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Global Market Perspective Vadim Zlotnikov Chief Market Strategist & Co-Head—Multi-Asset Solutions Global Market Perspective An Alternative Framework for Multi-Asset Diversification Diversifying by time horizon and equity beta may allow investors to benefit from high expected returns to contrarian, multi-asset investment opportunities while reducing drawdown risk. How We’re Positioned and Where the Opportunities Are Highlights Fears of slowing economic growth accelerated during September. Long-term n Continued volatility—from declining expectations for inflation and nominal growth collapsed. The decline was most liquidity as well as decelerating pronounced in the US, but also extended to Europe, Japan and Australia. emerging-market growth and tepid earnings growth—should create bigger mispricings. (continued) n These opportunities are necessarily coupled with drawdown risks that can’t be hedged, because illiquidity and Current Positioning unpredictable government response can amplify short-term losses. Position Trend Overweight Underweight/Short Equities – – Japan, EU Canada, US, Australia n Distress and mispricing are often Comments and Recent Activity: Absence of traditional excesses that mark end of cycle; profit margins to sustain. Modest improvements in credit flows improve Europe, Japan outlook. High volatility, valuation drove underweight thematic, but multi-asset diversifica- Sovereign Bonds 0 Flat US, Australia, Canada Japan, Europe tion may reduce common risk Comments: Low real rates; no exposure to Japanese bonds; overweight CAN, US, AUS sovereigns for higher yields exposures. IG Credit 0/+ Flat n HY Credit 0/+ – Contrarian opportunities today Comments: EM more attractive, but selectivity is key; added on improved valuation include energy/commodity equities, Petroleum + Down Long-Dated Futures, emerging-market investment-grade Oil Services Comments: Supply growth decelerates as capex cuts offset gains from technology. Bought put spreads credit and select commodity futures. Industrial Metals 0 Flat Comments: Attractive value; slow recovery Precious Metals 0 Flat This publication offers investors a systematic, Comments: Increased attractiveness due to decline in real yields. Gold miner equities increasingly attractive comprehensive assessment of the global Equity Style Flat GARP Style, Value Momentum, High Risk economy and the world’s capital markets. Using Comments: Quality growth stocks, with attractive free-cash-flow yield a short horizon, we analyze current and Currencies Flat USD, JPY, High-Yield EM GBP, AUD emerging trends, risks and opportunities across countries, regions and asset classes, providing perspective on the global investing landscape Highest-conviction ideas/active positions – / 0 / + Refer to underweight, neutral and investors face today. These materials present overweight positions vs. strategic allocation the viewpoint of the Multi-Asset team and do not necessarily represent the views of other AB As of September 30, 2015 portfolio-management teams. Source: AB OCTOBER 2015 Slower growth expectations also factored into projections for Display 1 corporate earnings globally: they’re now expected to be flat in 3Q 2015 Performance by Asset Class: Sensitivity to 10-Year 2015. Purchasing Managers’ Index surveys, which represent Breakeven business sector activity, declined substantially in most regions. 0.5 –15 Scale)(ReversedPercent This reassessment of the economic growth trajectory was 3Q Performance 0.4 Beta –12 accompanied by a sharp decline in most risk assets, most (Left Scale) 0.3 –9 notably in commodities and related equity and credit markets. The obvious question: Have valuations and expectations fallen 0.2 –6 enough that investors should consider adding exposure to 0.1 –3 economically sensitive assets and value strategies? We look at 0.0 0 Beta to 10-Year Breakeven10-Yearto Beta that topic in this report. Equities: Equities: Cyclicals– EM Equity EM Global HY Global DM Equity DM Defensive Aggregate Defensives Cyclicals— In general, we’ve been adding to the reflation trade through Aggregate Commodities: Commodities: Consumer Price Index (CPI) swaps, select emerging-market (EM) equities and integrated oil stocks. And we’ve been shifting away As of September 30, 2015 Source: Bloomberg, Federal Reserve and AB from momentum strategies in equities, as we discussed in last month’s report. In most allocation products, we’re still under- weight equities, overweight high-yield credit and modestly Display 2 underweight sovereign bonds. What’s more, West Texas Framework to Segment Contrarian Opportunities Intermediate oil prices never declined to the $35–$40 range Typical Horizon of the Payoff that we had targeted to add exposure. As a result, we missed 6–12 Months 1–3 Years part of the early-October rally. On the flip side, selling put Procyclical; benefit from decline in Benefit from acceleration in nominal risk aversion economic growth options on gold mining companies, which we discussed last Valuation implies fundamental Valuation and profitability imply month, proved to be a profitable trade. deterioration distress Need 1–2 standard value spread to Need 2+ standard deviation enter valuation spread to enter There weren’t many winners in September’s equity rout. Positive Globally, markets declined by 3.4%, extending the quarterly Exit based on performance/valuation Exit based on performance/valuation loss to 8%. Japan’s 8% monthly loss may have been tied to Need confirmation of stable Need confirmation of capitulation fundamentals fears of Chinese demand, a stronger yen and a slow recovery. Beta Emerging-market losses abated during September, after a 10% Provides important defensive/yield Structural distress decline in the first two months of the third quarter. Across Equity Tends to be long volatility Perception of permanent mix shift equity sectors, returns showed a barbell pattern that’s consis- Market-neutral implementation Inconsistent with ROE/cost of capital tent with expectations of slower growth. The least crowded Correlated long-short construction Inconsistent with assumptions underlying other asset values (energy and materials) and most crowded (healthcare and Need fundamental catalyst to enter telecom) trades suffered the biggest losses. Value strategies Zero/Negative also fell, while price momentum and profitability had strong positive returns. Target Return: LIBOR +4%–8% LIBOR +8%–12% Among credit sectors, emerging-market and high-yield bonds As of September 30, 2015 underperformed, while government bonds gained modestly. In Source: AB corporates, energy spreads widened the most, but other sectors were affected. In governments, gains were largely tied to lower inflation expectations, with real rates relatively unchanged. In foreign currency markets, the US dollar lost ground against the 2 yen and yuan but gained against most other currencies. Most Display 3 currency risk premiums delivered positive returns. Our largest Forward-Start Variance Swap Strategy vs. MSCI ACWI allocation is to currency risk premiums in emerging markets. Performance 100% 10% Commodities saw significant losses, with the trailing three-year MSCI ACWI Performance (Left Scale) 80% 8% returns to the overall commodity index as well as petroleum, industrial metals and gold now the worst since at least the 60% 6% Percent mid-1970s. These dramatic periods of underperformance are 40% 4% generally followed by rebounds. Because of this, we continue to Percent 20% 2% favor a tactical approach that increases exposure to commodi- 0% 0% ties as they near the marginal cash cost of production. On a –20% –2% Variance Swap Strategy more strategic level, we favor 5%–10% portfolio exposure to –40% –4% real assets and other highly reflation-sensitive investments. 97 99 01 03 05 07 09 11 13 15 Through September 30, 2015 Defining Multi-Asset Contrarian Investment Trailing 12 months Opportunities Source: Bloomberg, FactSet, MSCI and AB After every significant period of underperformance, investors rush to find assets whose prices fell below some definition of Display 4 “intrinsic value.” The theory? Weaker fundamentals and rising Uncrowded Stocks vs. MSCI ACWI Performance risk aversion can create periods of illiquidity, creating opportuni- 100% 25% ties for investors—as long as their time horizon is long enough. MSCI ACWI Performance (Left Scale) 80% 20% We see this scenario happening in early October, following the 60% 15% sharp decline in reflation-linked assets (Display 1, page 2). Percent 40% 10% 20% 5% But attempting to exploit this mispricing can be challenging for Percent several reasons: 0% 0% –20% –5% n Uncrowded Stocks The gap between prices and value can last longer than many –40% –10% investors’ horizons, especially given the loss aversion that 97 99 01 03 05 07 09 11 13 15 followed the events of 2008. Through September 30, 2015 Trailing 12 months Source: Bloomberg, FactSet, MSCI and AB n Undervalued assets can become even more undervalued and lead to losses. n The headline risk of any single investment becoming worth- Exposure to contrarian investments is critical, both to diversify less may be organizationally unacceptable. trend-following and risk-reducing strategies and to generate long-term returns. But there aren’t many extremely distressed n Long periods of high liquidity, economic expansion and areas today in which underwriting the risk of industrial restruc- resulting complacency can sharply increase risk and reduce turing (including M&A, investment cuts or bankruptcy that the expected return to value opportunities. removes
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