On June 22, Deutsche Asset Management’s Passive Thought Leadership team gathered at the Park Avenue office to attend the CIO Day, a quarterly meeting in which the global Chief Investment Officer (CIO) of Deutsche Asset Management invites the investment platform to come together to determine the firm’s strategic views over the next twelve months. This post will highlight some of the key takeaways from the CIO Day that we feel are most relevant, namely: a more positive outlook on gross domestic product (GDP) growth in China, tightening of U.S. high-yield Credit spreads, an improved outlook on the euro/ U.S dollar (EUR/USD) exchange rate, and a preference for European and emerging market equities.
China seems to have settled into a steady state underpinned by a buoyant housing market (due to urbanization) and the expectation that economic support by the government will help prevent a significant downturn. To this end, the forecast for 2017 GDP growth in China has been revised slightly upward from 6.3% (last quarter’s estimate) to 6.5%, which is a cautious view that is still below consensus. The multiyear outlook is that GDP growth is expected to continue to slow, as per China’s longer‐term trend (i.e. 10 years ago it was approximately double its current rate). Accordingly, the firm's forecast for GDP growth drops back to 6.3% in 2018. This view reflects moderate decreases in infrastructure spending and a slight pullback in private consumption, which has grown robustly in the last 4 years. For more on China, see the CIO View focus article, “China's Economic Balancing Act.”
U.S. High-Yield Credit Spreads:
The CIO team also discussed U.S. high-yield spreads. The firm revised its forecast of high-yield spreads for the next twelve months to 380 basis points (bps), down from 400 bps forecasted in March 2017. This downward revision reflects a positive outlook for high-yield bonds, since prices rise when spreads tighten. The revised forecast was driven by investor's continued reach for yield combined with our assessment that persistent economic strength will further lower default rates. As of the date of this blog post, high-yield spreads have tightened through the firm’s forecast, which somewhat validates the team’s bullish view taken in June.
We increased our 12‐month forecast for the EUR/USD exchange rate to $1.10 per euro from $1.00 per euro previously forecasted in March 2017 (Note that as of this writing, the euro has appreciated significantly to $1.17 per euro). Since 2012, the Eurozone has posted a sizeable current accounts surplus (exports exceeded imports by an annualized $350bn), which should have naturally boosted demand for and increased the value of the euro. One may ask, then, why has the euro not appreciated against the dollar over this period? It could be that the drawn-out drama of the Eurozone debt crisis may have mitigated any expected appreciation of the euro against the dollar. However, the firm’s recent revision of the exchange rate forecast reflects three main factors: receding political risks caused by the success of pro‐European parties in recent national elections, a general brightening of the macroeconomic picture in Europe, and the expectation that at some point in the near future the European Central Bank (ECB) will begin to taper. Such tapering by the ECB could lag the Federal Reserve’s decision to tighten monetary conditions, much in the same way that the ECB lagged the Federal Reserve’s decision to begin quantitative easing following the global financial crisis. Therefore, the exchange rate forecast adjustment anticipates that markets are unlikely to wait for the ECB’s first interest rate hike and will anticipate the move well in advance.
Preference for European and Emerging Market Equities:
Lastly, and importantly, a recurring theme mentioned during the CIO Day was that European and emerging market equities are preferred over U.S. equities. There are three main explanations for this theme:
- Foreign equities are exhibiting cheaper valuations than U.S. equities in general.
- We have a positive earnings outlook for Europe and the emerging markets.
- Macroeconomic stabilization is occurring overseas with increased political stability in Europe.
In summary, key takeaways from this quarter’s CIO Day include forecasts for higher than previously expected 2017 GDP growth in China (with a continued secular trend of declining GDP growth), compression of U.S. high-yield credit spreads, a cautious shift away from parity in the EUR/USD exchange rate, and an investment theme that emphasizes investing in European and emerging market equities.
More information on our CIO View can be found here