January 22, 2017
United States:
This $4 Billion Manager Is Preparing for an Inflation Surprise
Inflation is what could jolt the markets this year. At least that’s what the tactical asset allocation team at DNB Asset Management is preparing for. “Inflation surprising on the upside is the biggest risk,” Torje Gundersen, portfolio manager, said in an interview in Oslo on Thursday. “2018 can be the year when stronger inflation surprises a lot of investors.” Global economic growth spurred the stock rally in 2017. But inflation expectations are likely to rise as the prolonged expansion eats into spare capacity and the U.S. cuts taxes. The yield on the U.S. 10-year Treasury note climbed in the past week to the highest levels since 2014.“The timing of the tax cuts are therefore wrong in our view,” said Gundersen, whose team manages about 33 billion kroner ($4 billion). “The effect is comparable to pouring gas onto a campfire. The economy will overheat and financial conditions will tighten more than the markets expect.”Gundersen sees the U.S. 10-year Treasury yield rising toward 3 percent. DNB’s asset allocation team is neutral equities and bonds, but has sold out of its holdings in U.S. and European investment grade bonds. “They have a low yield and long duration,” he said. “If interest rates rise there’s a risk of negative return.” Instead, Gundersen holds Nordic high-yield bonds with shorter duration. He also takes region and sector bets to seek excess return in the stock market. His portfolios are overweight energy, materials and industrials, which are likely to get some support from accelerating inflation. He also prefers an overweight in technology companies. “They have a very strong underlying growth,” he said. “They aren’t cheap but they aren’t more expensive compared with the rest of the market.” The DNB Aktiv 80 fund had an average annual return of 14 percent in the past five years. But investors should expect lower returns in the coming years, according to Gundersen.“So this year it will be a struggle between earnings growth and rising interest rates. And what should the pricing of stocks be then,” he said. “We don’t see a catastrophe scenario for the stock market but lower return expectations than last year.”
Federal Shutdown Seen as Blip Not Bust for Robust U.S. Economy
The U.S. government shutdown may slow the nation’s economy a little bit, but economists largely agree there won’t be serious harm as long as the political stalemate ends soon. Heading into its first business day, the idling of all but essential federal workers and some services comes amid a tight labor market, a soaring stock market and possibly the strongest three quarters of growth in more than a decade. The disruptions shouldn’t cloud the picture too much for Federal Reserve officials who are trying to gauge whether to continue raising interest rates. A shutdown that lasts a week and puts 850,000 federal workers on furlough would reduce U.S. economic growth in the quarter by about 0.1 percentage point, said Nancy Vanden Houten of Oxford Economics. Goldman Sachs Group Inc., in a note on Jan. 18, estimated the drag on GDP at 0.2 percentage point a week, though the effects “would be reversed the next quarter.”
Dollar Slips as Shutdown Drags On; Stocks Mixed: Markets Wrap
The dollar declined and Treasuries halted a recent selloff as investors assessed the impact of the U.S. government’s partial shutdown. European and Asian equities were mixed. The greenback edged lower against most major currencies as the disruption to federal services dragged into a third day. The euro climbed on optimism that German Chancellor Angela Merkel has made a potential breakthrough toward a fourth term. Traders monitored China’s appetite for a stronger currency as the yuan touched the symbolically key level of 6.4 per dollar. South Africa’s rand rose to its highest since 2015 on speculation President Jacob Zuma may be forced to leave office. U.S. stock futures fell.
“Due to the limited economic impact, markets should be largely unaffected,” by the government shutdown, said Poul Kristensen, portfolio manager at New York Life Investment Management. “If there is a little pullback, we believe it will be a buying opportunity. The last time the government shut down in 2013, markets moved higher.” Equity investors appear to have taken the latest U.S. government drama in their stride as the optimism over economic growth and profit increases that pushed many stock indexes to all-time highs lingers. Meanwhile, the next catalyst for bonds may come from commentary by policy makers after European and Japanese central bank decisions this week. Their signals that unprecedented stimulus will soon be wound back has sparked a surge in yields this month.
Europe:
No-Deal Brexit Could Cause Finance Chaos, Industry Group Warns
Financial markets in Britain and the European Union will face instability and significant business disruption if the U.K. exits the EU in March 2019 without a transition deal or final settlement on a number of crucial issues, a finance industry trade group warned. There are at least five key areas where financial firms need clarity from U.K. and EU policymakers to avoid instability, the Association for Financial Markets in Europe said in a report published Monday. These include an agreement on data transfers, continuity of contracts, legal jurisdiction, access to market infrastructure and recognition of bank resolution actions, according to AFME.A quarter of all over-the-counter derivative contracts entered into by parties in both the U.K. and EU with a gross notional value of 26 trillion pounds ($36 trillion) could be affected if U.K. financial firms lose their right to be recognized as properly regulated entities following Brexit, the group said. Of these, derivatives worth 12 trillion pounds are due to mature in the first quarter of 2019 alone.
Asia:
How a China Bank Foxed Regulators And May Force a Market Rethink
For years, a branch of a mid-sized Chinese bank outshone rivals by reporting zero bad loans at a time others were struggling with rising soured debt. Financial indicators at Shanghai Pudong Development Bank Co.’s branch in the western Chengdu city were healthy, officials raised no red flags, and Fitch Ratings upgraded the parent last July citing tighter support and supervision by local authorities. Unknown to most, however, regulators had been probing the lender for a fraud that may reverberate across China’s financial industry.” It is not just about Pudong Bank,” analysts at Guangfa Securities Co., led by Ni Jun, wrote in a report. “The underlying issue is that the market may conduct a systemic review and re-rating on the bad loan ratios of those highly-leveraged Chinese banks that had gone through a round of balance-sheet expansion.” The bombshell dropped late on Friday, when the China Banking Regulatory Commission slapped a 462 million yuan ($72 million) fine on the Pudong Bank branch, accusing it of hiding non-performing assets with a web of fresh lending. Not only is this one of the stiffest penalties imposed in the industry, it’s also an unusual level of disclosure by a regulator that has historically chosen to deal with malpractice away from the public gaze.
