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21st March 2019 EM Assets Win Out from the “Powell Pivot” Investors still cautious despite 2019Q1 rally in risk assets Investor attitudes towards risk assets have only improved modestly compared with our December survey. Bear in mind that while Global equities have rallied strongly since Christmas, they were only 4% higher during this fieldwork period than that of our previous survey in early December. Investors now ascribe a 53% probability to stocks being higher a year from now, and a 62% probability to stocks beating bonds. But they are also braced for higher equity volaltility, and remain worried about the possibilities of a US bear market and/or a global recession. They are wary of credit, less confident about corporate earnings, biased towards defensives and think higher equity valuations are unlikely. ASR’s Composite “Optimism” Indicator (p12) - based on seven “risk-on” trades - remains well below the average of the past four years. “Powell Pivot” prompts major rethink of interest-rate probabilities The Fed’s decision to move to ‘patient’ has led to some dramatic change in interest- rate probabilities. The likelihood of higher US 2yr yields a year from now has fallen to 54%. For the first time in this survey, more investors expect the US yield curve to steepen than to flatten. 16% of respondents even think that both 2yr and 10yr yields could be lower a year from now. While the panel still expects bond yields to be higher a year from now, the probabilities have fallen as inflation fears have receded. EM assets in favour due to softer US rate expectations & weaker USD Emerging Markets are back in favour. EM equities are expected to trounce Developed Market peers, while EM bonds are expected to outperform US HY Credit. 38% of respondents expect both trades to happen over the coming year. The change in US monetary policy and the prospect of a softer USD have been important catalysts. Investors’ Views Fracture Further Asset Survey 2019Q1 Asset Survey - A big data analysis (see p15) of our panellists’ responses reveals how this year’s weak economic data and strong equity-market performance has created rifts between investors. Our panel seems to be transitioning away from the old investment regime to a new one. This has fragmented the three groups seen in the Q4 2018 poll into five ‘tribes’. This is one of the widest ranges of groupings since we started running the survey. Multi The cluster of bullish panellists has fallen from a half to a third of all respondents, but in contrast to the previous survey, this group is now expecting business confidence to rise over the coming year. The division over the inflation outlook is still a differentiator for the two groups that believe business activity has stabilised and colours their outlook for yields, if not for equities where they are neutral. The final two groups of investors David Bowers are bearish on risk assets, but they differ on whether the economy will slow enough to +44 (0) 20 7073 0733 fall into recession and so drive bond yields lower. [email protected] The Fieldwork Charles Cara th th +44 (0) 20 7073 0738 The fieldwork was conducted between 28 February and 14 March 2019. A record [email protected] 252 asset managers participated in this wave, representing $4.7 trillion of assets. Ian Harnett +44 (0) 20 7073 0737 [email protected] Authorised and Regulated by the Financial Conduct Authority 1-2 Royal Exchange Buildings, London, EC3V 3LF Investment Strategy | 21st March 2019 Highlights from the Survey ASR’s Multi-Asset Survey is a survey of probabilities. Every quarter we ask more than 200 CIOs, asset allocators, economists and multi-asset strategists about the outlook for financial markets for the next 12 months. However, instead of asking them about they are positioned (as some surveys do), we ask them about the likelihood of certain financial events A Survey of Probabilities occurring: for example, how likely do they think it is that the dollar will be higher; how likely it is that stocks will outperform bonds; or how likely it is that 10yr bond yields will be higher? We are trying to map how they see the financial world in terms of probabilities. Where possible we contrast those probabilities with how often those events have in fact occurred over the past decade. This is a cartographical tool that can help identify pockets of ‘groupthink’ (where everyone sees the world in the same way). 1. The Macro Environment. The past three months have seen a major rethink on the business cycle as a result of the “Powell Less negative on the cycle Pivot” on US monetary policy. Investors are now much less short-term but recession confident that the business cycle will be weaker a year from now. That said, the risk of a global recession still remains elevated fears remain elevated (38% probability) and our panel is becoming more convinced that US unemployment rate will be higher in a year’s time (54%). 2. Inflation. There has been a significant collapse in inflation expectations over the past six months. Investors continue to Significant collapse in think that the probability of core PCE deflator exceeding 2% is inflation expectations greater than 50% (as they have done ever since we introduced the question in 2016). In Japan and eurozone, investors have practically given up expecting to core CPI inflation to exceed 2% - in both countries, the probability is now sub-30%. 3. Bonds. Investors continue to cling on to the belief that bond yields are more likely to rise over the next 12 months (despite Consensus expecting higher the benign inflation outlook). But the collapse in 10yr yields since bond yields is being October has clearly challenged those probabilities. At 56%, the challenged probability of higher US yields a year from now is the lowest reading the survey has ever recorded. 4. Other US Interest Rates. The abrupt shift in Fed policy has had a dramatic impact on investors’ rate expectations. Just three months ago, investors put the probability of higher US 2yr yields Major fall is the probability at 65%; today it has fallen sharply to 54%. Interestingly the that 2yr Yields will be higher probability is still above 50%; investors are still reluctant to a year from now contemplate lower 2yr rates a year from now. The probability of higher real yields has also fallen – this is particularly important for the dollar and for real assets. However, our panel is less confident that US “TIPS” will beat Conventionals suggesting some downward bias to inflation breakevens. 5. Corporate Credit & EM Debt. Despite a strong performance from US corporate credit in 2019Q1, investors’ ‘love-affair’ with Credit remains out of favour the asset class is over. Since 2017H1 our panellists have become less convinced the IG credit can outperform Treasuries; they have become progressively less convinced that HY credit can outperform IG credit; and they have become more convinced 2 For full Research Library click here Now available on Bloomberg, Thomson Reuters & Factset Investment Strategy | 21st March 2019 that EM bonds will beat US HY credit. That partly reflects a preference for sovereign paper over corporate, but there is also EM bonds (and EM assets in growing interest in EM assets more generally, prompted by lower general) are in favour expectations of higher US interest rates and a weaker dollar. 6. Global Equities. Despite (or maybe because of) the 17% rally since their lows on Christmas Eve, investors place a probability Lacklustre equity drivers of only 53% on higher Global equities. The chances of higher corporate earnings is a modest 54% and the probability of higher multiples remains below 50% for the fifth survey running. 7. Risk Appetite. One of the reasons for the cautious equity view is the elevated fear of a US bear market within the next 12 months especially relative to its historical base. The concern is Investors still quite risk- underpinned by the high probability (67%) investors are giving averse despite the rally in to increased equity volatility over the next 12 months. 27% of risk assets in 2019Q1 respondents think that both higher equity volatility and lower global equities are likely over the coming year. Another cross- check on risk appetite is whether investors think that cyclical stocks can outperform defensive stocks. Our panel puts this probability at less than 50% for the third survey running, suggesting a risk-averse stance. 8. Equity Allocation. Investors are increasingly confident that EM Equities are expected to Emerging Market (EM) equities are set to outperform Developed outperform DM Equities Market (DM) equities over the next 12 months (implied probability: 60%). 38% of the panel not only think it likely that EM equities will beat DM, but also expect EM Bonds to outperform US High Yield. Interestingly, they remain strangely ambivalent when it comes to choosing between US and non-US equity markets: typically, EM equity outperformance has been strongly correlated with US equity underperformance. Investors place a 54% probability on the ‘Value’ factor beating ‘Growth’. Investors still think it likely 9. Asset Allocation. Investors believe stocks will beat bonds over that stocks will beat bonds the next 12 months, with a probability of 62% (although that is over the next 12 months the second lowest reading in the survey’s history). Investors are becoming increasingly sceptical that the dollar can continue to appreciate – especially given the downward shift in short-rate and real-yield expectations. Our summary indicator – ASR’s But remain “risk-off” Composite Optimism Indicator (COI) based on seven survey relative to the average of questions – has shown a small rebound, but remains in “risk off” the past four years territory, well below the average of the past four years.

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