May 2016 - Allianz Global Investors

5
Volume 8, Issue 5
Allianz Global Investors
Insights
May 2016
Global View
More Volatility Hits Markets
as Growth Remains Dull
Asset markets endured a great deal of sound
and fury during the first quarter, as fears
surrounding China, oil, negative interest-rate
policies (NIRP) and politics all served to undermine investor confidence. That, in turn, led to
a severe rout in the first half of the first quarter,
which was followed by a strong rally that
nearly moved markets back to starting levels.
So where are we now and how might the
second quarter play out? Amusingly, despite all
this market volatility, global economic growth
has remained as dull as we expected it to be,
with our financial repression thesis in full effect.
pace, which has allowed the US Federal
Reserve to sound more dovish once again.
In turn, the dollar has weakened somewhat,
which boosts the prospects for US earnings
and emerging economies.
We expect more of the same in the second
quarter, although it seems prudent to expect
one hike in interest rates before the summer:
The Fed does not want to implement a policy
change during the serious election campaigning later this year.
China
As a result, growth expectations have progressively fallen toward a sub-2-per-cent
Fears of a massive renminbi (RMB) devaluation, a recessionary economy and a credit
bubble have ameliorated somewhat as China’s
government has agreed on – and started to
execute – its next Five-Year Plan. Beijing
knows it needs economic growth while it
transforms from exports and manufacturing
toward consumption and services, and we
expect China’s economy to become more
stable this year. This transformation will
take time and will structurally alter the level
of demand for many commodities where
2 Perspective on Europe
4 Soundbites from Research
3 Viewpoint
4 GrassrootsSM Research
The United States
Notably, US economic data remain lacklustre
and unconvincing, despite the fact that during the same time last year, economic performance was weak due to a polar vortex.
Industrial production has stalled, employment is stable and wage data are flat, so
there are few real drivers for the US economy.
Euro-Zone Periphery Must Use
Low Yields to Boost Growth
Keys to the New ‘Mega Plan’
Guiding China to 2020
Online Clothing Specialists
Have a Winning Formula
China Seeking Foreign-Exchange Stability
Neil Dwane
Global Strategist
excess supply capacity has been created; as a
result, we would still avoid many commodities-driven emerging-market economies.
Europe
The European Union (EU) has quietly had yet
another good quarter – possibly outgrowing
the US – as austerity benefits continue to pay
off and as the European Central Bank (ECB)
finds increasingly innovative initiatives to
support and invigorate both the weak EU
banking system and the underlying demand
for credit in the real economy.
(Continued on page 5)
Allianz Global Investors Insights
Perspective on Europe
Euro-Zone Periphery Must Use
Low Yields to Boost Growth
Financial repression continues to take a
growing toll on the euro zone, driving yields
further into negative territory. The ECB’s
main refinancing rate is at 0 per cent, while
its deposit rate runs at -0.4 per cent.
Moreover, policymakers went even further at
the ECB’s March 10 meeting, announcing
several new initiatives:
◾◾ Starting this June, the ECB will provide
liquidity to banks through a new longterm refinancing operation.
◾◾ Toward the end of the first half of 2016,
the range of assets the ECB will directly
purchase through its quantitative-easing
program will be expanded to include
high-quality corporate bonds.
We believe these measures have the potential
to lead to further spread compression
between euro-zone peripheral countries’
debt and German bunds. Euro-zone spreads
have continued to tighten in recent years, and
are now not too far from the levels last seen in
November 2011 – before the euro-zone crisis
erupted. This result is clearly a success for
the ECB, but the time is coming when ECB
support alone will no longer be sufficient.
As a result, market participants – including
Allianz Global Investors – will become
increasingly concerned with whether or not
member countries on the periphery have
the capacity to use the current ultra-lowyield environment to boost growth and
reduce debt.
Ireland and Portugal provide two good
examples. Both countries were in trouble
during the 2011 euro-zone crisis and both
eventually fell to below-investment-grade
levels, which resulted in an increase in the
cost of their debt compared to German
bunds. While both have benefited from
spread compression – driven by the ECB’s
bold actions – their economic paths clearly
diverged after 2013. In fact, Ireland’s real
gross domestic product (GDP) grew 5.2 per
cent in 2014 and 7.8 per cent in 2015, while
Portugal’s grew a meager 0.9 per cent and
1.5 per cent, respectively. The accompanying
chart clearly shows how different growth
paths have substantially impacted gross
debt-to-GDP ratios for the two countries.
Mauro Vittorangeli
CIO Conviction Fixed Income
Portugal’s debt is at further risk; while
Ireland’s debt has returned to the stable
investment-grade camp, Portugal’s debt is
still stuck at sub-investment grade, and its
10-year bond yields are close to 3.5 per cent.
Clearly, those investing in the debt of eurozone peripheral countries will start becoming
more selective as time goes by, and they will
begin to reward countries that have done a
better job with public finances – particularly
given that the ongoing environment of
financial repression shows no sign of waning
anytime soon.
Higher growth has allowed Ireland to reverse
the trend of its gross debt-to-GDP ratio,
which returned to below 100 per cent at the
end of 2015, while Portugal’s gross debt-toGDP ratio was stuck at 130.5 per cent. If for
any reason interest rates start to increase,
Gross Debt-to-GDP Ratios Show Stark Contrast Between Ireland and Portugal
Thanks to Ireland’s higher growth, it has reversed the trend of its gross debt-to-GDP ratio, while Portugal’s ratio has remained stuck in a rut.
140
Portugal
Ireland
Gross Debt-to-GDP Ratio
120
100
80
60
40
20
Q1 2009 Q3 2009 Q1 2010 Q3 2010 Q1 2011 Q3 2011 Q1 2012 Q3 2012 Q1 2013 Q3 2013 Q1 2014 Q3 2014 Q1 2015 Q3 2015
Source: Eurostat as at April 2016.
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Allianz Global Investors Insights
Viewpoint
Keys to the New ‘Mega Plan’
Guiding China to 2020
The 13th Five-Year Plan
In a few years, 2016 could be viewed as an
important milestone in China’s economic
development. It marks the start of the 13th
Five-Year Plan (FYP), which will guide China’s
direction until 2020. Approved in March by
the State Council, the 13th FYP comes
squarely on the heels of the post-globalfinancial-crisis drop in export demand, and in
context of the recent fallout from China’s
RMB 4 trillion fiscal investment package.
The new Five-Year Plan is characterized
by its emphasis on the quality of
growth and on central governmentdirected planning.
Notably, the objective of this new FYP is to
establish a more stable, balanced and
sustainable society. In contrast to China’s
previous provincial economic race, which
mostly focused on the pace of growth, the
new FYP is characterized by its emphasis on
the quality of growth and on central
government-directed planning.
Among the long list of policy targets under
this FYP, five key areas may become major
themes in China’s market and are therefore
worth investors’ attention:
◾◾ Maintaining the target of doubling 2010
GDP by 2020, which requires an annual
GDP growth rate of about 6.5 per cent for
the next five years.
◾◾ Making China’s institutional, technological
and cultural initiatives more innovative.
◾◾ Seeking balanced development through
industrial upgrades, modernization of
agriculture, urbanization and regional
coordination.
◾◾ Making ecological improvements,
including improving energy conservation
and environmental protections.
◾◾ Strengthening social welfare initiatives,
including education, vocational training,
social security and insurance protection.
3
T his mega plan addresses many structural
problems, such as over-reliance on capital
investment, overcapacity in the industrial
sector, environmental pollution and wealth
inequality. If implemented successfully,
this FYP would bring China to a new level
compared with other developed countries.
Nonetheless, reform is never easy, and many
of these new initiatives involve changing the
existing rules of the game. For these changes
to be implemented successfully, it is essential
that Chinese President Xi Jinping and other
leaders demonstrate determination and
execution power. Investors should closely
monitor relevant policy details and keep
track of the reform measures’ progress.
Economic outlook for 2016
There has been a subtle shift of policy
priority in China since the fourth quarter of
last year, as government leaders seem to be
increasingly concerned about the stability
of both the banking system and society
overall. While making a successful
economic transition toward a consumptionbased economy remains an important
medium-term target, China’s near-term
priority has shifted; policymakers are now
focused on containing economic downside
risk. Selective expansionary measures –
including offering tax cuts for car purchases,
relaxing mortgage-loan restrictions and
setting up specialized construction funds
for infrastructure projects – were introduced
to counter the pressure of economic
deceleration. Clearly, China’s policy stance
has turned more accommodative.
As reflected in recently announced
macroeconomic data, the policy stimulus
measures that China has launched in the
past six months are starting to take effect.
In March, China’s official manufacturing
Purchasing Managers’ Index (PMI) and
services PMI – which reached 50.2 and 53.8,
respectively – beat market expectations and
moved into the expansionary zone. In
addition, China’s Producer Price Index had
its first month-over-month increase since
August 2013. With China’s housing market
Raymond Chan
CIO Equity Asia Pacific
and infrastructure investment regaining
momentum, there are also signs that
demand for construction machinery and
building materials is gradually picking up.
Barring any external shock, China should
see sequential improvements in the second
half of 2016, and it should be on track to
achieve its 6.5 per cent growth target.
The real challenge for China’s
government now seems to be whether
it can balance the near-term target of
supporting growth and the longer-term
objective of transforming the economy.
On the flip side, containing near-term
economic downside risk would come at the
expense of the country’s progress in economic
transformation and deleveraging. In fact, we
may continue to see the public sector incur
higher leverage – at least in 2016 – to fund
infrastructure investment and public-service
expenditures. Therefore, the real challenge
for China’s government now seems to be
whether it can balance the near-term target
of supporting growth and the longer-term
objective of transforming the economy.
Meanwhile, the volatility of the RMB exchange
rate, capital outflows and accelerating
inflation are the biggest risk factors with
the potential to derail China’s game plan.
Allianz Global Investors Insights
Soundbites from Research
Online Clothing Specialists
Have a Winning Formula
The winter of 2015-2016 was one of discontent
for clothing retailers across the globe. Record
high temperatures and increased discounts
reduced profits in most cases.
However, amongst all the carnage, one
group of retailers stood out as more
successful than the rest: the online
specialists. The online clothing business
seems to be reaching a tipping point,
particularly in Europe, where barriers to
shopping online are falling and consumer
attitudes are shifting.
Yet our research shows that attaining success
in this area is certainly not as simple as
launching a website and waiting for the cash
to roll in. There are some key drivers that
retailers need to get right if they want
customers to shop in their virtual stores.
◾◾ It’s important to have a local-language
website that loads quickly and is easy to
use, with minimal clicks required to
complete a purchase.
◾◾ Retailers should have a reliable mobile
app for each market, preferably with
editorial content.
◾◾ Other helpful website features include
multiple local-currency payment options,
a free-delivery offer and a range of delivery
methods to suit the consumers’ needs.
◾◾ Above all, retailers need to make it as easy as
possible for consumers to return unwanted
items, preferably at zero cost to them.
Overcoming these hurdles requires retailers
to have a wealth of expertise – not to mention
make significant investments. As a result,
many store-based retailers have been slow
to develop their online capabilities.
In particular, companies with extensive store
estates and high market share that try a shift
Elizabeth Houston
European Consumer Analyst
to online sales can see a painful effect on
their profit margins. Customers abandon
physical stores, where the cost base is largely
fixed, in favour of shopping online, where
costs are variable. And that’s on top of
everything the company had to invest in
its shiny new online distribution facilities.
Some store-based retailers are getting it right,
but they are few and far between. As a result,
the outperformance of online specialists
looks set to continue.
GrassrootsSM Research
China Seeking Foreign-Exchange Stability
In February 2016, GrassrootsSM Research
conducted two studies, speaking with a
total of 40 branch managers at major banks
in China, to gauge China’s banking business
in terms of loan default risk, the appetite for
loan business, the outlook for deposit
growth and capital-outflow controls.
In the first study, three-fourths of our sources
noted a trend of increasing loan defaults in
recent months, mainly in the heavy and lowend manufacturing industries, and an overall
expectation for higher defaults in the first
half of 2016. Banks are shifting loan exposure
to sectors related to high-end manufacturing,
health care, the Internet and environmental
protection, which sources believe will
be bright spots for fast growth in the
coming years.
In the second study, our sources expected
muted overall deposit growth of 5 per cent
4
due to an economic slowdown, lower
consumer income for savings, RMB
depreciation, low interest rates and inflation
concerns. In addition, limits imposed on
foreign-exchange activities have already
caused a sense of worry and unhappiness
among bank customers. That said, sources
expect further capital-control measures
to be implemented, including delaying or
restricting foreign-exchange wire transfers
and cracking down on grey-market
currency exchanges.
“Our internal GrassrootsSM Research confirms
that China is implementing numerous
administrative measures to stabilize its level
of foreign-exchange reserves,” said Terence
Law, Head of Research, Asia Pacific, at Allianz
Global Investors. “This should lend support
to the RMB and to market sentiment
in general.”
Joey Wong
GrassrootsSM Research Analyst
Allianz Global Investors Insights
(Continued from page 1)
Global View
While the migration crisis still festers –
including painful outbursts of anti-immigration sentiment in Brussels, home of the EU’s
headquarters – another significant political
threat will emerge in the second quarter: the
Brexit referendum in late June. This vote will
have important consequences for Europe
if the UK votes to leave the EU, which we
believe is unlikely; Brexit would add volatility
to pound sterling and euro assets, and
challenge politicians across the continent.
Interestingly, the European identity crisis is
still having effects on national politics around
the region; with Ireland and Spain having
Investing involves risk. The value of an investment and
the income from it will fluctuate and investors may not
get back the principal invested. Past performance is not
indicative of future performance. Equities have tended
to be volatile, and unlike bonds do not offer a fixed rate of
return. Emerging markets may be more volatile, less
liquid, less transparent and subject to less oversight, and
values may fluctuate with currency exchange rates.
Bond prices will normally decline as interest rates rise.
Below investment grade convertible and fixed-income
securities involve a greater risk to principal than investment grade securities. This is a marketing communication. It is for informational purposes only. This document
does not constitute investment advice. References to
specific securities are not intended to be, and should not
be interpreted as an offer, solicitation or recommendation to purchase or sell any financial instrument, an indication that the purchase of such securities was or will be
profitable, or representative of the composition or performance of any AllianzGI product.
The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its
affiliated companies at the time of publication. Certain
data used are derived from various sources believed to be
reliable, but the accuracy or completeness of the data is
not guaranteed and no liability is assumed for any direct or
both experienced incomplete election
results recently, we expect European politics
to remain a headline-grabber for the rest
of the year.
Emerging markets
Other economies have continued the trends
they followed in 2015. Brazil remains in a
recession, and it faces a serious political crisis
with the impending impeachment of its current president. South Africa, too, is facing its
own recession and another African National
Congress leadership crisis. On a positive note,
Indonesia is seeing some improving investment under the leadership of Joko “Jokowi”
Widodo. In India, Prime Minister Narendra
Modi is getting inflation under control and
starting to implement reforms; so far, he has
been hampered only by abnormal monsoon
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seasons, caused by El Niño. Japan, on the
other hand, has reacted badly to the implementation of NIRP, with an ageing population
that currently fears inflation more than getting a return on its investments.
Investment implications
We continue to expect growth globally to
remain slow, low and fragile, and we expect
many asset markets will be buffeted by
volatility – both from within, in terms of
the economic and corporate sectors, and
from without, especially from the political
sphere. On a global scale, investors still have
opportunities to find attractive income
and capital appreciation potential, but
they must be prepared to be active in their
stock selection and asset allocation.
GrassrootsSM Research is a division of AllianzGI Research.
Data used to generate GrassrootsSM Research recommendations is received from reporters and field force investigators who work as independent contractors for broker-dealers. Those broker dealers supply research to AllianzGI and
certain of its affiliates that is paid for by commissions generated by orders executed on behalf of AllianzGI’s clients.
Source of all data (unless otherwise stated): Allianz Global
Investors as at March 2016. No part of this material may be
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