Presentazione di PowerPoint - Generali Worldwide€¦ · · 2016-06-03universe of the asset purchase program of the ECB should ... annualized) showed healthy, but decelerating household

Market Perspectives June 2016

Content

Global View p. 3

USA p. 4

Euro Area p. 6

Japan p. 8

China p. 9

Central and Eastern Europe p. 10

Bonds/Fixed Income Strategy p. 11

Corporate Bonds p. 13

Currencies p. 15

Equities p. 17

Mark-to-Market Allocation p. 20

Forecast Tables p. 21

Imprint p. 22

| Generali Investments – Market Perspectives June 2016

Following a weak start into the month, risky assets

ended May on a stronger note, while European core

yields decoupled from US yields and remained at

their very low levels.

Financial markets’ focus in June will be on the Fed

and the Brexit referendum in the UK. Regarding the

latter, our base case is a ‘Remain’ vote, but the risk

of a ‘Leave’ decision remains high with potentially

strong adverse effects on markets.

The Fed will likely use its June meeting to prepare

markets for a rate hike in summer, potentially as

early as July.

Ahead of these events, it seems appropriate to

keep a prudent tactical allocation stance. Investors

with a medium-term focus may well stick to a

moderate overexposure to euro area corporate

bonds, which will be backed by ECB purchases

going forward.

Following disappointing data from the US and China,

global risk sentiment suffered at the start of May with

equities and core government bonds falling. Over the

course of the month, however, a further recovery in the oil

price, a deal between Greece and its creditors and again

more reassuring indicators from the euro area (and in

parts also the US) helped global equities to recover to

levels close to the levels seen in mid April. A more

hawkish rhetoric by Fed officials lifted US yields and non-

financial credit spreads, while euro area government

bonds continued to be sought by investors.

In a series of communications, the Fed has laid the ground

for its second rate hike in a decade for the summer

months. FOMC members – including recently Fed Chair

Janet Yellen – gave stronger hints that economic data for

the US would back a rate hike over the coming months;

the minutes to the Fed meeting in April even highlighted

the coming meeting in June as a candidate for the next

rate increase. This has led to a sharp re-pricing of

discounted future rate hikes by markets. Yields on 2-year

Treasuries temporarily rose 20 bps within May. Market-

implied odds of a Fed rate hike by September doubled to a

likelihood of two thirds.

While, in our judgment, the Fed is still unlikely to hike its

key rate just eight days ahead of the Brexit referendum in

June already, we anticipate a hawkish FOMC statement

that would give clear signals to a rate hike at the July

meeting. However, the Fed will remain eager to soothe the

market impact by highlighting that any further rate hikes in

the future will be strongly data-dependent.

The Fed tightening hike could still be postponed in case

the UK’s referendum on EU membership results in a

‘Leave’ vote. Recent polls point to a lead of the ‘Remain’

camp, but the poor performance of polls in the run-up to

last year’s parliamentary elections in the US have shown

the clear limits of the forecasting power of polls in the UK.

A ‘Leave’ vote would have no immediate consequences for

trade and labor mobility, since a negotiation period of up to

two years is foreseen for fixing the terms of an exit from

the European Union. That said, worries about wider

political repercussions for the European integration project

may well trigger high market volatility, which ultimately

may also affect real economic activity. A sharp

depreciation of the British pound would be the most likely

fallout on financial markets, but this could well be

accompanied by a more general sell-off in risky assets and

a flight to safety (in particular Bunds and Treasuries).

Given this binary political event with potentially global

repercussions, we recommend to avoid strong active

allocation positions for the moment. Investors with a

stronger medium-term orientation in their investment

targets, however, may well stick to a moderate

overexposure to corporate bonds in the euro area. The

ECB will start to buy bonds issues by non-bank

corporations from the euro area in June, providing an

important market backstop here. At the same time, low

default rates still bode well for this market segments. So

while it seems appropriate to maintain a prudent stance on

risky assets like equities, financial assets falling into the

universe of the asset purchase program of the ECB should

be better shielded against the risk of market setbacks.

Thomas Hempell

3

Global View

Bonds Current 3M 6M 12M

10-Year Treasuries 1.84 1.85 1.85 1.90

10-Year Bunds 0.15 0.20 0.30 0.30

Corporate Bonds Current 3M 6M 12M

IBOXX Corp. Non Fin 155 145 140 130

IBOXX Corp. Sen Fin 128 125 125 125

Forex Current 3M 6M 12M

USD/EUR 1.12 1.10 1.12 1.13

JPY/USD 110 111 112 113

Equities Current 3M 6M 12M

S&P500 2093 2030 2020 2040

MSCI EMU 106.9 105.5 105.0 106.0

Current values = average of last three trading days

Growth Inflation

2015 2016f 2017f 2015 2016f 2017f

US 2.3 1.5 2.1 0.1 1.6 2.2

Euro Area 1.5 1.4 1.2 0.0 0.3 1.4

China 6.9 6.4 6.1 1.4 2.3 2.1

World 2.5 2.3 2.8 1.6 2.2 2.5

f = forecast


The relatively weak Q1 figures and subdued

investment will likely slow down growth this year,

but we expect a rebound in 2017. The faster

recovery in oil prices will lead CPI inflation to 2% by

the end of the year.

The recent communication by the Fed has turned

more hawkish. We see this mostly as a way to steer

expectations, as economic fundamentals remain

consistent with a very cautious stance.

The revised figures for Q1 GDP growth (0.8% qoq

annualized) showed healthy, but decelerating household

consumption being still dampened by negative investment

growth and subdued net trade. Despite some volatility, the

labor market continues to strengthen, while demand

pressures are keeping core inflation on an upward trend.

We stick to our scenario of a deceleration in GDP growth

this year (to 1.5%) while remaining confident in a pick up to

around 2% in 2017. However, the balance of risks has

further tilted on the downside, given the continuing

weakening capital expenditure. A faster climb in oil prices

and relatively strong showing of services prices led us to

slightly revise the forecast for CPI inflation up, which

should average 1.5% this year, before reaching 2.2% in

2017.

Upside risk for consumption, capex still weak

The expected rebound in Q2 will depend crucially on the

behavior of corporate capex, while the fundamentals

underpinning household consumption remain strong.

Indeed, the main risk to our outlook is that growth remains

overly dependent on private consumption.

In March personal consumption was up 2.6% yoy and in

the year to April retail sales (excluding fuel) posted a 3%

increase. The deceleration from the second half of 2015 is

almost completely due to the fading of the windfall gains

from the collapse in oil prices. The saving rate appears

high, both in comparison with the historical norm, and to

net worth as a share of income, with the recent uptick that

can be explained as a reaction to Q1 financial market

turbulence. This, in principle, constitutes an upside risk to

consumption as dissaving would add to labor income.

Despite still favorable financing conditions, the outlook for

investment is clouded by poor profitability. The

retrenchment in investment seen over the last two quarters

reflects to a large extent the cutbacks in oil and drilling, but

also the non-oil component was down, in line with the

downward revision in corporate earnings. Going forward,

capex is set to benefit from the easing in financial

conditions seen from February. Yet, the final impact is

likely to be dampened by the increase in interest rates after

the Fed’s more hawkish twist and the tightening in lending

standards loan officers expects for Q2.

Paolo Zanghieri

USA

4


April data on durable goods orders were only mildly

encouraging. The 0.4% increase over March (ex.

transportation goods) was driven by consumption, while

the investment-component contracted for the third straight

month. Forward looking information from business survey

point to moderate optimism. According to the ISM indices,

activity in both manufacturing and services continued to

expand in April, with new orders at or near the highest

values in a year. Moreover, according to the April’s NFIB

survey, the net percentage of small businesses planning

to increase investment remains around the post crisis

high.

Tightening labor market, but stable inflation

Employment is not showing evident signs of a slowdown.

The relatively weak April’s payroll growth (160k against a

Q1 average of 210k) is partially due to seasonal factors.

Other indicators, from involuntary part time to percentage

of workers quitting a job, indicate that the labor market is

at its tightest level since the Spring 2008. While wage

growth remains muted (in April hourly compensation was

up 2.5% yoy, the same reading as in the previous four

months), unit labor costs are lifted by stagnating

productivity, and constitute one of the biggest drag to

corporate profitability. Their impact on inflation is so far

relatively subdued. In April, overall CPI increased 1.1%

yoy, lifted by the fuel component. The core rate eased a

bit to 2.1%, but the steady and widespread increase in

most components is consistent with an ongoing buildup of

inflationary pressures, which should lead inflation above

2% by the end of the year.

The Fed’s tone turns more hawkish

The minutes to the April FOMC meeting, released in mid

May, signaled a higher than expected willingness by the

Fed to accelerate the normalization of monetary policy.

The message was subsequently reinforced by governor

Yellen rather explicitly calling for an increase in rates in

the coming months. This has sharply increased, to around

45%, the odds of a rate hike to occur as early as in June.

However, we interpret the most recent statements more

as a way to gradually steer market expectations (much in

the same ways the Fed did before the December hike)

than a radical deviation from the cautious stance seen so

far. The deceleration in domestic demand shown in Q1

data and the mixed outlook for capex may slow down

growth in the rest of the year. This, and the possible

stronger appreciation of the dollar, could put a lid to the

convergence of PCE inflation to the 2% target. Moreover,

the economic global outlook, while improving, remains

highly uncertain. On top of that, in the weeks surrounding

the June 16-17 meeting, several political events, starting

from the June 23 UK referendum on EU membership,

might add to market volatility.

5

USA


In May, key sentiment indicators remained

consistent with solid activity in Q2 and a

continuation of the recovery.

While a new agreement with Greece has been

reached, the outcome of the Brexit referendum

(June 23) is key for the outlook.

Polls suggest that the chances for a Brexit are

almost fifty-fifty.

We do not expect the ECB to hint at further

measures at its June 2 meeting but to maintain a

dovish stance.

Following a better-than-expected start into the year,

indicators for Q2 suggest that activity in the euro area

stayed solid. In May, the composite PMI came in at 52.9,

almost constant compared to the month before. However,

expectation-related survey indicators – a good gauge for the

direction of future activity – gave conflicting signals. While

the Sentix index and the ifo expectation component

improved, forward-looking indicators within the May PMI

surveys trended down. We find it striking that in the very

much domestically-oriented service sector the components

business expectations and new business dropped

significantly. This is at odds with a rise in (flash) consumer

confidence, backed by the ongoing improvement in the

labor market (unemployment rate down to 10.2% in March)

and low commodity prices.

Brexit referendum a neck-and-neck race?

We conjecture that political risks are casting their shadows.

Here, the Brexit referendum that will be held on June 23 is

to be mentioned in the first place. According to polls, it will

be a very close race with the high share of yet undecided

voters to be crucial.

We have built our macro economic forecasts on the

assumption that the UK will stay in the EU. If the British

were to vote to leave the EU, there would be an exit

negotiation period of up to two years. In our view, the UK

would not leave the European Union before 2018.

Therefore, the legal and institutional environment for firms

from both sides of the channel will not change immediately

right after the referendum. That said, there might be a

significant effect via the impact on sentiment also in the

short term. Empirically, higher economic policy uncertainty

tends to go hand in hand with lower consumer confidence.

Moreover, euro area firms will be harmed by the likely

depreciation of the British pound and by weaker activity and

hence demand from the UK.

In the UK, PMI sentiment weakened significantly and

consumer confidence also receded as of late. This has

been widely interpreted as caused by Brexit concerns.

However, retail sales as well as new job creation so far

defied expectations about a stronger slowdown.

Martin Wolburg

6

Euro Area

-40

-35

-30

-25

-20

-15

-10

-5

0

30

35

40

45

50

55

60

65

05/06 05/07 05/08 05/09 05/10 05/11 05/12 05/13 05/14 05/15 05/16

Euro Area Key Activity Indicators

Services PMI Manufacturing PMI Consumer confidence (rhs)

-30

-20

-10

0

10

20

30

40

01/16 02/16 03/16 04/16 05/16

British Referendum Polls "Stay" - "Leave" shares in polls +/- share of undecided voters, %

All undecided vote "Stay"

All undecided vote "Leave"

-40

-35

-30

-25

-20

-15

-10

-5

00

50

100

150

200

250

300

05/06 05/07 05/08 05/09 05/10 05/11 05/12 05/13 05/14 05/15 05/16

Economic Policy Uncertainty & Consumer Confidence

Euro area: Economic policy uncertainty index, 3mma

Euro area consumer confidence (rhs, inverted)


We conjecture that in case the “Leave” camp wins, the

immediate impact on activity likely remains limited. Apart

from the just discussed arguments, in case of larger

market turmoil central banks will in our view also intervene

verbally and by flooding markets with liquidity. The longer

term effect on euro area growth will also be negative but

its magnitude depends on the details of the new trade

agreement with the UK. However, in case of a Brexit

disintegrating and separatist forces in the EU will likely be

getting support and ultimately hampering decision making

on the European level.

Recovery to continue

All in all, even in case of a Brexit vote we expect a

continuation of the euro area recovery, albeit at a reduced

momentum. The key argument is that the Q1 GDP data

confirm our view of strengthening domestic activity, that

the labor market improvement continues and that

sentiment indicators remain consistent with solid growth.

That said, political risks other that the Brexit remain in the

euro area. On the positive side, the euro group finally

found an agreement with Greece on May 24. However, the

polls regarding the Spanish snap elections on June 26 still

point to a hung parliament. The longer the period of

political stalemate lasts the more significant it will also

become for activity in the euro area’s fourth largest

economy.

ECB to stay on hold and to maintain a dovish stance

On June 2, the ECB Governing Council will meet again.

From a macroeconomic perspective it will be pleased as

the recovery basically proceeds in line with expectations.

The ECB’s 2016 growth projection is sensible in our view.

However, we see some need to adjust the inflation path

slightly to the upside. Future markets lifted especially the

prices for oil one year ahead by about € 10 per barrel

Brent. In the mechanics of the ECB projection exercise

this implies a need to adjust the inflation outlook to the

upside. The 2016 projection will likely be lifted towards

0.3% to 0.4%.

That said, inflation expectations still remain far too low

from a monetary policy perspective and also underlying

inflation is stubbornly low (0.7% yoy in April). All in all, we

think that the ECB remains in a wait-and-see mode for the

time being as it had also stated that one has to be “patient”

regarding inflation expectations. That said, president

Draghi will most likely emphasize that the ECB is ready to

act again, if needed. We do not deem it likely that he hints

concretely at specific potential measures. In our view

another cut in the deposit rate is still on the table but will

not be used yet. Therefore, the press conference following

Thursday’s meeting will largely be about reiterating the

ECB’s dovish policy stance.

7

Euro Area

-1.0

0.0

1.0

2.0

3.0

4.0

-1.0

0.0

1.0

2.0

3.0

4.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Harmonized Consumer Price Indexannual % change

Total index Core rate ECB medium-term inflation target

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Euro Area GDP Forecast

Annualized growth rate, %

Potential growth range currently 1.5% - 1.7%

GDP 0.9 1.5 1.4 1.2

Consumer spending 0.8 1.7 1.4 1.1

Gov. consumption 0.8 1.3 1.1 0.6

Total fixed investment 1.4 2.6 2.7 1.9

Inventories 0.1 0.0 0.3 0.0

Net trade -0.1 -0.2 -0.4 0.1

Domestic demand 0.9 1.7 1.5 1.1

Consumer prices 0.4 0.0 0.3 1.4

Unemployment rate2)

12.0 11.6 10.9 10.1

Budget balance3)

-2.6 -2.1 -1.9 -1.7

ECB refi rate4)

0.25 0.05 0.00 0.001) unless noted otherwise, annual % change, net trade and inventories: growth contribution

to GDP, 2) yearly average as %, 3) ratio of budget balance to nominal gdp, 4) as %; year-

end

2014 2015 2016 2017fMain Forecasts1)


Japan’s Q1 GDP growth surprised strongly on the

upside, avoiding the expected drop into recession.

However, details show consumer demand to be

weak. Coupled with rising deflationary forces, this

will keep the BoJ under pressure to act.

In a first print, Japan’s real GDP grew by 1.7% qoq annua-

lized in Q1, surprising strongly on the upside compared to a

consensus forecast of 0.3% qoq ann, and ours of flirting

with recession. The discrepancy had mainly two sources.

Firstly, real private consumption rose 1.9% qoq ann, while

the Japanese monthly synthetic real consumption index

had (before revision) predicted a much lower result of 0.4%

qoq ann. The revisions were likely due to stronger

deflationary effects. In fact, nominal – instead of real –

consumer expenditures receded by 0.5% qoq ann, implying

that the consumption deflator dropped by 2.4% ann. over

the quarter. This was much more pronounced than the CPI

alone. The development was exacerbated by the strong

drop in import prices and the trend appreciation of the yen

in Q1. Deflationary tendencies also pushed real labor

income up, while nominally it rose by 2.5% qoq ann.

Secondly, net exports contributed to real GDP growth by

+0.7 pp ann. This is again in stark contrast to what data

from the customs office and the BoJ had signaled.

In sum, soft nominal private consumption combined with

marked deflationary tendencies against the background of

receding private investments do not offer much relief for

economic policy, despite the positive headline figure.

Fiscal policy measures to be announced soon

Moreover, April monthly activity data continued to be

mixed. IP suffered from the repercussions of the Kumamoto

earthquake. After the G7 summit stressed the need to

strengthen demand, we expect a fiscal package (1-2% of

GDP) to be announced soon. PM Abe already indicated to

postpone the sales tax hike.

Inflation dropped further back into negative territory, with a

headline number at -0.3% yoy. Given the marked appre-

ciation of the yen compared to early 2015 and the weak-

ness in private demand, negative rates are likely to persist

over the summer. This constitutes a fundamental case for

more monetary easing. However, timing remains difficult:

After the inaction of the BoJ at the end of April, Governor

Kuroda repeatedly claimed more time for the negative

interest policy to work. This, the better real growth rate, the

recently softer yen and the likely support from the fiscal

package may suggest that the BoJ could delay its decision

further. From a tactical perspective, it could be advisable to

stress the policy divergence with the Fed, for which

markets see at least a 50% chance of a hike in July. This

suggests July currently as the likeliest candidate but does

not exclude June or even October as further possibilities.

Christoph Siepmann

8

Japan

Main Forecasts1)

2014 2015 2016f 2017f

GDP -0.1 0.5 0.6 0.8

Consumer spending -1.0 -1.2 0.2 0.6

Government consumption 0.1 1.1 2.4 0.9

Investment 1.1 0.1 0.5 1.2

Inventories 0.1 0.4 -0.1 -0.1

Net trade 0.3 0.4 0.1 0.1

Domestic demand -0.3 -0.5 0.5 0.8


Unemployment rate2)

3.6 3.4 3.2 3.0

Budget balance3)

-5.2 -5.2 -5.2 -5.0

1) unless noted otherwise, annual % changes, net trade and inventories: growth contribution to

GDP 2) yearly average as %, 3) in terms of GDP, general government 4) as %; year-end


China’s latest data defied market hopes of a more

lasting upturn, but still signal some stabilization.

High credit growth and an „authorative“ press

article sparked fears about a shift in the policy

stance already in the offing. We see it less likely

and would consider it premature.

After the marked improvement in PMIs and real activity

data in March, April indicators had a sobering effect on

markets and expectations. Manufacturing as well as

service PMIs receded, albeit in part only marginally. This

preceded softer real activity data with industrial production

decreasing to 6.0% yoy, after 6.8% in April. Similarly,

urban investment growth diminished to 10.5% yoy on a

cumulative basis, after 10.7% yoy before. Despite this

slowing, indicators were still better than the data from the

beginning of the year. Looking forward, additional credit

supply in April was much weaker than during April 2015.

However, summed over the first four months, new yuan

loans still rose by 17.9% compared to the same period

last year. This should still elicit some stabilizing effects on

the economy over the next month (while we do not see

this stabilization to have a lasting effect). Ongoing support

should also come from the real estate sector. Investments

have risen to a cumulative 7.2% yoy in April, the highest

level in about a year. Sales of residential buildings

continued to expand at a rapid pace (63.7% yoy in April,

after 71.2% yoy in March), which should foster more

investment over the coming months. Prices on average

accelerated to 6.2% yoy, with some Tier 1 cities wit-

nessing very strong property inflation. Accordingly, some

local authorities re-introduced tightening measures.

Policy shift already in the offing?

Against this backdrop, markets started again to increa-

singly worry about the rising debt-to-GDP ratio (according

to our calculation, it rose to 233% by the end of March

compared to 225% by end of 2015) and hidden non-

performing loans in the banking sector. While the official

rate is at 1.75%, some market participants estimate it

massively higher. Fears were heightened by an “autho-

rative” press article, calling for more attention to be paid to

credit risks and reiterating the need for implementing

supply-side reforms, cutting excess capacity, containing

leverage and reducing the tax burden of the corporate

sector. This was largely interpreted as already the

beginning of another policy shift. In our view, we are

witnessing a continuation of the stop-and-go policy like

seen over the last years. On the one hand, Beijing does

not want growth to slip below a certain comfort level, while

at the same time do not hinder the needed structural

change. We see China stabilization not yet sufficiently

confirmed as to withdraw its support at this stage, but this

will likely be the case later in the year.

Christoph Siepmann

9

China

-10

-5

0

5

10

15

20

25

30

35

40

45

-50

-30

-10

10

30

50

70

90

110

130

150

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

China: Investment in Real Estate and Property Sales

yoy in %, 3mma

Property Sales Investment in Real Estate (rhs)

9

14

19

24

29

34

60

80

100

120

140

160

180

200

220

2006 2007 2008 2009 2010 2011 2012 2013 204 2015

China: Credit of the Non-Financial Sector in terms of GDP

in %

Domestic credit by depository corporation to the non-financial sector asshare of GDPTotal social financing as share of GDP

Growth of Urban Investments (rhs)


– Annual GDP growth slowed in 2016 Q1 across the

region due to weaker inflows from the EU funds

and, very likely, also due to the irregular

seasonality.

– Inflation moved higher at the start of 2016 Q2;

except Poland, where we see the case for monetary

policy easing in 2016 H2.

– The Hungarian central bank cut its base rate to

0.90% and indicates that this is the floor but the

door is still open for non-conventional easing, if

needed.

The 2016 Q1 GDP flash estimates show that the annual

GDP growth decelerated across the region. This tendency

is not a surprise: some deceleration was expected due to

the weaker inflow from the EU funds, particularly in the

Czech Republic, where the flow was extraordinarily strong

in 2015. However, while Czech GDP still grew by 0.5%

qoq, negative surprises came from Hungary (-0.8% qoq)

and Poland (-0.1% qoq). We think that irregular

seasonality, i.e. timing of Easter, had negative impact on

activity in March. If this interpretation is correct, quite solid

recovery should be reported by 2016 Q2 GDP data. Poland

is the only country that already reported hard data for April:

both retail sales and particularly industrial output showed

strong start into 2016 Q2 indeed and we keep GDP

forecast for the whole 2016 unchanged for all three

countries.

Headline inflation rose in April from 0.3% to 0.6% yoy in the

Czech Republic and from -0.2% to 0.1% yoy in Hungary.

Fuel price was on the list of factors contributing to the CPI

increase. Poland on the other hand reported sharper

decline in headline CPI: from -0.9 to -1.1% yoy, driven by

food prices but also by core inflation items.

Hungarian central bank cut its base rate by 15bp to 0.90%

but at the same time indicated that the cutting-cycle has

ended. This is reflected not only the fact that inflation now

stands above forecast: more importantly, the wage growth

starts to accelerate, so the period of low inflation did not

have any detrimental impact on price expectations in the

economy. In Poland, the MPC left the key rate unchanged

at 1.50%. However, we think that the debate on policy

easing will intensify in Poland in 2016 H2, as inflation

remains well below the 2.5% target over the policy horizon

and this should be confirmed by the fresh forecast due in

July. The Czech CNB keeps the CZK above 27/EUR and

says that the FX commitment is likely to stay in place till

mid-2017. The CNB is ready to shift the FX cap to a

weaker CZK level if inflation expectations fall but this is not

the case in the Czech economy at the moment.

Central and Eastern Europe

10

Radomír Jáč

Main Forecasts 2014 2015 2016f 2017f

Czech Republic

GDP 2.0 4.3 2.2 2.2


Central bank's key rate 0.05 0.05 0.05 0.05

Hungary

GDP 3.5 2.9 2.7 2.6

Consumer prices -0.2 -0.1 0.2 2.0


Poland

GDP 3.3 3.6 3.5 3.7

Consumer prices 0.0 -0.9 -0.4 1.4


GDP and consumer prices: annual % change; CB interest rate: in %, year-end


The positive sentiment on government bond

markets prevailed in May. While euro area core

yields dropped moderately, US yields trended

sideways.

Peripheral bond spreads initially widened but they

were able to make up lost ground at the end of

May.

Assuming the Britons will decide to remain within

the EU, we expect euro area core yields to creep

upwards and peripheral spreads to tighten on a 3-

month horizon. Otherwise, safe haven flows are

likely to be triggered.

The range trading on international bond markets continued

in May. Although 10-year Bunds dropped moderately to

0.15% and 10-year US Treasuries crept upwards to

1.84%, the trading range remained intact. In fact, these 10-

year benchmark yields have moved between 0.09%/0.32%

and 1.66%/1.98%, respectively, since February.

A noteworthy diverging development occurred with respect

to real yields. While real 10-year euro area core yields fell

12 bps to -1.01% − the lowest level for more than one year

– the US counterpart increased to -0.04%. This implies

that the difference in inflation expectations shrank to 70

bps. While this is still large, it is 10 bps less than at the

end of April.

Leeway for higher euro area inflation expectations

Going forward, we expect euro area inflation expectations

to rise a bit further. First, from a current level of -0.2% yoy

the euro area headline inflation rate is seen to rise towards

1.0% yoy at the end of the year. Although the 2%

threshold is unlikely to be reached soon, the rebound in

commodity prices and the ongoing moderate economic

rebound signals that current 10-year inflation expectations

of less than 1.2% do not appear sustainable. Second, the

core rate is seen to creep upwards from the current level

(0.7%) towards 1.0% as well. Third, the ECB made it clear

that it is strongly committed to lift inflation expectations.

Hence, while an immediate strong reflationary pressure is

not on the cards, the inflation environment in the euro area

is expected to improve in the months to come.

Besides, macroeconomic data have on balance surprised

on the upside. This bodes well for the continuation of the

economic recovery and should put upward pressure on the

long end of the euro area curve. However, the looming

Brexit vote is forecast to limit any increase in the short

term. Moreover, it will take some time before market

participants are convinced that global growth concerns are

overdone. Finally, the ECB’s QE program will continue to

support government bond markets. Hence, assuming that

the British vote for a continuation of the EU membership,

euro area core yields are seen to increase moderately in

the months to come.

Florian Späte

11

Bonds/Fixed Income Strategy

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

01/14 07/14 01/15 07/15 01/16

10-Year Bond Yields Since 2014Index, 01/01/14=1.0

US Euro area Japan

0

0.5

1

1.5

2

2.5

3

01/12 07/12 01/13 07/13 01/14 07/14 01/15 07/15 01/16

Euro Area Inflation Swaps

10-year 5-year 5-yr 5-yr forward

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

31/12/10 31/12/11 31/12/12 31/12/13 31/12/14 31/12/15

Inflation Expectations in Lockstep with Headline Rate

in %

Euro area headline inflation y/y 10-year inflation swaps (rhs)


Limited upside potential for long-dated US yields

In contrast to euro area yields, 10-year US yields are

currently in the middle of the trading range. Although the

signals from the Fed were on balance hawkish in recent

weeks and the probability of higher key rates in July is

meanwhile above 50%, US yields failed to move higher.

Given that the economic rebound in Q2 is likely to be only

moderate, we do not expect US yields at the long end to

move considerably upwards. At the short end of the curve,

however, the continuation of the rate cycle is forecast to

leave its mark.

Peripheral bonds in waiting mode

Peripheral bond spreads finished the month under review

hardly changed. With the exception of Greek bonds, which

benefited from the agreement on the disbursement of the

next aid tranche for Greece, peripheral bond yields fell in

accordance with lower Bund yields. Until the results of the

“Brexit” vote will be announced, the potential for strong

spread movements appears limited. The looming elections

in Spain will keep investors on their toes as well and stand

in the way of a strong movement in either direction.

Assuming the British will remain part of the EU (our base

scenario), we see leeway for a moderate spread

tightening. The well-advanced issuance activity, the

intensified ECB buying and the search for a pick-up in a

low yield environment should trigger tighter spreads on a

medium-term horizon.

What if British vote for an exit?

The forecasts outlined above are derived under the

assumption that the UK will vote for a continuation of the

EU membership. Although the economic consequences

for the euro area are likely to be limited and an actual exit

will take place at earliest in 2018, in case of “No” euro area

government bonds are forecast to respond strongly. In a

knee-jerk reaction, Bund yields across the curve will drop

and given the already low levels even new historical lows

cannot be excluded. What is more, separatist movements

and euro-sceptical parties will celebrate the vote. This can

trigger a new round of the euro area crisis and a significant

peripheral spread widening is likely. However, as we

expect politicians to reassure markets and the ECB to

announce its commitment to act if necessary, losses are

likely to remain contained ultimately.

Our portfolios

Given the high political risks and the opposing possible

market reaction, we abstain from an active duration

allocation. While we still like the long duration stance for

peripheral bonds from a fundamental point of view and

given the benign technical situation, we regard the

risk/reward profile as unattractive and remain on the

sidelines for the time being.

12

Bonds/Fixed Income Strategy

7.7

6.6

7.7

6.6

0

1

2

3

4

5

6

7

8

9

Core Peripherals

EMU Bonds: Duration Allocationin years

Benchmark * Portfolio

* JPMorgan EMU Government Bond Index

0.00 0.000.00 0.000.00 0.00

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

Core Peripherals

EMU Bonds: Active Durationin years

Current Last MP Change

600

700

800

900

1000

1100

0

50

100

150

200

250

300

350

02/16 03/16 04/16

10-year Sov. Spread Euro Area Peripheralsin bps to German Bunds, daily data

Ireland Italy Portugal Spain Greece (rhs)


After spread tightening three months in a row, non-

financials took a break in May. Spreads widened by

8 bps, but due to lower underlying yields the yield

level hardly changed.

June is going to be a month crowded with event

risks. While the start of the ECB’s Corporate Sector

Purchase Program (CSPP) is a certain event, the

occurrence of a Brexit is much more uncertain.

Hence, investors should prepare for some volatility

going forward. Ultimately, however, we expect the

sound fundamental situation of euro area non-

financials in combination with the technical

support by the ECB to gain the upper hand.

Not least due to a very strong issuance activity (more than

€40 bn of gross issuance and €30 bn of net issuance in

May) the rally in non-financial corporate bonds stalled in

May and the (duration adjusted) non-financial spread

widened by 8 bps to 154 bps. However, the decrease in

underlying yields helped to keep the non-financial yield

around stable. As a result, non-financials still yielded a

positive monthly return (+0.12%) and the return year-to-

date inched up further in May (+3.6%).

June will be crowded with political events. Most

prominently, on June 23 the British people will decide

about the membership in the European Union (EU).

Although the immediate impact on economic fundamentals

is expected to be only moderate, non-financials are seen

to be rather volatile in the run up to the decision. In case

the British vote for an exit, the initial spread reaction is

expected to be strongly negative. But, notwithstanding

single names, investors should not be carried away by

such an event. Ultimately, the fundamental situation of

euro area corporates and the technical support by the

ECB’s CSPP is likely to be more important.

Defaults are on a low level and are expected to remain

well below the average going forward. The trailing rating

drift is on a long-term peak (3.3%) and funding costs are at

record lows. Moreover, from June onwards the ECB will

purchase non-bank IG corporates. While many details of

the CSPP were clarified over the last months, one crucial

question remains open so far. The exact volume is not

clear yet and will become only visible in the course of the

month as the ECB will publish data ex post on a weekly

basis. Estimates for the monthly amount range between

€3 bn and €10 bn – which we regard as reasonable.

In case the ECB will start cautiously, some spread

widening can occur particularly in the run up to the Brexit

vote. But, assuming the British remain in the EU further

spread tightening is on the cards, irrespective of the initial

ECB purchases. Hence, we adhere to our forecast of

around 20 bps spread tightening until the end of 2016.

Corporate Bonds (Non-Financials)

Florian Späte

13

0

50

100

150

200

250

300

350

400

450

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

05/06 05/08 05/10 05/12 05/14 05/16

iBoxx Euro Area Non-FinancialsAll maturities

Yield (in %) Duration adj. spread vs. Bunds (in bps, rhs)

0

50

100

150

200

250

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Issuance of Investm.-grade Non-financialsin bn euro (cumul.), 500 mill euro and up

2012 2013 2014 2015 2016

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

11/08 11/09 11/10 11/11 11/12 11/13 11/14 11/15

Corporates: Trailing 12-month Rating Drift(Upgrades - Downgrades)/(Rated Issuers)

US Global Europe


EUR IG Senior Financial spreads were barely up in

May, while Subordinated Financial bonds reversed

early-month losses in the last week.

Barring a victory of the pro-Brexit camp on June 23,

we believe that Senior Financial bonds remain

relatively attractive amid low volatility and decent

carry versus government bonds, although the

spread tightening potential remains limited.

EUR-denominated Investment Grade (IG) Senior Financial

corporate spreads moved barely higher in May. The

duration-adjusted spread of the iBoxx IG Senior Financial

index widened by 2 bps to 128 bps. The total return was

moderately positive (+0.44%), bringing the year-to-date

performance to +2.27%.

Senior financial bonds over-performed non-financial peers

in recent weeks, ending a 3-month long period of

uninterrupted underperformance driven by the inclusion of

non-bank credit in the eligible universe of ECB’s purchases,

the recovery in oil prices and the concerns over banks’

profitability. This latter issue continued to weigh on

Subordinated Financials, whose spreads rose by as much

as 20 bps in May (peak at 328 bps), before tightened again

to 318 bps on the back of a risk-on mode on global financial

markets.

The agreement between the Greek government and the EU

creditors on the release of the next aid tranche – reached at

the Eurogroup meeting on May 24 – removed a potential

downside risk in the short-term. However, the month of

June is characterized by a tight agenda both on the political

and monetary policy side. The most important event is the

referendum on the permanence of the UK in the European

Union. While the “Remain” camp is narrowly leading the

polls, the uncertainty over the outcome is still high. EUR-

denominated bonds issued by UK banks account for nearly

9% of Bank of America IG Unsubordinated Financial Index

and they have clearly underperformed year-to-date (+22

bps since end-December vs +5 bps for the whole index,

excluding rebalancing effects). A victory of the “Leave”

camp would aggravate this trend.

Under the assumption that the Brexit will be averted, we

believe that IG Senior Financial bonds remain attractive

compared to duration and rating-equivalent government

bonds. Moreover, they have persistently shown lower

volatility compared to Non-Financial peers over the last

twelve months. On the other hand, we acknowledge that

the spread tightening potential is rather limited due to the

concerns over banks’ profitability. As a result we expect

only a very limited tightening over the next 12 months.

Corporate Bonds (Financials)

Luca Colussa

14

200

240

280

320

360

400

440

90

100

110

120

130

140

150

160

170

05/15 07/15 09/15 11/15 01/16 03/16 05/16

Financial Corporate Spreadsspread vs Bund (duration adjusted), in bps

iBoxx € Financials Senior iBoxx € Financials Sub (rhs)

ECB disappoints at Dec meeting

ECB delivers

newmeasures

at Mar meeting

60

70

80

90

100

110

120

130

140

150

-15

-10

-5

0

5

10

15

20

25

12/1

4

01/1

5

02/1

5

03/1

5

04/1

5

05/1

5

06/1

5

07/1

5

08/1

5

09/1

5

10/1

5

11/1

5

12/1

5

01/1

6

02/1

6

03/1

6

04/1

6

05/1

6

Brexit risk for UK banksSource: BofA IG Unsubordinated Financials

Option Adjusted Spread in bps

Difference UK banks (rhs) All countries (rhs)

Conservativeparty wins UK

elections

Referendum to take place on

June 23

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

05/15 07/15 09/15 11/15 01/16 03/16 05/16

IG Corporate bonds: Realized volatilityannualized volatility on daily returns, 30-day rolling window, in %

Senior Financials Subordinated Financials Non-Financials


The US dollar recovered on a broad-based in May, led by a significant rebound in US rate hike expectations.

Near term, we see the potential for another leg lower in the EUR/USD, with our base case of a Fed rate hike in summer not yet fully priced by markets, but the medium-term outlook remains balanced.

The British pound will remain closely tied to Brexit opinion polls, given that sterling would be the prime victim of a British ‘Leave’ vote on June 23.

Barring a ‘Leave’ vote in the UK, the recent weakness of the Japanese yen is unlikely to reverse soon, given the opposed direction of monetary policies in Japan and the US.

The US dollar pared almost half of the losses incurred in trade-weighted terms over the earlier months this year. Against a broad basket of currencies, the Greenback strengthened 3% in May. Key reason for the reversal was the outlook for the Fed. Stronger inflation data and unexpectedly hawkish minutes of the FOMC meeting in April triggered a significant re-pricing of expected US rate hikes. The resulting rise in the US dollar was particular pronounced against EM currencies, with the South Africa rand (ZAR) falling by almost 10%. Also the EUR/USD moved lower from a temporary high above 1.15 USD/EUR to close to 1.11 USD/EUR towards the end of the month.

Looking ahead, near-term moves will be still affected by the Fed outlook. Since we anticipate the US central bank to strike a more hawkish tone over the coming weeks, this will leave at least, in the short term, leeway for some further US dollar strength. What is more, also ongoing high portfolio outflows out of the euro area may support some euro weakness. Further out, however, the outlook for the EUR/USD is more balanced. While the Fed may deliver a next rate hike in summer, it will remain extremely cautious in further normalizing monetary policy thereafter. The support to the US dollar from higher US rates is thus less likely to suffice to counter the gravitational pull towards long-term fair values. Moreover, while we do not anticipate the oil price to recover with a similar momentum seen over recent weeks, a further trend normalization over the longer term would give some support to the euro (see upper chart on next page). On balance, we thus leave our 12-month forecast of 1.13 USD/EUR unchanged.

Brexit may even give EUR/USD a boost short term

This forecast is based on the assumption that the Brexit referendum on June 23 results in a ‘Remain’ vote. In case of a slightly less likely, but well possible ‘Leave’ vote several offsetting forces would be at work regarding the EUR/USD. On the one hand, the euro will be boosted not only by investors moving out of the British pound, but also by a likely spike in global risk aversion which tends to

Thomas Hempell

15

Currencies

80

85

90

95

100

105

110

115

120

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50

10/11 04/12 10/12 04/13 10/13 04/14 10/14 04/15 10/15 04/16

US Dollar and EuroTWI Indices: 01/2005 = 100

USD/EUR Trade-weighted EUR (rhs) Trade-weighted USD (rhs)

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

FX performance

Data as of 27/5/2016

vs. euro 29/4/2016 to 27/5/2016, in %

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40-0.1

0.1

0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

12/13 03/14 06/14 09/14 12/14 03/15 06/15 09/15 12/15 03/16

Yield Differential and USD/EUR

Diff. 2y yield US Treasuries vs. Bunds (in pp) USD/EUR (rhs)


strengthen the euro as a funding currency over the US

dollar. Likewise, expectations regarding future rate hikes

by the Fed will be unwound, weighing on the Greenback.

This effect is likely to prevail in a first knee-jerk reaction.

On the other hand, however, market concerns about the

stability of the euro area (or even more broadly over the

European Union as a whole) may increase the risk

premium on the euro. This is likely to be a more gradual

process, which is why the temporal sequence in our view

would be a higher EUR/USD short-term, followed by a

potentially significant longer spell of euro weakness

thereafter, depending largely on the political repercussions

of a Brexit in Europe.

Brexit referendum a binary event for sterling outlook

Nonetheless, the strongest effect of the Brexit referendum

will almost surely be visible on the sterling exchange rate.

Over recent weeks, the pound has been heavily driven by

alternating referendum polls. More recently, indications of

rising support for the ‘Remain’ camp has helped the pound

to even strengthen against the broadly appreciating US

dollar. That said, the costs of insuring against a sterling

depreciation on the option markets (as reflected in risk

reversals, see chart) have risen further, reflecting the

continued demand for hedging against a Brexit vote among

investors. Given Britain’s large current account deficit of

more than 5% of GDP, a Brexit may leave the UK

vulnerable to a sudden stop of capital inflows, which could

lead the trade-weighted pound weaker by more than 10%,

with most of this weakness expressed against the US

dollar and the euro. On the positive side, however, a

‘Leave’ vote will provide tailwinds to sterling. The upside

potential appears much more limited, though, given also

that markets are ascribing significantly higher odds to a

‘Remain’ vote than to an outright Brexit.

Yen strength has proved short-lived

In the meanwhile, the yen followed the broader trend on FX

markets and weakened against the US dollar. In parts this

is reflected by the more hawkish communication of the

Fed, but also improved risk sentiment has partially

underpinned this move.

Looking ahead, we still anticipate the Bank of Japan to

extend its monetary policy support to the economy,

potentially even at the June meeting. Beyond this, the

continued portfolio outflows out of Japan should keep a lid

on the Japanese currency, which is why we stick to our

view of a moderate trend depreciation of the JPY/USD.

A key risk to this outlook would be against related to a

Brexit. In this case, another spike in global risk aversion

could boost the yen on safe have flows also against a US

dollar receiving shrinking support from the Fed rate

outlook.

16

Currencies

1.00

1.10

1.20

1.30

1.40

1.50

1.60

1.70

20

40

60

80

100

120

140

160

05/06 11/07 05/09 11/10 05/12 11/13 05/15

Oil Price and USD/EUR

Crude oil Brent US$/barrel (rhs) USD/EUR (rhs)

0.65

0.70

0.75

0.80

0.85

0.90

-1.5

-0.5

0.5

1.5

2.5

3.5

4.5

08/12 12/12 04/13 08/13 12/13 04/14 08/14 12/14 04/15 08/15 12/15 04/16

Risk Reversal and GBP/EUR3-month 25% delta contracts

Risk reversal GBP/EUR GBP/EUR spot (rhs)

Higher risk reversal* implies market positioning for higher GBP/EUR (weaker GBP)

* Risk reversals reflect the relative costs of insuring against a depreciation vs. an appreciation of GBP/EUR by an equal amount on the option markets.

75

80

85

90

95

100

105

110

115

120

125

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

JPY/USD


– In the short term the good market tone could last

due to the reflation momentum and the first

earning upgrades in the US and in energy sectors.

– But valuation is no more at discount in the euro

area (EA) and the premium in the US is already

10%. We add the uncertainty on the Chinese

economy and the enduring political risks in

Europe.

– Inside the equity space our preference continues

to be for EA equities and Japan against US ones,

as relative valuations have become extreme.

– In Europe we favor “value” sectors like financials,

telecoms and food retail plus discretionary names.

In early May EM and EA equities lost more than 4%, the

S&P 2% and the Topix 6%. Reasons were the BoJ’s non-

action, the still weak US macro surprises, the weak

reporting season and the fears concerning a possible

softer economic momentum in China after the previous

stimulus lost its steam.

The earnings growth in Q1 remained generally negative

together with a poor guidance. In the US, retailers were

particularly beaten as results and guidance came lower

than expectations. This generated confusion among

investors because it put in question the apparent wealthy

conditions of the US consumers. Here we think that the

read through is exaggerated, as the US consumer spent

more on other items such as auto, on-line goods and

services, healthcare and shelter than in traditional shops.

The huge set-back of Italian financials didn't help too

together with the EA political issues: Brexit, Spanish

government and the new package for Greece. About the

latter an agreement was finally found so that a short term

negative trigger for markets is avoided. Concerning the

UK referendum, our base scenario contemplates UK to

remain. In the case of a Brexit, markets could plunge by

10% (Europe underperforming US). In this case, we

expect the global central banks to act aggressively in

concert so that markets should then be able to recover at

least some of the initial losses.

While global growth is going to remain anemic, recent

data from EA were decent and better than expected. Our

economic view for EA remains constructive. Global macro

surprise indices improved too in the month and earnings

revisions started to stabilize accordingly: While they

remain in negative territory in the euro area, in the US

they are positive for the first time since mid-2014. This, in

turn, helped markets’ performance in May. The improving

price component of global trade, the oil price surge, the

resiliency of core inflation in US and EA, all suggest a

stabilization of the global inflation momentum. Which in

turn is potentially positive for the nominal earnings growth

perspectives, and finally for equity valuation.

Equities

17

Michele Morganti


Earnings upgrades are already visible in Russia, Brazil and in the energy sector (+8% the European oils). In the very short term the better sentiment could last, particularly in the EA. More recently the Fed gave indications to maintain its hawkish policy with a possible hike in June. While we think it could be too early, nevertheless such wording put some tailwinds to the USD. While a stronger USD ultimately contributes to cap the EM performance, it helps to generate a better investors' sentiment towards EA equities.

In Japan, we expect the BoJ to be less aggressive than forecasted few months ago but a fiscal stimulus looks more plausible in the short term. In the meantime Japanese earnings continue to be at risk and while valuations have turned more appealing the profit weakness which we continue to expect (our models outcome are lower than consensus earnings) keep us refraining from putting the Topix in full overweight.

Should the UK decide to stay, equities could extend the rally. But starting from fair valuations and given both structural growth constraints and enduring investors’ concern about monetary policy limits, the market upside should then be capped. Current market multiples are indeed already 2.5% higher than historical average for EA equities and 10% for US ones. Furthermore, as we approach the bulk of the dividend season, we definitively need earnings growth to show more momentum. But Q2 results should remain weak (ex-oil). And while 2016 expectations could continue to be helped by the improved oil prices, the 2017 and 2018 earnings estimates remain uncomfortably too high at +13% and 11% respectively (MSCI World).

Overall we continue to prefer EA and Japanese equities to US ones. The former has a higher beta and it is more cyclical in nature. Which plays well when deflation scares are receding. EA valuations are also more attractive.

Since 2015, EA market multiples have shifted from being at a reasonable premium to a current discount if compared to the US. Longer-term valuations favor the MSCI EMU index too (Shiller PE), together with the result of our regression models (+2.5% return expected in 3 months vs. -1.1% for US). Monetary policy in the EA is also more accommodative and wages’ growth subdued. EA margins have scope to expand should the GDP continue to grow at more than 1% as we think. On the contrary, the NIPA profits in the US are showing signs of significant stress (-11% yoy in Q4 2015 and -5.7% in Q1) which can eventually continue as wages do increase.

As far as European sectors are concerned we continue to prefer Value and discretionary themes (extreme valuation appeal plus a tilt to the consumer and to a better cycle momentum): banks, insurance, TLC, Commercial & Professional services, IT hardware, food retail, media and retail. We underweight food, pharma, capital goods and utilities.

Equities

18

last available date: 27/05/16

Avg. Avg.

12m f Discount 12m f Discount 12m f Discount 12m f Discount Discount Disc. (-1M)

USA 16.9 11.2 2.6 14.6 11.4 18.6 2.2 2.5 10.5 10.6

JAPAN 13.0 -55.0 1.1 -15.6 6.7 -4.0 2.3 24.9 -24.9 -22.9

UK 15.9 15.1 1.7 -4.7 9.0 15.9 4.2 5.2 5.3 5.6

SWITZERLAND 16.7 9.3 2.3 3.4 13.0 18.1 3.6 12.1 4.7 3.0

EMU 13.8 -2.9 1.4 -7.8 7.1 14.3 3.7 -5.1 2.2 4.2

FRANCE 14.5 1.1 1.4 -5.3 7.7 17.0 3.7 -2.8 3.9 3.4

GERMANY 12.7 -16.5 1.5 0.7 7.6 18.8 3.3 -3.2 1.5 4.5

GREECE 12.3 -3.3 0.9 -45.8 4.6 -20.5 3.3 -17.6 -13.0 -11.7

ITALY 13.3 -14.3 0.9 -26.4 4.6 1.3 4.7 -0.2 -9.8 -8.2

PORTUGAL 13.0 5.4 1.4 -21.9 6.4 10.9 7.4 64.3 -17.5 2.1

SPAIN 13.0 0.5 1.1 -31.9 4.9 -3.6 4.6 -11.3 -5.9 -4.2

EURO STOXX 50 13.4 1.5 1.3 -8.0 7.0 19.2 4.1 -5.8 4.6 5.6

STOXX SMALL 16.0 14.0 1.6 -0.3 8.7 8.7 3.1 -4.1 6.6 6.5

EM, $ 11.5 -21.6 1.3 -21.3 6.8 -11.6 3.0 -15.8 -9.7 -7.0

BRAZIL 10.6 22.4 1.1 -34.2 6.2 -58.6 4.0 -9.5 -15.2 -6.2

RUSSIA 6.0 -16.3 0.6 -42.6 3.6 -22.5 5.1 52.8 -33.6 -24.1

INDIA 17.7 25.2 2.7 0.5 11.8 3.8 1.7 4.8 6.2 3.7

CHINA 10.4 -20.4 1.2 -31.7 6.2 -17.1 2.7 -13.8 -13.8 -11.7

Note: Discount in % to long-run norm; blue and negative numbers = undervaluation. Red and pos. numbers = overvaluation;

PEs are since 1987, the rest is since 2003. In case of DY, a discount means the market had a higher DY,

meaning the market is at premium for this multiple. 12m f = expected in 12 months

Source: Thomson Reuters Datastream, IBES estimates.

PCF DYPBMarkets

PE


Despite rising oil prices, EM markets have suffered

losses over the month. The fall was triggered by

doubts about Chinese momentum and a stronger

US dollar (+3%). Short term, volatility will stay.

Longer term, EMs are to benefit from further

stabilization of both the commodity prices and the

US dollar plus the benefits of reforms and low

valuations.

In relative terms we continue to favor India, the

smaller CEE countries, and South Korea.

Over the last month emerging markets equities have

decreased in dollar terms by 4.1%. Chinese slowing

momentum has overweighed the positive effect of the

higher commodity and oil prices (+4.4% and 9%,

respectively). The top performers were Greece and India;

+12.2% and +1.6%, respectively. The over-performance of

the Greek stocks was supported by the progress in the

negotiations over the release of the aid tranche and

increasing earnings. The Indian stocks, on the other hand,

have benefitted from improving domestic fundamentals

and a better reporting season. The worst performance

came from the Brazilian and Turkish markets, which

suffered from elevated political uncertainty / risks.

Overall, EM earnings are only slightly up (+0.4% the

positive revision of the 2016 estimate). Appreciable

increase in oil prices has contributed to significant

improvement of Brazilian and Russian earnings (8.4% and

11.4%, respectively), but Chinese ones slumped further

(by around 2%), like most of the Asian countries.

While the EM sentiment has become better (higher oil

prices and stabilizing world trade pricing), overhaul is not

yet completed: the economic momentum remains poor,

with productivity-enhancing reforms lagging. Chinese

slowing momentum gives a reason to be concerned, too.

Positive factors for EMs are low valuations and declining

outflows. In some cases (Brazil, Russia, Indonesia),

monetary policies are playing also more favorably.

Looking at the Indian market, we note that industrial

momentum is getting weaker and reforms proceed slowly.

One exception is the much-awaited bankruptcy legislation

which has finally been passed by the parliament. The Q1

reporting season was quite successful too: the median

sector earnings growth is 10.5%. Our macro model keeps

on indicating undervaluation of the market (around 7%).

In China, the economic impulse is getting slightly softer;

with the exception of real estate, which remains solid.

Market sentiment is bearish, and confusion prevails about

next policy moves. Should reforms stall, investors would

most likely sell. Here, our macro-based models point at a

potential negative return for the MSCI China over the next

three months.

Vladimir Oleinikov

19

Emerging Markets Equities

10y yld

-1M YTD -1M YTD chg, YTD MTD YTD

WORLD ($) -0.6 0.8 0.2 -0.9

US 0.2 2.7 0.9 -0.7 -44 2.9 -1.0

EMU -1.2 -4.9 -0.1 -3.5 -38 -0.6 1.7

GREECE 12.2 -3.4 10.8 -38.5 -109 -0.6 1.7

CZECH REP. -2.4 -2.3 -2.2 -11.4 -6 -0.2 0.8

HUNGARY -1.7 12.3 2.2 6.9 -5 -1.0 1.4

POLAND -3.1 -1.9 1.1 -0.9 1 -0.7 -1.6

EM ($) -4.1 1.8 -0.2 -1.0 -75

BRAZIL -10.0 11.4 6.4 3.2 -337 -2.8 9.4

CHINA -3.0 -6.9 -0.5 -4.9 11 0.8 -3.1

INDIA 1.6 1.2 -0.7 -1.6 -29 1.1 -2.3

INDONESIA -1.2 4.1 -0.7 2.0 -104 -0.9 -0.4

KOREA -2.8 0.3 2.9 -0.1 -30 -1.3 -2.1

MALAYSIA -3.1 -2.3 0.3 0.5 -33 -2.4 3.8

MEXICO -0.7 7.1 0.2 2.7 -18 -5.6 -7.6

RUSSIA -1.5 10.1 10.1 -6.4 -86 -0.2 9.0

TAIWAN -0.9 1.9 -1.7 -5.1 -19 1.1 -0.2

THAILAND 1.0 13.9 -0.4 -4.9 -41 -0.1 -1.1

TURKEY -8.8 9.1 -0.1 4.5 -71 -3.4 -2.8

VIETNAM 0.0 -2.3 -0.1 4.5 -11 1.6 -0.7

SHANGHAI -4.5 -20.3 -2.6 -10.2 11 0.8 -3.1

All the markets are represented by MSCI indices, except for US (S&P500) and Shanghai.

Marketsearnings, %-chg FX (TW), %-chgprice, %-chg

25

30

35

40

45

50

55

60

65

650

700

750

800

850

900

950

1,000

1,050

1,100

12/14 03/15 06/15 09/15 12/15 03/16

EM vs. oil prices

EM Oil price (WTI)

600

700

800

900

1,000

1,100

1,200

1,300

600

700

800

900

1,000

1,100

1,200

1,300

08/10 08/11 08/12 08/13 08/14 08/15

MSCI EM index: Value indicatorusing hard currency yield for bonds

MSCI EM - price index (in U$)

Value indicator (12m fwd earnings / 10-year yield)


– Equity markets continued to reveal positive perfor-

mance figures during the course of May so far, with

the euro area clearly outperforming the US.

– In that sense, our recommendation to slightly raise

the exposure for euro area equities towards a

neutral alignment hinted in the right direction. That

said, with hindsight, an outright overweight would

have been even more rewarding.

– Against the backdrop of the various political risks,

neither a significant tightening of peripheral bond

spreads is expected, nor does a rally in risky assets

appear likely.

– Thus, looking forward, we renew our cautious tac-

tical allocation stance with respect to equities still

favoring the euro area to the US.

Since our last recommendation at the end of April, equity

markets have continued to reveal positive performance

figures so far. Indeed, apart from Switzerland, the euro

area equities turned out to be the most attractive asset

class in our covered universe. Thus, in particular under-

pinning our preference for the euro area compared to the

US. Insofar, our recommendation to slightly raise the ex-

posure for euro area equities towards a neutral alignment

clearly added value compared to the previous tactical

allocation stance. With hindsight, of course, an outright

overweight would have been even more rewarding.

While macro economic conditions seem firm by and large,

political uncertainties come increasingly into the focus of

the market participants. In polls about the “Brexit” referen-

dum proponents and opponents are nip and tuck. Further-

more, the Spanish General Elections seem unlikely to

unlock the political stalemate. Looking further into the year,

there are also political imponderables resulting from the

nomination of Donald Trump as Republican candidate for

the US presidential elections.

The ECB is expected to confirm its dovish policy stance but

refrain from further measures, as long as the recovery

proceeds and the already decided actions do not yet make

their impact. From the latest Fed minutes, we con-sider a

Funds Rate hike in July or September more likely,

depending on the outcome of the British EU referendum.

Thus, a rally in risky assets appears unlikely in the weeks

to come. In such an uncertain environment, core govern-

ment bond yields will remain low and a considerable

tightening of peripheral bond spreads is not expected ei-

ther. Looking forward, we renew our cautious tactical allo-

cation stance with respect to equities still favoring the euro

area to the US due to high valuations and the continued

squeeze on profit margins. Thus, we leave proposed opti-

mal portfolio structure unchanged.

Mark to Market Allocation

Thorsten Runde

20

Asset Class BenchmarkModel

Portfolio

Previous

Allocation

Equities 20.0 19.6 19.6

Bonds 75.0 75.5 75.5

Cash 5.0 4.9 4.9

Equities, US 3.0 2.9 2.9

Equities, EMU 12.0 12.0 12.0

Equities, UK 2.0 1.9 1.9

Equities, Switzerland 1.0 1.0 1.0

Equities, Japan 2.0 1.9 1.9

Bonds, Gvt. US 11.3 11.5 11.5

Bonds, Gvt. EMU Core 27.0 26.7 26.7

Bonds, Gvt. EMU GIIPS 18.0 18.0 18.0

Bonds, Gvt. UK 7.5 8.0 8.0

Bonds, Gvt. Switzerland 3.8 3.8 3.8

Bonds, Gvt. Japan 7.5 7.6 7.6

Cash, Euro 3-Mth. 5.0 4.9 4.9

Asset Classes

Equities - Regional Structure

Bonds - Regional Structure

Benchmark Model Portfolio

Equities20.0

Bonds75.0

Cash5.0 Equities

19.6

Bonds75.5

Cash4.9

-1.0

-0.5

0.0

0.5

1.0

1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

USA Euroland UK CH Japan

-1.0

-0.8

-0.5

-0.3

0.0

0.3

0.5

0.8

-1.0

-0.8

-0.5

-0.3

0.0

0.3

0.5

0.8

USA Euroland UK CH Japan


Financial Markets

Forecast Tables

21

*The forecast range for the assets is predetermined by their historical volatility. The volatility calculation is based on a 5 year history of percentage changes, exponentially weighted. The

length of the bars within each asset group is proportional to the relative deviations from their mean forecasts.

0.20

1.85

-0.15

1.50

-0.30

105.5

2,030

1,325

6,160

8,110

1.10

111

0.74

1.11

0.20

2.10

-0.15

1.70

-1.10

115

2,140

1,440

6,470

8,560

1.14

115

0.76

1.14

0.20

1.60

-0.15

1.30

0.50

100

1,920

1,210

5,850

7,660

1.06

107

0.72

1.08

10-Year Bunds

10-Year Treasuries

10-Year JGBs

10-Year Gilts

10-Year Bonds CH

MSCI EMU

S&P500

TOPIX

FTSE 100

SMIC

USD/EUR

JPY/USD

GBP/EUR

CHF/EUR

3-Months Horizon

Go

ve

rnm

en

t B

on

ds

Eq

uit

ies

Cu

rre

ncie

s

0.30

1.90

-0.10

1.60

-0.20

106.0

2,040

1,335

6,200

8,150

1.13

113

0.79

1.12

0.35

2.40

-0.20

2.00

-0.30

120

2,250

1,570

6,830

9,110

1.21

122

0.83

1.19

0.25

1.40

0

1.20

-0.10

90

1,830

1,100

5,570

7,190

1.05

104

0.75

1.05

10-Year Bunds

10-Year Treasuries

10-Year JGBs

10-Year Gilts

10-Year Bonds CH

MSCI EMU

S&P500

TOPIX

FTSE 100

SMIC

USD/EUR

JPY/USD

GBP/EUR

CHF/EUR

12-Months Horizon

Go

ve

rnm

en

t B

on

ds

Eq

uit

ies

Cu

rre

ncie

s

3-M Money Market Rates 27/05/16* 3M 6M 12M Corporate Spreads 27/05/16* 3M 6M 12M

USA 0.67 0.80 0.90 1.20 IBOXX Corp. Non Fin 155 145 140 130

EUR -0.28 -0.30 -0.40 -0.40 IBOXX Corp. Sen Fin 128 125 125 125

JPN -0.02 -0.05 -0.10 -0.15 Forex 27/05/16* 3M 6M 12M

UK 0.59 0.60 0.65 0.90 USD/EUR 1.12 1.10 1.12 1.13

SWI -0.73 -0.70 -0.70 -0.70 JPY/USD 110 111 112 113

10-Year Bonds 27/05/16* 3M 6M 12M JPY/EUR 123 122 125 128

Treasuries 1.84 1.85 1.85 1.90 USD/GBP 1.47 1.49 1.47 1.43

Bunds 0.15 0.20 0.30 0.30 GBP/EUR 0.76 0.74 0.76 0.79

BTPs 1.37 1.40 1.45 1.40 CHF/EUR 1.11 1.11 1.11 1.12

OATs 0.48 0.55 0.60 0.60 Equities 27/05/16* 3M 6M 12M

JGBs -0.10 -0.15 -0.10 -0.10 S&P500 2093 2030 2020 2040

Gilts 1.44 1.50 1.55 1.60 MSCI EMU 106.9 105.5 105.0 106.0

SWI -0.31 -0.30 -0.30 -0.20 TOPIX 1345 1325 1325 1335

Spreads 27/05/16* 3M 6M 12M FTSE 6266 6160 6130 6200

GIIPS 135 130 125 120 SMI 8230 8110 8065 8150

Covered Bonds 67 65 65 65* average of last three trading days

Growth Inflation2014 2015 2016f 2017f 2014 2015 2016f 2017f

US 2.4 2.3 1.5 2.1 US 1.6 0.1 1.6 2.2

Euro Area 0.9 1.5 1.4 1.2 Euro Area 0.4 0.0 0.3 1.4

- Germany 1.6 1.4 1.5 1.4 - Germany 0.8 0.1 0.4 1.4

- France 0.2 1.2 1.4 1.3 - France 0.6 0.1 0.3 1.2

- Italy -0.3 0.6 0.9 0.8 - Italy 0.2 0.1 0.1 1.0

Non-EMU 2.6 2.3 2.1 2.1 Non-EMU 1.0 0.1 0.8 1.3

- UK 2.8 2.2 1.9 2.1 - UK 1.5 0.0 0.8 1.5

- Switzerland 1.9 0.9 0.9 1.6 - Switzerland 0.0 -1.1 -0.8 0.2

Japan -0.1 0.5 0.6 0.8 Japan 2.7 0.8 0.1 0.4

Asia ex Japan 6.2 5.8 5.7 5.7 Asia ex Japan 3.3 2.2 2.5 2.6

- China 7.4 6.9 6.4 6.1 - China 2.0 1.4 2.3 2.1

Central/Eastern Europe 1.9 0.3 1.4 2.8 Central/Eastern Europe 5.6 8.9 5.1 4.8

Latin America 1.0 -0.6 -1.1 1.8 Latin America 10.4 13.6 19.1 13.9

World 2.8 2.5 2.3 2.8 World 2.3 1.6 2.2 2.5

This document is based on information and opinions which Generali Investments Europe S.p.A. Società di gestione del risparmio considers as reliable. However, no representation or warranty, expressed or implied, is made that such information or opinions are accurate or complete. Opinions expressed in this document represent only the judgment of Generali Investments Europe S.p.A. Società di gestione del risparmio and may be subject to any change without notification. They do not constitute an evaluation of any strategy or any investment in financial instruments. This document does not constitute an offer, solicitation or recommendation to buy or to sell financial instruments. Generali Investments Europe S.p.A. Società di gestione del risparmio is not liable for any investment decision based on this document. Generali Investments Europe S.p.A. Società di gestione del risparmio may have taken, and may in the future take, investment decisions for the portfolios it manages which are contrary to the views expressed herein. Any reproduction, total or partial, of this document is prohibited without prior consent of Generali Investments Europe S.p.A. Società di gestione del risparmio. Generali Investments is part of the Generali Group which was established in 1831 in Trieste as Assicurazioni Generali Austro-Italiche. Generali Investments is a commercial brand of Generali Investments Europe S.p.A. S Società di gestione del risparmio.

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Head of Research (ad interim): Santo Borsellino ([email protected])

Deputy Head of Research: Dr. Thomas Hempell, CFA ([email protected])

Team: Luca Colussa, CFA ([email protected])

Radomír Jáč ([email protected])

Jakub Krátký ([email protected])

Michele Morganti ([email protected])

Vladimir Oleinikov, CFA ([email protected])

Dr. Martin Pohl ([email protected])

Dr. Thorsten Runde ([email protected])

Frank Ruppel ([email protected])

Dr. Christoph Siepmann ([email protected])

Dr. Florian Späte, CIIA ([email protected])

Dr. Martin Wolburg, CIIA ([email protected])

Paolo Zanghieri ([email protected])

Edited by: Elisabeth Assmuth ([email protected])

Tamara Hardt ([email protected])

Issued by: Generali Investments Europe Research Department

Cologne, Germany · Trieste, Italy

Tunisstraße 19-23, D-50667 Cologne

Version completed on May 31

Sources for charts and tables: Thomson Reuters Datastream, Bloomberg, own calculations

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