Although fundamentals are positive with a global economy firing on all cylinders, risky assets are expensive. Technical factors are not helping either: towards the end of this year, central banks will be leaving a void which will be virtually impossible for private investors to fill. Our positioning is cautious but active.
Still, there’s no reason to panic either. In fact, this is when active managers come to life. With the Fed in Quantitative Tightening (QT) mode, and the ECB about to taper its Corporate Sector Purchase Programme (CSPP), volatility is set to increase. This will cause higher dispersion in our universe and this offers opportunities for issuer selection.
Within a global context, we have a clear preference for Europe, where high yield offers extra carry and investment grade companies tend to be more conservative than in the US. We also like financials, believing that insurance companies and banks can be a hedge in an environment of rising interest rates.
There are several indicators that the cycle is maturing. It is hard to predict the exact turn of the cycle and markets can stay in ‘peakish’ periods for quite a while. We believe that US markets are leading and have drawn their dot just behind the peak of the bull market.
In our outlook, we always look at three factors: fundamentals, valuations and technicals.
Fundamentals are still favorable for credits. Global growth is driven by three locomotives: the US, Europe and China. Whereas the former two show synchronized growth, growth in China is moderating but still high.
How long will the US economic cycle last? True, fiscal stimulus may extend it a little, but at the same time it will only aggravate the imbalances and ultimately deepen a potential recession. Inflation is still very much subdued, but all ingredients for higher inflation are already there. Labor markets are tight. The labor force is shrinking due to the withdrawal of baby boomers, making labor scarce and thus more expensive. Other ingredients are the US twin deficit and increasing protectionism.
US corporate leverage is unsustainably high. European growth is solid, with broad participation of the entire euro area. Risks are certainly not coming from Europe, but if the US were to slow down, Europe will not be immune.
For emerging markets, it is important to watch the dollar. The market is very relaxed in expecting further dollar weakness. It is easy to see why the dollar would drop further, given the ballooning twin deficit. However, if this does not happen, emerging debt could be seriously at risk. Foreign borrowers have used the dollar market for funding. When dollar depreciates it helps their balance sheets, but dollar strength would do exactly the opposite.
No matter which way you look at it, credit markets are expensive in all rating categories, both in Europe and in the US. We still prefer Europe, though. For European high yield, we still get some extra spread compared with similarly rated US high yield companies. For investment grade, spreads are pretty similar, but European companies tend to be more conservative.
Within Europe we still see some value in financials. Insurance bonds should provide some sort of hedge against rising rates, as their profitability tends to increase when interest rates rise. The same goes for banks, which benefit from falling levels of Non-Performing Loans and stronger balance sheets.
We have extensively discussed the LIBOR-OIS spread widening. This spread reflects the difference between the risk free central bank rate and the rate banks pay in the interbank market. It is considered a measure of health in the banking system. A wider spread means that it is more expensive to borrow dollars. This makes hedging dollar risk more expensive for foreign investors, which could lower their appetite for US fixed income assets or even cause them to sell out of them.
Global central banks are still a key factor to watch. Although the European Central Bank and the Bank of Japan are still buying more than what the Fed is shrinking, expansion will turn into reduction by the end of 2018.
We have seen a dramatic increase in capital market funding by corporates, shifting away from bank lending. As capital markets tend to respond faster to a changing environment than loan officers, credit conditions for corporates could tighten much faster than has historically been the case.
This report is not available for users from countries where the offering of foreign financial services is not permitted, such as US Persons.
Your details are not shared with third parties. This information is exclusively intended for professional investors. All requests are checked.
The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).
This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.
This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.