S. and vulnerable to volatility in 2018.
European 2-year yields and alternative
drivers are already in play. In addition to Investment implications
interest rate differentials, central bank Favor the U.S. dollar in early 2018, in the
rhetoric, politics (e.g. tax cuts) and fund wake of Fed tightening, but be prepared
flows exist and can impact valuations. for a euro revival later in the year.
Note, for example, the relationship Look beyond investing around obvious
between President Trump’s approval currency pairs: consider, for example,
ratings and the DXY dollar index. a trade-weighted U.S. dollar index or a
Specific drivers in 2018 could include basket of the currency against sterling,
U.S. earnings repatriation benefiting the Japanese yen, the Swiss franc and
the U.S. dollar and fears around the the Chinese renminbi. Minor currency
Italian election impacting the euro. With pairs could also offer opportunities.
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
14
09
$60
$58 Current WTI Price
$56
$55
$54
$53
$52
$50
$50
$48 $48
Oil déjà vu
$48
$47
$46 $46
$44
$42
$40
Permian Scoop Eagle Ford Permian Permian Other U.S. Other U.S.
(Delaware) (Central) (non-shale) (shale)
Mean Breakeven Prices for New Wells by Region
Figure 9:
Oil prices are now above U.S. breakeven levels
Source: FactSet, Deutsche Bank Wealth Management. Data of November 2017.
We don’t expect a further surge in oil production will rise to a record high of
prices, but be aware that oil market 9.8mn b/d. It is also possible that further
dynamics are shifting. In particular, rising increases in U.S. oil rig productivity lift
political tensions in the Middle East production further. A further negative
may add to concerns about temporary factor on global oil prices over the longer
supply disruption. Short-term spikes in term could be the changing energy-use
prices are possible but we continue to landscape with (for example) increased
believe that U.S. production will likely use of electric vehicles lowering oil
accelerate in response to higher prices, demand.
ultimately keeping a lid on them. Oil
prices are currently well above estimated Investment implications
breakeven levels for sources of U.S. Be cautious on oil and related sectors.
shale and non-shale output, which range Short-term oil price gains, for example
from $46-$55/b. The U.S. government’s due to OPEC production limitations, are
Energy Information Administration likely to be short-lived.
(EIA) currently anticipates that U.S.
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Ten Themes
15
10
2019
107,000
2021
213,000
2018
64,000
2023
426,000
2020
149,000
2025
569,000
Tomorrow's 2022
themes today 320,000
2024
512,000
Estimation of Fully Autonomous Car Shipments
Figure 10:
Autonomous vehicle shipments are forecast to rise
Source: Bloomberg Intelligence, Deutsche Bank Wealth Management. Data as of November 2017.
Long term investments that benefit and problem solving in a disciplined
from evolving secular trends remain manner will attract more investment to
important drivers of portfolios. We this theme.
re-iterate our long-term secular themes
that we introduced last year that focused Investment implications
on infrastructure, cyber security, global You could approach investing in these
aging and millennials. This year we add areas through multiple ways, for example
two additional themes: smart mobility through theme-based exchange traded
and artificial intelligence (AI). Smart funds (ETFs) or (for some clients) via
mobility is a new tech theme focused on private equity investment related to
the multiple implications of self-driving AI, Smart Mobility and so on. The
cars and other technological advances radical change that AI creates will
in transport. There will be implications not be painless – so you don’t just
for car makers, batteries, powertrains need to look for the opportunities it
and the whole charging infrastructure creates in individual firms/sectors, you
– possibly including power generation. need to look for dangers to existing
AI has an impact on multiple sectors, investments. Possible social responses
including smart mobility. The quest to (e.g. through education) could also create
“intelligently” automate repetitive tasks, opportunities.
anticipate human action/preferences,
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Macroeconomics
16
Macroeconomics
Growth without tears
Figure 11: Further evidence of synchronized global growth, combined with
Growth forecasts for 2018
Source: Deutsche Bank
a careful approach from policymakers, is likely to ensure another
Wealth Management. Data as of year of solid global economic recovery in 2018. But political and
November 17, 2017.
*The ASEAN 5 are Indonesia, Malaysia,
policy risks have not completely disappeared.
the Philippines, Singapore and Thailand.
Developed Markets All on the up of tapering by the European Central Bank,
although the Bank of Japan is likely to keep
U.S.
Growth data has been almost universally faith with its current policy.
2.3
good in 2017, as continued signs of U.S.
Eurozone
economic vibrancy matched the stronger Political and policy risks
2.0 growth in Europe, Japan and in many
emerging markets. At the same time, Risks remain, however, many of them
Germany inflation has generally remained low, giving political. In the U.S., the current focus is on
2.1
central banks the option to keep monetary whether or not President Trump manages
policy relatively loose. to get Congress to agree to tax reforms.
France
2.0 The outcome of this process is likely to
The U.S. recovery has continued to benefit become clear in the first quarter of 2018
Italy from labour market healing, and has also and the focus will then turn to the mid-
1.2 been underpinned by sound household term Congressional elections in November
and business finances and some modest 2018. In Europe, continuing debate around
Spain
2.5
stimulus from Washington. In Europe Brexit could create growth uncertainties,
both business sentiment and hard data not just in the UK. The Italian general
UK suggest that the recovery is expected election, most likely to be held in the spring,
1.3 to continue and a strengthening labour could also still throw up some surprises.
market will boost consumption. We do In the emerging markets, political and
Japan not expect substantial fiscal stimulus in economic concerns may centre around
1.5
Europe but there may be an increased markets such as Brazil and South Africa.
degree of flexibility around budget deficits. Mexico will also be wary of President
Japan is now experiencing a pick-up in Trump’s ambition of renegotiating the
consumption after more than two years of North American Free Trade Agreement
stagnation. Consumption will further help (NAFTA).
Emerging Markets drive the Chinese economy, with structural
reforms also boosting the economy over Other risks to the macro-economic outlook
India
7.5
the medium-term: so far the People’s Bank may be policy-related. Here there are both
of China (PBoC) has managed to gently upside and downside risks to growth. In the
China deleverage the economy without causing U.S., one upside risk is that we get a bigger
6.5 economic or investment upset. stimulus from Washington than we expect,
so "animal spirits” kick in, and that with
ASEAN 5*
Global growth therefore looks likely to monetary policy still relatively loose, we get
5.2
pick up slightly in 2018, to reach 3.8%. a sharp pick up in U.S. growth and inflation.
Russia A further increase in growth in the U.S. The U.S. downside risk is that policy
2.0 and the emerging markets (in aggregate) risk and political turmoil in Washington
will be only particularly offset by slower intensify, that the economic recovery
Brazil growth in China, the Eurozone and UK. (already the third longest in history) simply
1.8
This seems likely to set the stage nicely runs out of steam, that financial conditions
for further interest rate rises by the U.S. begin to tighten and bite and that we get
Federal Reserve (Fed) and the introduction sharp disinflation. We discuss these and
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable
indicator of future performance. Readers should refer to disclosures and risk warnings at the end of
this document. Produced in December 2017.CIO Insights
Macroeconomics
17
other threats to the global economy in the
box on the following page.
Potential risks for 2018
Inflation Further evidence of synchronized global growth, combined
As we noted in the last CIO Insights,
with a careful approach from policymakers, is likely to ensure
inflation has very much been “the dog another year of solid global economic recovery in 2018. But
that didn’t bark in the night” in the
current recovery: rates have remained
political and policy risks have not completely disappeared.
obstinately low. The chart below illustrates
the personal consumption expenditure
(PCE) rate of inflation for the U.S., the
1 Excessive central bank tightening
Fed’s preferred measure. However, it The first risk arises from central banks, especially the Federal Reserve, which is
is still worth considering what might widely expected to raise interest rates at least twice in 2018, in line with a healthily
cause an unexpected increase in prices, growing economy. If however the Fed were to raise rates too aggressively under its
particularly as, after the central banks’ new chairman, other central banks might be forced to turn more hawkish as well
various quantitative easing programs, the in order not to be excessively misaligned, which could result in a global monetary
monetary base has been much expanded. squeeze that would put the brakes on global synchronized growth. This scenario
One possibility would be a supply-side would be detrimental for both equity and bond prices and might also strengthen
shock, for example through an increase in the U.S. dollar, putting pressure on emerging markets and on commodity prices.
the oil price. We are now accustomed to
living in a world with ample oil supplies: 2 Oil supply shock
geopolitical events could however lead
Over the last few years, crude oil production in the United States has kept the oil
to a supply cut. Upward movements
price in check by increasing global supply every time that OPEC has reduced its
in metals prices could also have an
output, thereby creating a price ceiling that has prevented an energy-induced boost
inflationary impact. In the U.S., inflation
to inflation. However, a geopolitical shock to supplies large enough to outstrip the
expectations are tame but Eurozone
capacity of the United States to fill the gap could push prices up in a short period
inflation expectations could move up from
of time, to the detriment of economic growth. Both the credit sector (with the
their current low levels if, for example,
exception of energy-related bonds) and equity markets would suffer as a result.
skilled labour shortages add to upward
pressure on wages, or rising house prices
have an effect on rents. The example of the
3 Credit bubbles
UK, where inflation is already troublesome, The current economic expansion has been achieved partly thanks to a constant
should remind us that this is a problem that increase in public and private debt. While the banking system and corporate
never really goes away. balance sheets are more solid than they were before the financial crisis of 2007-
2008, a credit crisis triggered by spiralling defaults is a risk factor to take into
consideration. Concerns over excessive credit growth focus on China. The Chinese
authorities have been successful in reducing the rate of credit growth, but it
remains high. Rising debt is closely linked to asset price inflation in the Chinese
Figure 12: property market and the share of the financial sector in Chinese GDP has more
U.S. inflation* remains obstinately low than tripled over the last 20 years, to around 16% now. China’s economic resilience
Source: Deutsche Bank Wealth Management. has been a key driver of the strong growth in emerging markets this year, and they
Data as of November 17, 2017. would be very vulnerable to any Chinese reversal, with developed markets in the
*Personal Consumption Expenditure (PCE) firing line too. Equities and corporate bonds would suffer, while developed market
measure government bonds and safe haven assets such as gold and the Japanese Yen
could benefit.
4.5
3.5
4 Geopolitics
2.5
Throughout 2017, financial markets have shrugged off geopolitical concerns
with, for example, rising tensions between North Korea and the United States
1.5 not making any sustained dent into equity market performance. However, there
could be a crunch point: if markets start to believe an escalation of tensions will
0.5 lead towards war, this would have an immediate negative impact on all risky asset
classes, with the only exception of some safe haven assets such as gold. But other
-0.5
safe haven assets such as Japanese Yen might not prove immune – given that
-1.5 Japan itself could be threatened by the reach of North Korean missiles. Geopolitical
Jan 2008 May 2017 crises are also possible elsewhere.
Total Core Fed's Target
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a
reliable indicator of future performance. Readers should refer to disclosures and risk warnings
at the end of this document. Produced in December 2017.CIO Insights
Multi Asset
18
Multi Asset
Forward but not so fast
Looking out over a 3-month horizon, our strategic asset allocation
still suggests a broadly “risk on” approach with a focus on
equities. But we expect returns next year to be rather lower than
those recently enjoyed by investors.
Stéphane Junod
CIO EMEA and Head of Wealth Our multi asset investment process has In coming months we continue to expect
Discretionary EMEA three pillars: we start with the initial a generally supportive economic and
views of our committee members and policy environment, with continued
key risk takers (Pillar 1) and then refine global growth accompanied by only
the results through consideration of modest and careful efforts to tighten
individual scorings of asset classes on monetary policy. Macroeconomic scores
macroeconomic, valuations and technical in our Pillar 2 assessment were generally
factors (Pillar 2) and using four models to positive in late 2017 although they were
asset the overall level of risk (Pillar 3). partially offset by negative scores on
valuations for many asset classes.
Figure 13:
Seasonality trends on the S&P 500: average monthly returns
Source: Deutsche Bank Wealth Management. Data as of November 17, 2017.
%
4.5
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Since 1928 Since 1980 Since 1990 Since 2010
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Multi Asset
19
Still “risk on”
Figure 14:
What is interesting at the moment is that, despite all the Asset allocation (balanced portfolio as of December 8, 2017)
concerns around a possible late cycle environment, our four risk
models in late 2017 generally supported a “risk on” approach. Equity De
velo
Our macro indicator remained at very high levels, with the ped
Ma
global surprise indicator (data meeting expectations) stabilizing rke
ts
in very positive territory too. Risk and regime indicators were es
iti Equity
od
1
also positive. ves
ati
m
rn
m
te
Al
Co
This, combined with general good news on earnings,
s
ket
encourages us to keep faith in equities, despite high valuation
sh
Mar
Emergingome
levels, current low levels of volatility and the length of the
Ca
current economic cycle. However, we are growing slightly more
Fixed Inc
cautious and think that valuation multiples could move down to
more normal levels during 2018, meaning that further earnings
growth will be necessary to sustain the upward moves in prices.
If earnings growth disappoints, this could refocus attention on
increased levels of corporate debt, possibly unsettling markets.
Possibly negative seasonality at the start of 2018 (see Figure
13) could also temporarily dent returns.
Eq
s
uit
ign
yE
re
On fixed income, we see further opportunities in emerging
m
ve
er
o
markets debt (after a good year for this asset class) but are
Fix
S
gi
ed I
n
e
ncome g
cautious on high yield, believing that only slight further spread om M
nc ar
ke
dI
tightening is likely versus Treasuries. We have a broadly e ts
Fix Fix
ed I
neutral view on investment grade credit, believing that the ncom
e Credit
fundamentals and market technicals still offer support. We
continue to underweight government bonds (seeing little
opportunity for returns here) but keep an appreciable allocation
to cash. We are short duration as economic momentum and Equity
changed central bank direction should drive rates higher, even if
Developed Markets 33.0%
we expect this move to be gradual and market-friendly.
Emerging Markets 9.0%
On commodities, we do not expect a sharp further upwards
Fixed Income
move in the oil price and believe that the overall global
economic environment will not be supportive for gold, despite Credit 15.0%
geopolitical uncertainties.
Sovereigns 18.0%
Emerging Markets 6.0%
Preparing for lower returns Cash 4.0%
Commodities 3.0%
Our 12-month forecasts do imply, however, that multi asset
Alternatives 12.0%
returns may be lower in 2018 than the historical average of
the last 20 years. This lower return environment calls over the
longer term for both active risk taking (if you want to maintain Footnote: Asset allocation as of December 8, 2017. 1 Alternative
returns at current levels) and active risk management. Including investments are not suitable for and may not be available to all investors.
a higher proportion of risky assets in a portfolio should push us Restrictions apply. Sources: EMEA Regional Investment Committee,
further up the risk-return curve, boosting expected returns but Deutsche Bank Wealth Management. This allocation may not be suitable
at the cost of increasing risk; active risk management would for all investors. Past performance is not indicative of future returns. No
assurance can be given that any forecast, investment objectives and/
then aim to trade a slight decrease in returns (because of the
or expected returns will be achieved. Allocations are subject to change
cost of implementing the strategy) for achieving reduced risk. without notice. Forecasts are based on assumptions, estimates, opinions
and hypothetical models that may prove to be incorrect. Investments come
with risk. The value of an investment may fall as well as rise and your capital
may be at risk. You might not get back the amount originally invested at any
point in time. Readers should refer to disclaimers and risk warnings at the
end of this document.
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Equities
20
Equities
Room for more
After strong gains in 2017, fears are growing that equities are about to peak.
But continued growth and supportive policy should leave room for further modest index increases.
UK (FTSE 100)
Index change YTD (GBP): Switzerland (SMI)
Europe and Japan
+2.4%
End-Dec 2018 forecast:
Index change YTD (CHF):
+13.3% over the U.S.
7,500 End-Dec 2018 forecast:
Eurozone (Eurostoxx 50) 9,450
Index change YTD (EUR): At a regional level, U.S. valuations
United States (S&P 500) Asia ex. Japan (MSCI Asia ex Japan)
Index change YTD (USD):
+7.2%
End-Dec 2018 forecast: Index change YTD (USD): appear expensive relative to history,
+18.3% 3,780 +35.3%
End-Dec 2018 forecast:
although they are cheap vs. current
End-Dec 2018 forecast:
2,750 760 levels. Valuations in Europe appear more
Japan (MSCI Japan) attractive, although we have now adopted
Index change YTD (JPY):
+16.2% a neutral stance on German equities.
End-Dec 2018 forecast: We are positive on Japanese equities,
1,210
Latam (MSCI Latam) believing that there is room for a further
Index change YTD (USD):
+16.9% catch-up with other developed markets.
End-Dec 2018 forecast:
2,850
Emerging markets
keep on going
We are positive on emerging markets,
Figure 15:
even after their strong performance
Equity market forecasts and January-November 2017 index change by region
in 2017. We see a highly supportive
Data as of November 30, 2017; forecasts are as of December 8, 2017. All returns are YTD.
environment with generally good
Source: Bloomberg Finance L.P., Deutsche Bank Wealth Management
economic growth, low inflation and
realistic earnings expectations. Valuations
are also still reasonable, particularly in
There is a whiff of “late cycle” in the air. Earnings growth will be key Asia. Within emerging markets we favour
Another year of unexpectedly strong Asia, but are more cautious on Latin
global economic growth has culminated Don’t expect a completely smooth ride. America. All in all, emerging markets look
in close to the longest uninterrupted Volatility is likely to increase and rising poised to slightly outperform developed
expansion of the U.S. equity market in interest rates and already stretched markets over the next 12 months.
history and made for rather stretched valuations are likely to result in a However, selectivity will be important as
valuations. Investors increasingly fret contraction of price/earnings (P/E) ratios certain regions, such as Latin America,
about being near the peak. throughout developed markets, with the carry higher levels of risk.
likely exception of Japan. So further rises
But we believe that it would be in markets will require continued growth
premature to conclude that the end in earnings. We believe that this will be
of the expansion is nigh. Time and forthcoming, with earnings expected to
again, equities have shown to do well grow between 5.5% and 16% for major
in a late cycle environment. Moreover, markets, with emerging markets at the
solid global economic growth, broadly upper end of this range and the FTSE 100
accommodative central bank policies and at the lower. Tech and financials are likely
the potential for tax reform in the U.S. in to be the key drivers. On the other hand,
early 2018 are likely to support stronger we don’t believe that earnings will keep
corporate earnings as we head into next surprising on the upside as they have
year, further underpinning equity markets. done in 2017.
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Equities
21
Figure 16:
Equity views by sector
Source: Deutsche Bank Wealth Management. Data as of November 17, 2017.
Overweight Neutral Underweight
EMERGING
MARKETS
S E C TO R POSITIVES N E G AT I V E S REGIONAL
EUROPE
PREFERENCE
U.S.
Consumer –– Healthy consumer sentiment in the U.S.,
Japan, China and other markets
–– Problems continue for U.S department stores
–– UK consumer sentiment weakens in
Auto & components
Discretionary –– Gentle increase in global inflation to anticipation of Brexit: retail and car sales Durable & apparel
drive margins already showing weakness
VIEW Consumer service
–– Urbanisation in emerging markets –– Eurozone: Improving macro conditions to
drives demand for premium goods and encourage some tightening in policy.
Media
global brands –– Sluggish demand in some emerging markets
Retail
Consumer –– Staples a prime beneficiary of emerging
market improvements, through both macro/
–– Underlying business trends tough and
unlikely to improve soon
Beverages
Staples consumption and FX –– Input costs could become an issue in some Food retail
–– More reasonable valuations sectors
VIEW Food products
–– Continued M&A activity, including cross –– Use of sector as some form of bond proxy is
sub-sector attempts. mostly a headwind
Tobacco
–– Progress in e-commerce is a double edged
sword for many fast-moving consumer Household &
goods (FMCG) personal products
Energy ––
––
Oil markets look relatively stable
U.S. rig count growth has moderated for now
–– OPEC has no exit strategy from its current
approach
Equipment & services
–– Dividend risk appears to be decreasing –– As always, valuations imply some price Integrated
VIEW –– Industry planning for “lower (prices) for recovery which may not materialize Exploration &
longer” –– Fracking as the marginal producer may cap production
upside for oil prices
Refining & marketing
Financials –– U.S. interest rate cycle is turning
–– Rising dividends and share buybacks
–– Low yield environment still hurting margins
and investment income outside the US.
Banks
–– Capital management and cost cutting to –– Regulation likely to weigh on banking Insurance
VIEW offset headwinds activities
Diverse financials
Heath Care –– Enough product innovation to find equities
with superior growth outlook
–– Continued pricing pressure in competitive
indication areas
Pharma
–– Biotech valuations still attractive –– Large cap pharma and biotech face growth Biotech
VIEW –– Mid and small cap companies could benefit challenges
from acquisition by mature companies keen –– Pharma earnings could suffer from negative Medtech
to bolster pipelines revisions and aggregate growth will decelerate
Services & facilities
Industrials –– Chinese demand is holding up and
European demand has improved
–– Sector valuation back to a premium
–– Long-term attractive but strong economic
Conglomerates
–– Energy and materials capital expenditure is improvement needed for sustained Rails & earnings
VIEW improving outperformance
Aerospace & defence
–– Leading indicators surprise on the upside –– Cost pressures from raw materials and other
costs not yet passed on to consumers
Information –– Diverse sector with clear market leaders in
subsectors and increasing barriers to entry
–– Short product cycles can potentially disrupt
business models
Software & service
Technology –– Growth potential from innovation and –– Smartphone penetration, previously a key Hardware
disruption of other industries growth drive, has now entered saturation
VIEW Semiconductors
–– Solid balance sheets and strong future cash phase
flow generation –– Earnings interpretation complicated by
several factors
Materials –– Synchronized global growth bullish for sector
–– Earnings from chemicals largely positive
–– Environmental controls in China could hit
demand
Chemicals
–– A lot of mergers and acquisition activity –– Specialty chemicals hit by raw materials prices Metals & mining
VIEW –– Rebound of U.S. dollar or China slowdown
would be a negative
Telecom –– Operating performance has improved
–– Data monetisation remains a key theme
–– Promotions could heat up competition and
hit pricing
Telecom
Services –– Valuations back to more attractive “pre- –– Content costs increasing in many markets
M&A” levels –– Penetration rates in U.S. close to saturation
VIEW
Utilities –– In Europe, H1 2017 mostly ahead of
expectations
–– Rising bond yields would not help regulated
stocks
Utilities
–– Forecasts suggest that European sector will –– UK government suggesting price cap on
VIEW end a decade of earnings decline energy tariffs
–– Market-friendly policy measures in some –– Demand picture in wind sector getting more
markets, notably Brazil challenging
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Fixed income and foreign exchange
22
Fixed income and foreign exchange
Compliments of the chef
The central bank chefs will remain in control of the fixed income kitchen in 2018,
as they push on with policy normalization. The process should go smoothly, but
previous spread tightening means that fixed income returns are likely to be rather
lower in 2018 than this year. We don’t expect a sharp reversal in the market, but
this will be a year to be cautious and selective.
35
Central banks in 2018
33% Central banks will continue to move
30
only slowly along the long road to policy
normalization, with monetary policy
remaining broadly accommodative.
25
A Fed rate rise in December 2017 is likely
to be followed by at least two more in the
20 course of 2018; as importantly, the Fed
has already determined how it will run
down its balance sheet and this process
15 appears to be running smoothly. Markets
are assuming that Jerome Powell taking
over as Fed chair will not result in any
10 significant change in policy. However
Jul 2017 Jan 2018 Jul 2018 Jan 2019 the combination of Fed balance sheet
reduction needs and budget deficit
Germany France Italy Spain Netherlands Belgium financing needs could increase bill supply
over the next year, with the Q1 2018
Figure 17: increase in supply perhaps as high as
ECB purchase program could be curtailed by 33% issuer limit USD350bn. This will have implications
Source: Deutsche Bank Asset Management forecasts. Data as of November 16, 2017. for the U.S. Treasuries yield curve, as
discussed below.
The ECB is some way behind on the
path to normalization, but over the
course of 2018 we are likely to see
asset purchases wound down to zero:
the program is currently scheduled to
end in September 2018, and seems
unlikely to run beyond the fourth quarter
of the year at the latest. This could be
as much due to technical factors as
economic ones: as Figure 17 shows,
the ECB could next year hit the 33%
issuer limit for German bonds. (The ECB
defines a maximum share of a country’s
outstanding securities that it is prepared
to buy, to avoid it becoming the dominant
Marketing Material - Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance. Readers should refer
to disclosures and risk warnings at the end of this document. Produced in December 2017.CIO Insights
Fixed income and foreign exchange
23
creditor to EU governments: it can grade due to their large cash investments
change this limit, but any upwards move held overseas (12-month spread forecast
would be politically sensitive.) Mr Draghi lowered to 80 bps from 90 bps). In fact, The lesson from 2017
has however been careful to promise we see some room for tightening in both
to maintain current interest rate levels U.S. and European investment grade. We is that foreign exchange
until well beyond the end of quantitative are rather cooler on high yield, although
easing and to reinvest the principal from a better default environment should give drivers are likely to be
maturing bonds for as long as necessary. some support to both U.S. and European
With Eurozone inflation likely to remain markets (U.S. 12-month spread forecast diverse, and include
below the 2% ECB target in 2018 and revised from 360 bps to 350 bps; the
2019, the ECB is under no pressure to European forecast moves from 275 bps politics and fund flows
tighten policy soon. to 260 bps). European high yield may
be less attractive when compared to the as well as economic
The Bank of Japan (BoJ) has already U.S., on the basis of valuations (spreads
pushed back its inflation target for to default rate), and relative valuation to fundamentals.
another year, and seems very relaxed equities. We have slightly upgraded our
about maintaining current policy for outlook for emerging market (EM) credit
as long as possible: we do not expect (12 months spread forecast 270 bps
meaningful change until 2019. The BoJ’s from 280 bps) as EM companies have
yield curve control policy has been very benefited from the global synchronized
successful so far and we think that the recovery. More accessible investment
10-year yield could be kept at around opportunities could however exist in EM
0% without major market volume: in sovereigns, which we remain positive on.
fact, BoJ monthly purchases appear to
be running at around ¥50 trillion at an
annualized rate, rather than the previous
Foreign exchange
¥80 trillion.
Given that returns on fixed income
investments are likely to be relatively low
Government bonds in 2018, foreign exchange trends could
prove particularly important. These were
Central banks have been managing not entirely as expected in 2017: the
radical monetary policy for nearly 10 euro strengthened against the U.S. dollar
years now – and they have learnt much for much of the year, despite policy (in
from the experience, at least on the terms of interest rate differentials) and
need for careful communication of their economic growth being theoretically
intentions. So they are likely to be very in the dollar’s favour. Supporting the
transparent and methodical as they taper euro was a growing sense of economic
their asset purchases. The net result is optimism around Europe, as well as
likely to be a very gradual increase in a belief (for most of the year) that
interest rates accompanied by, in the European political risks had dissipated,
case of the U.S., a slight flattening of at least to a degree. In recent months,
the yield curve for the reasons given however, the dollar has showed signs of
above. Our 12-month forecast for global strength and we think that it could make
sovereign rates remains unchanged at further ground against the euro in early
the longer end (U.S. 10 year at 2.6%, 2018 (in the wake of the end-2017 Fed
German 10 year at 0.8%, UK 10 year at rate rise and in anticipation of tax reform)
1.4% and Japan 10 year at 0.10%). before the euro, in turn, gathers strength
again later in the year. The lesson from
2017 is that foreign exchange drivers are
Corporates likely to be diverse, and include politics
and fund flows as well as economic
2018 will be a year where it will pay
fundamentals. It could also pay to look
to be selective, cautious and aware of
at a variety of currency based indices or
specific factors in individual corporate
currency pairs.
credit markets. So, for example, our
expectations of tax reform and business
friendly policies in the U.S. (e.g. tax cuts
and repatriation) should benefit U.S.
corporations, especially investment
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