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Highlights of H2 market outlook (Part 1)


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We wrapped up our H2 Market Outlook seminar in July where we invited four major fund houses to share their views on the market as well as opportunities for the second half of 2018. In case you missed the seminar, we have summarized the highlights from PIMCO, Lion Global Investors, BlackRock and Wellington Management on behalf of UOB Asset Management in this two-part series. For part 1, we have PIMCO and Lion Global Investors to share their insights below.


Opportunities in Fixed Income amidst rising interest rates by PIMCO

PIMCO spoke on opportunities in Fixed Income amidst rising interest rates, with a focus on the PIMCO GIS Income Fund. While rising interest rates does affect bond prices, PIMCO GIS Income positions its portfolio by leveraging on tactical Duration management by positioning Duration on the shorter end to reduce the impact of interest rate hike on the overall portfolio. It also invests in bonds that benefit from positive economic environment as well as a sizeable holding in floating-rate securities in anticipation for periods of rising rates.


According to PIMCO's research, they found that the historical frequency of a US recession over five year periods has been over 70%, and their baseline includes a recession in the next 3-5 years. Hence it is crucial for investors to stay invested in defensive, diversified and income-generating asset throughout the business cycle.


Here is what PIMCO have to say about their views on the market in the Q&A below.


What are the upside and downside risks that fixed income investors should expect in the next 12 to 24 months?


Increased volatility as central banks step back from monetary accommodation
As the Fed works to remove the extraordinary stimulus needed for the economy to recover from the global financial crisis, it is simultaneously reducing the size of its balance sheet and raising interest rates in a measured way. Similarly, the European Central Bank is expected to end its asset purchase program in 2019, the Bank of Japan may raise its yield target for Japanese government bonds and various other central banks have also hiked rates. While all of these moves may be well-telegraphed, the actual experience of less central bank support may result in increased volatility and can be destabilizing for markets.

Unexpected increases in inflation
Output gaps are closing and commodity prices are stabilizing; input (producer) prices have already started moving up. Meanwhile, the U.S. government is embarking on a path of fiscal stimulus at such a late stage in the economic cycle, with the prospect of increased infrastructure spending following the recently enacted tax cuts. Stimulus coupled with more trade tariffs and trade frictions in addition to those already announced mean consumer price inflation may surprise above our base case. A fiscal policy-induced overheating might force the Fed into pushing policy rates significantly above neutral, something which has usually not ended well in past cycles.

Trade tensions
While PIMCO does not foresee a full-blown trade war, there is potential for further escalation of trade war rhetoric and continued implementation of tariffs. For investor confidence to collapse, we will have to see significantly more tariffs and harsher rhetoric and potentially other counter means implemented by China (e.g. CNY devaluation or selling US treasuries, which we view as unlikely). That said, if further escalation does play out, the impact will likely be negative for risk assets. On balance, the adverse effect on growth should dominate in the near-term and benefit Treasuries in a flight-to-safety scenario.

Productivity and growth surprises on the upside
One way the real economy could break out from the post-crisis lull on a sustainable basis is through a significant pickup in productivity growth as the diffusion of new technologies finally accelerates via stronger business investment. However, stronger potential growth would likely also produce higher real interest rates, hurting many investors in fixed income assets and equities alike (though while potentially painful in the short run, rising rates tend to benefit long-term fixed income investors, given that the higher income can offset mark-to-market losses and boost returns over time).


When does PIMCO expect interest rates to peak, and what is the estimated peak rate?


Rates likely to remain range-bound
PIMCO has continued conviction in our New Neutral framework where we believe lower-for-longer equilibrium policy rates remains a valid anchor over the medium term. Looking at data going back to the 1950s (please see chart below), US 10 year treasury yield has tended to remain just under US nominal growth (other than the period of high inflation in the 1980s which was a different regime). We think this relationship still holds today - if yields were higher than levels of growth, it makes little sense to take risk, conduct any sort of economic activity and take on volatility when an investor can earn returns that are higher in risk-free assets. In the US, we think potential levels of growth should be modest because of secular forces, as aging demographics, low productivity gains and high debt levels, will keep interest rates lower than in previous rate-hiking cycles.


As such, we think US potential growth could be as low as 1.5%-1.75%, and when you add that to the Fed's inflation target of 2%, you reach a number in the mid-3s, and that is where to expect, on average, the US 10 year yield to be. Hence, interest rates may not move much higher from here as the move up to the low-3s has already been reflected in price. Additionally, global level of yields are probably suppressing US yield from moving higher for some period.


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Even if rates do rise further - it is not necessarily universally bad for bonds

We would like to remind that only rises in rates above what the market expects may lead to a temporary mark-to-market loss. Importantly, rising rates tend to benefit long-term fixed income investors, given that the higher income can offset mark-to-market loss. Further, active management is important to help mitigate risks associated with rising rates and to identify better-priced or higher-yielding, quality securities. In light of recent market volatility and increasing geopolitical tensions, we would like to remind investors on the role of bonds in the wake of destabilizing events. Fixed income continues to offer diversification and serve as a hedge to volatility/economic slowdown, playing an important role in portfolios.


Click here to learn more about how PIMCO GIS Income can complement your portfolio.


Better weather market volatility in 2018 with Lion Global Investors (LGI)

LGI spoke of the near term political uncertainty coupled with divergent central bank policies and the risk of a rising USD, while also iterating the view that Asian growth will outpace that of the US in the longer term. In-line with the uncertain economic environment, LGI's theme for the rest of 2018 is to help investors 'better weather market volatility in 2018' through their newly launched low-cost Multi-Asset All Seasons Fund that boasts of a Total Expense Ratio capped at 0.5%.


Here is what LGI have to say about their views on the market in the Q&A below.


What are the pros and cons between investing in a multi-asset fund versus doing it yourself and individually selecting best-of-breed equity and fixed income funds separately?

It's a balance between control and convenience. One would assume investors who want to do their own selection and research tend to enjoy being able to exercise some degree of control over their portfolio. There is much to gain from this – in time, investors who continue to learn often walk away to be more knowledgeable and better equipped to weather the ups and downs of the market. On the other hand, there are many convenient options in the market that will take the burden of asset allocation, portfolio rebalancing, implementation, currency risk management off the investor's books. In this case, investors may benefit from the greater convenience, and this frees up time for other activities. In short, there are options for both do-it-yourself and done-for-you investors. One common denominator is the cost of investing, which all investors should be very aware of.


What is LionGlobal's outlook on Singapore equities in the next 12 to 24 months?

Any movement in Singapore equities over the next 12 months are subject to the rising trade tensions that continue to dominate headlines and affect sentiment. In short, volatility continues to be the theme for the next 12 months. Over the next 24 months, if investors are able to take a mid-long term view, the current uncertainty presents opportunities to pick up quality assets at distressed prices.


What kind of outcome does LGI expect from the recent US-China trade spat?

The outcome is uncertain although we currently do not expect the trade spat to escalate out of control. As the implementation of the proposed tariffs remain in discussion, the pressures on US producers from a potential trade tariffs are now making their way back to the US government in the form of moving jobs out of the US. With the RMB declining 3.8% against the USD YTD (as at 26 July 2018), the strength of the USD as rate hikes continue may partially offset the net impact of trade tariffs on Chinese exports.


To find out more about the new LionGlobal All Seasons Fund, click here.


What is a Regular Savings Plan (RSP) and how will it help me invest smartly?

A RSP is a disciplined way to invest for those who are just starting their investment journey. Through RSPs, investors can invest small amounts of funds every month into unit trusts, thus building up an investment account in a safe manner.

By having investors contribute small amounts to investments monthly, RSPs reduce the investment risk by applying an investment technique known as dollarcost averaging.


Continue reading: Part-two of the H2 Market Outlook Highlights from BlackRock and UOBAM


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Information is correct as of 17/09/2018.