OVERINDEBTEDNESS AMPLE LIQUIDITY BEGGAR THY NEIGHBOUR CURRENCY ACTIONS
REGULATION GLUT DEMOGRAPHICS AND THE DRIVE TOWARDS DEBT LOW GOVERNMENT
BOND YIELDS LOWFLATION OVERINDEBTEDNESS AMPLE LIQUIDITY BEGGAR THY
NEIGHBOUR CURRENCY ACTIONS REGULATION GLUT DEMOGRAPHICS AND THE DRIVE
TOWARDS DEBT LOW GOVERNMENT BOND YIELDS LOWFLATION OVERINDEBTEDNESS
AMPLE LIQUIDITY BEGGAR THY NEIGHBOUR CURRENCY ACTIONS REGULATION GLUT
DEMOGRAPHICS AND THE DRIVE TOWARDS DEBT LOW GOVERNMENT BOND YIELDS
LOWFLATION OVERINDEBTEDNESS AMPLE LIQUIDITY BEGGAR THY NEIGHBOUR
CURRENCY ACTIONS REGULATION GLUT DEMOGRAPHICS AND THE DRIVE TOWARDS
DEBT LOW GOVERNMENT BOND YIELDS LOWFLATION OVERINDEBTEDNESS AMPLE
LIQUIDITY BEGGAR THY NEIGHBOUR CURRENCY ACTIONS REGULATION GLUT
DEMOGRAPHICS AND THE DRIVE TOWARDS DEBT LOW GOVERNMENT BOND YIELDS
LOWFLATION OVERINDEBTEDNESS AMPLE LIQUIDITY BEGGAR THY NEIGHBOUR
CURRENCY ACTIONS REGULATION GLUT DEMOGRAPHICS AND THE DRIVE TOWARDS
DEBT LOW GOVERNMENT BOND YIELDS LOWFLATION OVERINDEBTEDNESS AMPLE
LIQUIDITY BEGGAR THY NEIGHBOUR CURRENCY ACTIONS REGULATION GLUT
DEMOGRAPHICS AND THE DRIVE TOWARDS DEBT LOW GOVERNMENT BOND YIELDS
LOWFLATION OVERINDEBTEDNESS AMPLE LIQUIDITY BEGGAR THY NEIGHBOUR
CURRENCY ACTIONS REGULATION GLUT DEMOGRAPHICS AND THE DRIVE TOWARDS
DEBT LOW GOVERNMENT BOND YIELDS LOWFLATION OVERINDEBTEDNESS AMPLE
LIQUIDITY BEGGAR THY NEIGHBOUR CURRENCY ACTIONS REGULATION GLUT
DEMOGRAPHICS AND THE DRIVE TOWARDS DEBT LOW GOVERNMENT BOND YIELDS
LOWFLATION
OVERINDEBTEDNESS
LIQUIDITY
THY NEIGHBOUR
Seven Key
EconomicAMPLE
Themes
for BEGGAR
the Months
CURRENCY ACTIONS REGULATION GLUT DEMOGRAPHICS AND THE DRIVE TOWARDS
Ahead & Beyond
DEBT LOW GOVERNMENT BOND YIELDS LOWFLATION OVERINDEBTEDNESS AMPLE
LIQUIDITY BEGGAR THY NEIGHBOUR CURRENCY ACTIONS REGULATION GLUT
October 2016
DEMOGRAPHICS AND THE DRIVE TOWARDS DEBT LOW GOVERNMENT BOND YIELDS
LOWFLATION OVERINDEBTEDNESS AMPLE LIQUIDITY BEGGAR THY NEIGHBOUR
CURRENCY ACTIONS REGULATION GLUT DEMOGRAPHICS AND THE DRIVE TOWARDS
DEBT LOW GOVERNMENT BOND YIELDS LOWFLATION OVERINDEBTEDNESS AMPLE
LIQUIDITY BEGGAR THY NEIGHBOUR CURRENCY ACTIONS REGULATION GLUT
DEMOGRAPHICS AND THE DRIVE TOWARDS DEBT LOW GOVERNMENT BOND YIELDS
The Salient Seven – An Update:
ManulifeAM.com
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
Executive Summary
There are a number of global factors raising uncertainty including Brexit, the rise of an isolationist, anti-immigration,
anti-globalization discourse in Europe and the US, subdued oil prices, monetary policy divergence between the US
Fed and most other central banks, the continued failure of Abenomics to achieve its targets, and the trilemma
dilemma in China (between the capital account, interest rates and the currency). These are all issues driving
market volatility not just this year but in our view for years to come. What do these developments mean for
investors in the longer term? In this report, Megan Greene, Manulife Asset Management’s Chief Economist takes
another look at the Salient Seven – seven key themes she introduced last year that she believes will underpin
macroeconomic and market dynamics in the foreseeable future. And Robert Boyda, Co-Head of Asset Allocation,
assesses what this could mean for investors.
Megan Greene,
Chief Economist
2
Bob Boyda,
Co-Head of Asset Allocation
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
RE-INTRODUCING THE SALIENT SEVEN
I was lucky enough to be included in a group of world-renowned economists and investors at the annual Camp
Kotok — also known as the “shadow Fed” — in Maine this year¹. Camp Kotok produces a survey of forecasts of
various economic indicators and asset classes one year out. Having filled out our surveys, the participants at my table
compared answers. Much to our surprise, our answers were incredibly similar — both to one another’s and to what
the values and levels of these indicators were today. Bearish and bullish are no longer the only two classifications of
an investor. The third classification — uncertain — has been growing. This has been driven by a number of events
and trends that are all in some way underpinned by the notion that we have an oversupply of a number of factors
globally, which will continue to be big drivers of the macroeconomic environment and markets for years to come.
OVER-INDEBTEDNESS
Total indebtedness by governments, corporates, financial services companies and households
continues to increase.
AMPLE LIQUIDITY
The global economy is awash with macro liquidity and credit, thanks to successive rounds of
easing measures by major central banks.
BEGGAR THY NEIGHBOR CURRENCY ACTIONS
Countries are trying to boost demand and growth by increasing their competitiveness via a
weaker currency.
REGULATION GLUT
As capital requirements for other assets rise, investing in sovereign bonds has become more
attractive from a capital cost perspective.
DEMOGRAPHICS AND THE DRIVE TOWARDS DEBT
An aging global population is encouraging many investors to shift into fixed income from
equities.
LOW GOVERNMENT BOND YIELDS
Secular stagnation and easy monetary policy are likely to mean the continued compression of
government bond yields.
LOWFLATION
Lack of global demand is expected to translate into little upward pressure on inflation, with
many central banks missing their inflation targets.
1
3
MarketWatch: These top investing minds see stormy seas ahead over the next year, August 15, 2016
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
1 Over-indebtedness
GDP growth in the developed world remains well below the pre-crisis trend and with weak
productivity gains, we expect potential growth going forward to remain lower than it has been in the past.
Low growth means low revenue growth and little capacity for spending without running up budget deficits
and debt/GDP ratios. This is even more the case for any country looking to boost aggregate demand by
implementing fiscal stimulus. Despite extraordinary efforts on the part of governments, companies and
households to retrench, repair their balance sheets and deleverage, total indebtedness (private and public debt)
in most major economies continues to increase. Indeed, total debt for the five major economies shown in the
chart below is higher now than it was at the peak of the Global Financial Crisis in 2008.
Total Debt Outstanding
350
Debt as % of NGDP
300
250
200
150
100
US
Japan
Eurozone
2008
China
Canada
2015
Source: Manulife Asset Management, Bloomberg, Oxford Economics, as of end 2015
In the absence of robust economic growth or inflation (or, even more unlikely, debt forgiveness), this debt overhang
is likely to persist for years. In our view, the risk of deflation is greater in most major economies than the risk of robust
inflation. Deflation exacerbates a large debt burden because borrowing must be paid back in more expensive future
dollars. The logic of deflation runs totally contrary to the norms of the last 40 years of persistent inflation whereby
borrowers were used to paying back debt in inflation-diminished future dollars. As the logic reverses, the future debt
burden becomes considerably more onerous. This, in turn, reduces aggregate demand, exacerbating deflation and
creating a debt-deflation spiral.
4
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
Implications for investors
Indeed, over-indebtedness and a debt-deflation spiral are kindling for a major crisis. Since there is ample
liquidity, there are no matches to light the fire. There are few places to hide and receive safety of principal
and safety of purchasing power: a regrettable reality.
That said, according to the bond market, the world must be in very dire straits. One-third of all sovereign
bonds currently carry negative yields which imply that the highest², best and safest use of your money is to
give it away with the certain knowledge you will have returned to you less money 10, 20 or 30 years hence.
By parity of reasoning, all the other investment options must be completely horrible as you will not only take
more risk but also prospectively lose much more.
NO. In our base scenario, the world will muddle along. In our view, sovereign bonds, particularly with
negative nominal and negative real rates, are overpriced. As investors have hunted down every spec of yield,
they have bid long-duration bonds of 30 years exponentially higher. Like a climber going up a very steep
wall though, one slip and the fall becomes quite breathtaking. We have seen these steep climbs before; they
don’t end well. We are extremely cautious on long-dated and most sovereign bonds at these high prices/
low yields.
2
5
Manulife Asset Management, Bloomberg, as of August 25, 2016
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
2 Ample Liquidity
Since most governments cannot engage in a coordinated fiscal stimulus effort given the massive
debt overhang, central banks have stepped in as the pinch hitters, offering monetary stimulus instead. Central
banks globally have injected an unprecedented amount of liquidity into the global money supply, and we now
have an oversupply of liquidity in the macro system. This should not be confused with a glut of liquidity in the
markets — in fact precisely the opposite is true. In part because of regulations, banks can no longer play the
market maker role to the extent that they used to. This, combined with the entry of new actors such as high
frequency traders, has reduced market liquidity — particularly during “risk off” periods³.
With weak growth and rock bottom policy rates, many central banks have turned to unconventional measures
to try to improve lending conditions and ease market stress on sovereigns. This has propped up asset prices in a
number of economies, though European and Japanese equities have not been as buoyant as expected given the
aggressive easing by both central banks.
The Federal Reserve (Fed), Bank of England (BoE), Bank of Japan (BoJ) and European Central Bank (ECB) have
all engaged in sovereign debt purchases through quantitative easing (QE). The BoJ and ECB have also cut their
deposit rates into negative territory in an attempt to push banks to lend instead of parking their reserves at the
central bank overnight. The ECB has gone a step further to offer Targeted Long-Term Refinancing Operations
(TLTROs) at rates as low as the deposit rate (negative) if banks lend4. In essence, the ECB is paying banks to lend,
providing a permanent transfer from the central bank to the private sector.
Central Bank Assets/Nominal GDP %
Central banks are buying assets to provide markets with ample liquidity
80
70
60
50
40
30
20
10
0
Jun-08
Dec-09
BoJ
Jun-11
ECB
Dec-12
BoE
Jun-14
Fed
Source: Bloomberg, as of May 2016
3
4
6
For further reading, see Bank for International Settlements: Fixed Income Market Liquidity, January 2016
ECB: ECB announces new series of Targeted Longer-term Refinancing Operations, March 10, 2016
BoC
Dec-15
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
Post Brexit, we expect the Bank of England, the ECB and the BoJ to continue easing monetary policy for at least the
next two years – thus amplifying liquidity. The Fed will no doubt consider external risks and headwinds in its rate
decisions. The Fed has a natural hawkish bias, and if economic data continue to indicate sluggish growth instead of
a slowdown, then we believe the Fed will likely act sooner instead of waiting till the second quarter of next year5.
That said, two major risks abound. The first is the Fed hiking too much too quickly, pulling all the liquidity out of the
global system. This could push the US and the global economy into a recession. The second risk is that central banks
have used up all of their firepower already in easing monetary policy. If the global economy goes into recession,
central banks do not have many more tricks up their sleeves. Further QE and even more negative rates would have
little impact on inflation expectations or financial stability. There is a limit to how much these policies can be employed
as well — eventually a central bank will run out of assets to purchase (a risk in Japan and especially in the Eurozone)
and if rates go negative enough, people will find it cheaper to keep their cash in a safe, bypassing the banks entirely.
Ideally, fiscal stimulus would be provided alongside monetary stimulus to create demand, but this is politically toxic
in places like the United States and the eurozone. The final option that central banks could employ in the event of a
recession is helicopter money, or permanent QE that bypasses the banks and goes directly to the end-user. Helicopter
money could come in the form of tax rebates or in infrastructure projects financed directly by the central bank.
We expect the BoJ to be the first central bank to employ helicopter money, with the ECB and possibly the Bank of
England to follow. The main concern about helicopter money is it conflates monetary and fiscal policy and so severely
threatens central bank independence. There is also a concern that it could cause too much inflation and cannot be
withdrawn, though that is less of a worry in today’s environment of stubbornly low inflation.
Implications for investors
Markets have become rightly obsessed with the actions of policymakers because of the potential for a major
negative surprise. Just like bond investors worrying about a slip off the steep climb in bond prices, so too equity
investors are deeply concerned about a sharp fall from current valuation levels. That is, the equity market is
thought to be floating on a bubble of liquidity and hence just as vulnerable as bonds. However, with so much
liquidity being injected into the global monetary system, we believe equity markets are unlikely to come under
real sustained pressure any time soon. We believe companies that can prosper in this current environment
delivering real earnings growth, rising cash flows with increasing dividends can sustain premium valuations.
5
7
Manulife Asset Management: Fed Groundhog Day in September, September 27, 2016
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
3 Beggar Thy Neighbor currency actions
The expectation of significant monetary policy divergence between the United States and the rest
of the developed market world contributed to a substantial appreciation of the US dollar (USD) against nearly
every major currency pairing in 2015. While this created some benefit to those that export to the US, it also put
substantial stress on the global system. Currencies that are pegged or loosely pegged to the USD effectively
strengthened to the same degree. Concerns have specifically mounted over China’s ability to maintain the
Renminbi’s peg to the USD in the midst of capital outflows, which have recently slowed but may pick up again
with further indications of an economic slowdown in China. While we believe the probability of a currency crisis
in China is low, fears over the government and central bank’s ability to defend or support the economy and the
currency in the face of reform and deleveraging will likely continue to contribute to volatility in the near term.
The USD has weakened moderately in H1 2016 relative to a trade-weighted basket of currencies², largely as a result
of a slower rate path from the Fed and a slower than expected growth profile in the United States. This has eased
global financial conditions significantly, but it is likely this could be reversed when the Fed next hikes interest rates
or when other major central banks such as the BoJ and ECB ease further aggressively, as we expect will happen
before the end of 2017.
Furthermore, we also expect to see non-US currency pairings become more important, particularly for those countries
that export to a long list of non-US countries. Asian currencies vis-à-vis the Renminbi and Japanese Yen will be key to
these countries’ ability to generate export-led growth. The Yen, in particular, has strengthened significantly against
the USD since Brexit given its status as a “safe haven currency”. The BoJ might engage in direct foreign exchange
intervention or it could announce helicopter money, or the purchase of foreign bonds.
Implications for investors
The consensus trade for 2016 had the US dollar strengthening mightily against the rest of the world. We
continue to disagree with this view. The impact on US competitiveness puts a natural limit on the rise. While
we have some considerable conviction in adding assets outside the US, we recognize that currency volatility
has become one of the largest sources of risk in most portfolios. The key here is to keep calm and do the right
thing – cheap assets will overcome short-term currency issues. Many investors typically have a domestic bias,
but these monetary policy dynamics offer a strong case for casting a wider investment net and in particular
examining opportunities in international equity markets. Diversification remains a virtue6.
6
8
Diversification does not guarantee a profit nor protect against loss in any market.
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
4 Low Government Bond Yields
Japan Sovereign Curve as of 3/21/16
Japan Sovereign Curve as of 1/15/16
30Y
20Y
15Y
10Y
9Y
8Y
7Y
6Y
5Y
4Y
3Y
2Y
40Y
30Y
20Y
15Y
10Y
9Y
8Y
-1
7Y
-0.5
6Y
0
5Y
0
4Y
1
3Y
0.5
2Y
2
1Y
1
6M
3
3M
1.5
1Y
Another result of unconventional monetary policies has been the compression of long term
government yields, particularly relative to economic fundamentals. Negative interest rate policy in the Eurozone
and Japan has served to flatten yield curves and shift them downwards. Japanese Government Bonds (JGBs)
are negatively yielding out to 10 years, though the BoJ has changed its monetary policy regime such that it is
targeting 10-year yields at zero percent7. German bunds, another safe haven, are negatively yielding out beyond 5
years. According to Tradeweb, the total global volume of sovereign and corporate debt that is negatively yielding
represents roughly half of all western sovereign debt8.
Eurozone Curve as of 3/21/16
Eurozone Curve as of 6/04/14
Source: Bloomberg, March 2016
Investors have few safe havens to choose from in this economic environment, confined to US treasuries, JGBs and
German bunds. With so many Japanese and German bonds negatively yielding, there have been continued flows of
capital into the United States. When the Fed hiked rates in December 2015, the 10-year yield actually fell rather than
rising as investors piled even further into US treasuries.
While central bank sovereign debt purchases have pushed down government borrowing costs significantly, there is a
risk of central banks running out of bonds to buy and bond yields spiking as a result, particularly in Europe but also
potentially in Japan.
The ECB also risks running out of German bunds to purchase. The ECB’s QE program only allows the central bank to
buy up sovereign debt according to the capital key, which is determined by the size of the economy. The ECB must,
therefore, buy more German assets than any other sovereign debt. According to some estimates, the ECB could run
out of German assets to purchase as early as 20179.
Bank of Japan: Quantitative & Qualitative Monetary Easing with Yield Curve Control, September 21, 2016
Financial Times: Investors stockpile cash to offset economic despair, August 11, 2016
9
Bruegel: The European Central Bank’s Quantitative Easing Programme – Limits & Risks, February, 2016
7
8
9
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
If the ECB runs out of German assets, it cannot buy assets from other countries, and we could see yields spike in the
event of renewed instability in the Eurozone caused by any number of crises the region continues to face — Brexit, the
debt crisis, the banking crisis, the refugee crisis or the crisis in Ukraine. One solution would be to remove the capital
key limitation, but there is very little appetite for this in Germany and other northern European countries. Another
potential solution could be to purchase equities, but this would also find opposition in the core countries.
Implications for investors
Interest rates are at 5,000 year lows10 and we expect long-term yields to remain low over the next five years.
Investors need to recalibrate decades of thinking around where rates are likely to be for the foreseeable
future abandoning a view tied to some magic number like 5% because that is the historical average. Rather,
it might be constructive to think in terms of the real yield, the spread between what one earns in coupons
over and above the rate of inflation. Going back to the mid-1980s, the real return on 90-day Treasury bills
ranged from two percent over to two percent under inflation. It is unimaginable in the current environment
that risk-free11, short-term government treasuries will yield more than inflation – that is, 1.5% today at the
outside. At best, 10-year government bonds might get to 1% over inflation (2.5% today²) reflecting not so
much the incentive to put money away for ten years (term premium) as a payoff for the risk that inflation
exceeds the current low rates by up to one percent over the life of the bond. Our 5-year forecast for bond
returns is a puny 1%. High real positive returns in fixed income are available in a few markets, these options
come with considerable risks as many are in emerging markets.
10
11
10
Bank of England: Stuck, Speech by Andy Haldane, June 30, 2015
The risk free rate refers to the yield on high quality government bonds, for example, US Treasury Bills
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
5 Regulation Glut
Another factor contributing to compressed government bond yields is an overabundance of
regulation. Financial services industries currently face an alphabet soup of regulatory requirements, forcing
them to hold higher capital buffers for most of their credit exposures. This has contributed to a shortage of
liquidity in the markets, resulting in greater volatility. With larger capital buffers, banks have not been able
to serve the same role as market makers as previously. With such little liquidity — particularly during “risk
off” periods — companies in the mutual fund industry have been caught by surprise, as we saw when Third
Avenue shuttered in late 201512. We may continue to see this as more regulation is implemented.
Central government debt is an exception to the rule that banks have to hold more capital against their exposures —
sovereign risk exposures receive a zero risk weighting in Europe. As capital requirements for other assets rise, investing
in sovereign bonds has become more attractive from a capital cost perspective. Consequently, some investors have
shifted from stocks to debt over the past few years. With zero risk sovereign debt weights, banks have loaded up on
their own domestic debt. In Europe in particular, this has strengthened the sovereign-bank “doom loop13”. European
policymakers are currently debating whether to set limits for banks’ domestic sovereign bond holdings. This could
be ruinous for Italian banks in particular. In theory, Italian banks and other European banks would all be selling their
national sovereign debt to comply with the new limits and so Italian banks should find a buyer for their BTPs14. Given
that the ECB is also buying Eurozone sovereign bonds, Italian banks would have to compete with the central bank for
creditor government bonds, making those bonds incredibly expensive.
Implications for investors
Regulators continue to battle the last war. Increased regulation will persist. As a result, bond and stock
markets will be much more volatile on the downside now that the old model where banks used their
balance sheets and trading desks to intermediate transactions has radically diminished. Regulation is eating
into profits for these companies15. However, the relatively poor performance of US and select European
banks looks poised to turn – many of these institutions have great retail and institutional franchises, yet are
priced at impending disaster levels while the regulatory regimes have caused these companies to increase
capital positions making them safer for both debt and equity owners.
Third Avenue Management: Third Avenue Focused Credit Fund & Distribution Information, December 16, 2015
“Doom loop” refers to the potentially vicious circle that can emanate from bank’s ownership of their own countries’ government bonds. If they suffer
losses from these holdings, they would need to be bailed out, which in turn, hurt state finances.
14
Acronym for Italian government bonds, Buoni del Tesoro Poliennali
15
Economist Intelligence Unit: US banks buffted by regulators, politicians, lower profits, May 3, 2016
12
13
11
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
emographics and the drive
6 Dtowards
debt
The aging of the global population will continue to affect broad consumer and investor appetites over the coming
decade. Yet, this older demographic is particularly inversely impacted by the need to generate yield for retirement
in a low and negative rates environment.
In the more immediate future, however, the demographic issue with the most potential to affect policy decisions
is the ongoing refugee crisis in Europe. Germany received around one million refugees in 2015 alone16. This influx
of refugees has caused some political and social schisms — the Alternative fur Deutschland, a nationalist party,
has fared well in recent local elections in Germany for example — but given that the average age of refugees
is lower than the average age of the German population, this could be an opportunity to address Germany’s
aging population. To embrace this opportunity, refugees must be successfully integrated into the labor force.
Unfortunately, Germany has a poor record of integrating refugees.
Investors Shift from Stocks to Bonds (%of world
financial assets excl. bank assets)
70
60
% of Total Financial Assets
The EU has struck a deal with Turkey to return
refugees coming across the Aegean Sea to Turkey.
There are a number of legal and logistical challenges
involved in implementing this deal. The agreement
has slowed the flow of refugees into Europe for
now, but we expect refugees to reroute away
from the Aegean route to Europe to others, such
as the Libya/Italy route. A number of EU countries
have already reimposed national borders within
the Schengen area of free travel17. If these internal
borders remain, it will undermine one of the central
tenets of the European project: the freedom of
movement of labor, capital, and goods. German
Chancellor Angela Merkel has seemingly gone back
on her “refugees welcome” policy and the EU is
increasingly becoming “Fortress Europe.” In our
view, the demographic benefits of the refugee crisis
in Europe are therefore unlikely to be realized
50
40
30
20
10
0
Stock Market Capitalization
2005
2012
Total Debt Securities
2015
Source: Manulife Asset Management, Bloomberg, as of year-end 2015
16
17
12
Reuters: More than one million migrants registered in Germany in 2015: Newspaper, December 30, 2015
Reuters: Denmark extends controls on German border, EU set to authorize more, May 2, 2016
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
Implications for investors
Paradoxically, low interest rates are causing the retirees and near retirees to save even more. In this way,
low rates are hurting consumption. Older investors are usually more risk averse, but to maintain a lifestyle,
they are being pushed into higher risk investments. Money keeps flowing into that part of the equity market
that has bond-like characteristics: bond proxies like Utilities and Staples. These defensive dividend producing
stocks have been bid to high valuations². At this point, there appears to be better value in growth stocks,
smaller company stocks and even the much-hated cyclical stocks like energy, materials and industrials.
Investing isn’t all glamor and the current environment calls for diversification more than ever.
13
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
7 Lowflation
In the absence of global demand, we also expect inflation to remain low for a number of years. As
the chart below shows, most of the developed world is way off its inflation targets, and we expect that to remain
the case over the next five years.
2016 Inflation Forecast Relative to Central Bank Target
Above
Within
Below
Source: Manulife Asset Management, Bloomberg, April, 2016
This is in part owing to the oversupply of labor globally, with a huge influx of workers first in Russia and central
and Eastern Europe as the Soviet Union collapsed, and then in China as people moved to cities. We do not expect
this trend to change going forward; the next sources of a significant labor force are most likely India and Africa.
Furthermore, technological developments may reduce demand for labor, exacerbating the oversupply.
With an overabundance of workers, there will be little upward pressure on wages, and consequently prices will
likely remain subdued.
14
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
Implications for investors
Lowflation is the primary underpinning of our thesis that short term interest rates and real interest rates
remain low for an extended period of time. This will not help the savers much. On the plus side, the
possibility of a sharp rise in interest rates is virtually nil. And, with accommodative central banks the risk of a
policy induced recession is also virtually non-existent. Bond markets will not suffer major collapses into bear
markets. This should give investors some comfort sticking with core bond positions – duration risk is limited.
Over the next several years we expect a small uptick in inflation on a cyclical basis which should provide
some relief to the commodity producers. This suggests stock valuations of companies that are able to grow
in a low growth, low inflation world can move even higher.
15
The Salient Seven – An Update:
Seven Key Economic Themes for the Months Ahead & Beyond
Conclusion
We first introduced the Salient Seven last January. 20 months later, our conclusion remains largely unchanged.
We believe the Salient Seven will continue to shape the global macroeconomic environment for years to come in
the absence of major shocks or significant policy reversals.
We are in an era characterized by oversupply, and we expect that will change the global macroeconomic and
investment arenas significantly.
What does all this mean for investors? Many of these themes suggest some form of structural support for equity
prices – with stock markets around the world bolstered in particular by continued ample liquidity and a low
inflationary environment. Equity markets in some countries may additionally benefit from a demand boost thanks
to currency depreciation.
Conversely, these themes point to continued pressure on fixed income, made potentially less attractive by overindebtedness globally, a challenge exacerbated by “lowflation”, which prevents countries from inflating their way
out from under debt burdens. We will continue to sift our analysis through the sieve of the Salient Seven and
share our macroeconomic and investment insight on these themes in the years ahead.
16
No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment.
Diversification or asset allocation does not guarantee a profit nor protect against loss in any market.
Investing involves risk, and there is always the potential of losing money when you invest in securities. It is important that you consider this
information in the context of your personal risk tolerance and investment goals. Before acting on the information provided, you should consider
suitability for your circumstances and, if necessary, seek professional advice.
Global events have resulted, and may continue to result, in an unusually high degree of volatility in the financial markets, both domestic and
foreign.
Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.
Investments in foreign securities involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse
political, economic or other developments. These risks are magnified for investments made in emerging markets.
A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held, the more sensitive a strategy is likely
to be to interest-rate changes. The yield earned will vary with changes in interest rates.
Negative interest rate policies reduce the yields of government debt instruments and typically drive the prices of such instruments higher.
This material, intended for the exclusive use by the recipients who are allowable to receive this document under the applicable laws and regulations
of the relevant jurisdictions, was produced by and the opinions expressed are those of Manulife Asset Management as of the date of this
publication, and are subject to change based on market and other conditions. The information and/or analysis contained in this material have
been compiled or arrived at from sources believed to be reliable but Manulife Asset Management does not make any representation as to their
accuracy, correctness, usefulness or completeness and does not accept liability for any loss arising from the use hereof or the information and/or
analysis contained herein. The information in this document including statements concerning financial market trends, are based on current market
conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Asset Management disclaims
any responsibility to update such information.
Neither Manulife Asset Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for
any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein.
The material is not advice, a personal recommendation, research or a personal recommendation related to any investment opportunity. Accordingly,
all overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute
for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife Financial,
Manulife Asset Management™, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not
guarantee future results. This material was prepared solely for informational purposes, does not constitute an offer or an invitation by or on behalf
of Manulife Asset Management to any person to buy or sell any security and is no indication of trading intent in any fund or account managed
by Manulife Asset Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market
environment. Unless otherwise specified, all data is sourced from Manulife Asset Management.
Manulife Asset Management
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world. This investment expertise extends across a broad range of public and private asset classes, as well as asset allocation solutions.
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323172
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