investment perspectives update

February 2016

Overweight in equities and underweight in bonds maintained

Despite the turbulence in the global financial markets, we maintain the existing portfolio weightings. As we expect the unrest to be temporary and circumstances in China to improve – ultimately aided by effective government intervention – we remain overweight in equities. Continuing central bank stimulus and relatively attractive valuations also play a role in this respect. In view of the – albeit limited – increase in bond rates, we also maintain the underweight position in bonds.

Outlook > page 5

Market turbulence is not a harbinger of Chinese recession

The unrest in the global financial markets at the start of the year has been attributed to a strong decline in Chinese economic growth. In our view, this reasoning lacks justification. Investors have recently reacted very nervously to reports about the Chinese economy and the exchange rate policy of the Chinese authorities. In our opinion, the Chinese economy is growing at a satisfactory rate and there are good grounds for a certain weakening of the renminbi (which had risen too far in the dollar’s slipstream).

Special > page 4

Bright global economic outlook

US industrial growth has lost some momentum in the past period. The main cause is the strong dollar, which has dented the country’s competitiveness. This industrial weakness is largely offset by a buoyant services sector, as reflected in the employment data and the upbeat mood among purchasing managers in the services sector. The economy in Europe is flourishing, both in the industrial and the services sector.

Market environment > page 2

market environment

The uncertainties regarding the global economic outlook have increased. These are chiefly attributed to develop ments in China and triggered severe unrest in the global equity markets at the start of 2016 (see also the Special on page 4). The eurozone and US economies present different pictures. The main cause is the divergence between the industrial production sectors in the two regions due to the dollar’s strength versus the euro, which mainly affects the goods-producing sectors. Exports to China and other emerging countries play a less important role in our view.

Services sector is keeping US growth on track

The divergence between industrial production and services in the United States is clearly reflected in the opposite move ments of the purchasing managers indices of the two sectors. In a slightly delayed reaction to the strengthening dollar, the industrial index has declined steadily since early 2015. In the last months of 2015 it even dived below 50, the level at which purchasing managers expect neither growth nor contraction. Sentiment in the services sector, by contrast, has been improving since early 2014 and is now hovering around the 60 mark, 5 points higher than in the previous period. The difference between industry and services is also clearly visible in the labour market. Excluding agriculture, 2.7 million jobs were added in the US in 2015, an average of 225,000 jobs per month. In the last three months of 2015, the average increase was even as high as 284,000 jobs. This hardly points to a weak economy, particularly as unemployment fell in the same period from 5.7% of the labour force to 5%. The services sector accounted for virtually the entire growth in employment. The increase in the number of jobs in the goods-producing sector was negligible. In Federal Reserve terms, this probably means that the fed funds rate will be raised more often in 2016 than the single increase that is currently widely anticipated in the financial markets. We, incidentally, expect rates to be increased three times in 2016, while the Federal Reserve is evidently counting on four increases.

Persistently low inflation in eurozone

Economic development is much more balanced in the eurozone, which is benefiting from the weak euro, the low interest rates and the ultra-low energy prices. The index, which indicates the sentiment among purchasing managers, has been comfortably above 50 for a while now. This goes both for industry and services. Encouragingly, consumer confidence is also improving in most countries in the eurozone. That said, uncertainties and risks still hang over the European environment. Think, for instance, of a reignition of the problems in Greece, an unfa vourable outcome of the British referendum and the problems that the influx of refugees could cause for European govern ments. Another risk is the persistently low inflation. Though mainly due to the ongoing decline in oil prices (to below USD 30 per barrel on 15 January), this remains a major headache for the Governing Council of the European Central Bank (ECB). The governors are increasingly divided over the most appro priate policy. Even so, a further fall in prices could prompt the ECB to expand its bond-buying programme (now EUR 60 billion per month) and cut the refinancing rate even further (now 0.05%) in the coming months.

Mood among US purchasing managers

65 Index: 50=”growth nor contraction” 61 57 53 49 45 2010 Industry 2011 Services 2012 2013 2014 2015 Source: Institute for Supply Management US industrial purchasing managers have become steadily less optimistic since mid-2014 and have been really pessimistic since late 2015. The goods-producing sectors (particularly industry) are suffering more from the strong dollar than the service sectors where purchasing managers are still optimistic.

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market developments

The past weeks witnessed a renewed surge of turbulence in the global financial markets. One reason was the – possibly unjustified – fears of a sharp decline in Chinese economic growth. Doubts about the strength of the US industrial sector, the resilience of many emerging economies and, above all, the underlying reasons for the ongoing oil price slump added to the markets’ concerns. Against this market backdrop, it comes as no surprise that investors sought refuge in safer havens. Equities were sold off on a comparatively large scale and investors resorted to savings accounts or investment grade bonds.

Equity markets in downbeat mood

Since the previous investment committee meeting on 10 December 2015, global equity markets have been through turbulent times. The rest of December was comparatively calm, with US equities edging slightly lower while European equities even made modest gains. In the first weeks of 2016, however, not a single region was immune to the mounting risk aversion among investors. The epicentre was in China, where equity prices started to slide just before Christmas, but other parts of the world soon followed suit. Between 10 December and 14 January, Shanghai equities shed 16% of their value. In the United States, the losses of the S&P-500 were limited to just under 7%, while in Europe the Eurostoxx 600 surrendered 6.5%. The South European equity markets and also the German market (due to Germany’s strong export ties with China) lost slightly more, however. Closer to China, the equity markets in Tokyo and Hong Kong tumbled by, respectively, 9.5% and 8.7%. For the rest of 2016, we foresee continuing larger-than-normal fluctuations in global markets. Much will depend on the earnings results for the final quarter of 2015 that companies are due to report in the coming weeks. European companies can benefit from the weak euro, but US companies – on the contrary – have to face the adverse effects from the strong dollar. The reverse applies in the US. Relatively attractive valuation levels could provide some recovery potential.

Sustained pressure on bond yields in the short term

The flight to quality has lifted prices on the major bond markets. As a result, since the last investment committee on 10 December, the effective yield on 10-year government bonds has decreased by 10 basis points in Germany and 15 basis points in the US to, respectively, 2.07% and 0.51%. Inflation in both countries is comparatively stable. Adjusted for oil, however, the figures show a slight upward movement. The further decline in oil prices in January could put renewed downward pressure on inflation, possibly pushing bond yields somewhat lower in the short term. For the somewhat longer term, we foresee an increase in interest rates, though this could be dampened by a slightly more subdued economic outlook. In Germany, yields for terms up to 5 years are negative and prices must rise further to offer an alternative for savings. Corporate bond prices came under some pressure in the past month, mainly due to intensive issuing activity. One example was the bond issue of beer brewer AB InBev to finance the takeover of SAB Miller, which raised no less than USD 46 billion in half a day, making it the second-biggest bond issue ever.

Leading equity indices

160 Index: 1 Jan 2015 = 100 140 120 100 80 2015 S&P-500 Apr Nikkei-225 Jul Eurostoxx-600 AEX Oct 2016 Shanghai-index Source: Datastream Price swings on the Chinese equity market are much larger than elsewhere. As in August 2015, a renewed price fall occurred at the end of last year and then spread to other equity markets around the world. Fears that this points to a sharp deceleration of the Chinese economy – with adverse knock-on effects to the rest of the world – are unfounded in our opinion.

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special

What underlies the current market unrest?

The global financial markets started 2016 on a turbulent note. The epicentre was in China, where the markets were already unsettled before Christmas, but as in the summer of last year, the unrest rapidly spread to the rest of the world. Once again, the fear is that Chinese economic growth is decelerating at a much faster rate than most official data suggest. The sharp slowdown in Chinese imports since the start of 2015 is seen as one ominous sign. This constrains the export opportunities for both the west and China’s nearby trading partners. But is this explanation correct? Below, we give our view on the current state of the Chinese economy and look at a few alternative explanations for the current unrest.

It’s not the economy stupid...

In our opinion, too, the Chinese economy is gradually cooling down. The main reason is the transition from an investment and industrial export-driven economy to a services and domestic consumer-driven economy. In this process, the decrease in the strong growth of investments and exports is not being entirely compensated. As a result, imports started to slow down sharply at the beginning of 2015. Recent data, however, point to a stabilisation of imports and of the Chinese economy as a whole. Further indirect confirmation of this is found in the improving business confidence among nearby trading partners such as Taiwan and South Korea. A further deterioration of the Chinese economy would rule out any such optimism. A cautious recovery of industrial orders for Germany – a major supplier of capital goods to China – also points in this direction. The Chinese economy thus appears to be heading into calmer waters and the negative impact on the rest of the world seems to be gradually ebbing away.

…so what is the cause?

In China itself, the equity market is by nature very volatile with sharp price swings because of the dominant presence of small investors who are prone to erratic behaviour. Among other things, they tend to respond very nervously to measures taken by the Chinese authorities. This happened in August, for instance, when the renminbi was devalued, even though it was only by a small percentage. In December the authorities exchanged the pegging of the renminbi to the dollar for a pegging to a basket of currencies. The resulting fractional fall of the renminbi was widely interpreted as an attempt to prop up disappointing growth. The measures to rein in the ensuing market unrest – the suspension of trading, the selling ban for large shareholders and the equity purchases by government companies and institutions – did not help to restore confidence among Chinese investors. Many foreign investors think the Chinese economy is going through a hard landing. We disagree. In our opinion the Chinese authorities have sufficient room for manoeuvre to stabilise their country’s economic growth and ultimately restore calm to the financial markets. Experience shows that they will take the necessary action, though it may take some time. As you can read on the next page, we have therefore decided to leave the investment policy unchanged in January.

Economic growth in selected countries

US Eurozone Japan China India Brazil Russia 0,7 7,0 7,5 2015 2,5 1,5 -3,0 -4,0 1,0 6,5 7,5 2016 2,5 1,9 -2,0 0,5 0,6 6,0 7,5 2017 2,3 2,2 1,5 1,5 Source: ABN AMRO, Group Economics The economic outlook will continue to improve both this and next year in the major countries. Growth will hold up in the United States and accelerate further in the eurozone. While Russia and Brazil will gradually climb out of the recession. Growth in China will fall back slightly to a still high level.

page 4

outlook

Equities remain overweight with emphasis on Europe and Emerging Asia

The uncertainties surrounding a steady growth path for the global economy have clearly increased, as is expressed in the recent severe turbulence. Partly for this reason, we already somewhat reduced the interest in equities in November last year. Despite the lower expected growth in returns, we maintain the existing overweighting of equities. This is based on the continuing expansive central bank policies, the gradually receding risks in relation to China and the eurozone, and the relatively attractive valuations. Regionally, we maintain a neutral position for the more developed countries, with an overweight position for European equities and an underweight position for US equities. Our weighting for emerging markets is also neutral, with a strong emphasis on Emerging Asia (mainly China and India) at the expense of East Europe and Latin America. Our sector preferences also remain unchanged, with overweightings in Information Technology and Healthcare and underweightings in Utilities and Telecom.

Preference for European corporate bonds

As we expect the return on 10-year government bonds to double in the coming year to about 1% in Germany and to rise to about 3% in the United States, we remain strongly under weight in bonds as a whole. The underweighting mainly concerns European core government bonds. We are seeking to generate extra returns on European peripheral government bonds, particularly in Spain and Italy. Sentiment in the market for corporate debt has been somewhat downbeat in recent times. Contributing factors are scandals (dieselgate), problems at oil companies due to low oil prices, upcoming risk aversion on financial markets in recent weeks and intensive issuing activity. We expect improvements in the course of this year, mainly in the eurozone. Redemptions will boost liquidity and the ECB’s policy will cause investors to gravitate away from government bonds towards corporate bonds. Within the overall underweight bond position, we therefore remain overweight in corporate bonds. The emphasis remains on European bonds as issuing activity will continue to be higher in the United States. In addition, we maintain the overweight position in high yield (50% global and 50% Europe).

Property and commodities

Investments in property are normally sensitive to rising interest rates. Now that the anticipated interest rate increase will presumably be lower than previously expected, an increase in the property weighting to neutral is justified. Due to falling commodity prices, our overweight position in commodities did not work in our favour on balance. Nevertheless, we have maintained our position. In our opinion, prices have sunk too far and we expect a certain recovery in 2016 if economic growth remains steady in the United States and Europe and regains upward momentum in the emerging countries.

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Author: Ben Steinebach, Chief Investment Officer the Netherlands of ABN AMRO In case you wish further information, please contact your portfolio manager or investment advisor.