Asset Allocation Views

• On the macro theme, we see the following: (1) 2018 global growth to remain solid; (2) recent market volatility suggests a repricing of tail risks and an overdue correction; (3) a watch on green shoots for inflation; and (4) a similar global central banks’ policy direction, though the timing varies significantly.

• We are overweight on equities with a positive view on the US, Japan, Asia ex-Japan and Malaysia while staying neutral on the UK and Euro zone.

• On government bonds, we maintain a cautious view with a negative outlook on US Treasuries and German bunds while holding a neutral assessment on UK gilts, Japanese government bonds (JGB) and Malaysian Government Securities (MGS).

• Opportunities on “inflation-linked bonds” are underpinned by interest rates and inflation issues and we like the US, Italy and Australia inflation-linked bonds.

• On currencies, we are positive on the euro, yen, yuan, MYR and high-yielding currencies like the rupee and rupiah. We are neutral on the USD and pound.

A. Macro Themes

1. 2018 global growth remains solid

• 2018 global growth remains solid despite the emergence of trade uncertainties as policymakers introduce pro-cyclical fiscal stimulus though central banks continue to pull back the extraordinary support with a structural shift towards higher rates but with varying timing. We reiterate our 3.6% global GDP outlook for 2018 and 3.8% for 2019 from 3.3% in 2017, supported by continued improvement in the leading indicators and further fiscal expansion in the US that will feed into stronger global trade and growth. Countries like the UK, Japan and those in Asia ex-Japan and the euro zone are expected to perform well.

• Recent market volatility indicates a repricing of tail risks and an overdue correction rather than anything more threatening. The ongoing transition to more normal levels of inflation and interest rates will cause volatility across the markets as well as asset classes. We expect a more significant impact on fixed income investments as opposed to equities as policy rates are set to tighten steadily but remain accommodative and supportive of risky assets.

2. Looking at green shoots for inflation

• We are looking at green shoots for inflation as Europe’s inflation is supported by growth improving across the region. UK inflation is ahead of the Bank of England’s 2.0% target since February 2017, partially driven by a fall in the sterling and rise in import prices after the Brexit referendum. Although Japan posted 13 straight months of positive changes in core consumer prices, inflation is unlikely to threaten the Bank of Japan’s 2.0% target anytime soon.

• US inflation is closely watched, given its impact on global asset prices. Though core personal consumption expenditures (PCE), the Fed’s preferred inflation metric, are below target, inflation has picked up sharply in 2H2017 and into 2018 due to the firmer economy. Annualised six-month core PCE reads at 2.0% while core CPI growth over the last 12 shows 2.6%. Wage growth averages at 2.6% (average for last 12 months), with unemployment at 4.1% (latest).

• Another area we see a clear sign of rising inflation is China’s Producer Price Index (PPI). Lagged by 18 months, we found it to fit well with the US core goods CPI which is not a surprise since many finished goods imported by the US originate in or pass through China’s manufacturing sector. After falling steadily from 2011 to the end of 2016, the Chinese PPI has spent the last two years climbing rapidly.

• Malaysia’s inflation is poised to stay moderate in 2018 at around 2.0% – 2.5% partly due to a stronger Malaysian ringgit (MYR) against the USD and will partly cushion the firmer global energy and commodity prices as well as import costs. Besides, the high base will lead to lower inflation contribution in 2018. Core inflation is projected to moderate due to limited pass-through to retail prices.

3. Gradual monetary tightening

• Global central banks’ policy direction is similar, though the timing varies significantly. While the focus is still on rising inflation, there is no surge in wage pressures thus far. We expect the US Fed to raise rates two (2) more times in 2018 and three (3) times in 2019 to settle at 3.00%. The probability for four (4) rate hikes in 2018 is at a low 25% chance at the moment. The ECB should wind down its bond-buying programme from €30bil by reducing to €15bil from October and end in December 2018. We expect rate hikes to kick start from early 2019 onwards. The BoE is expected to hike rates once in May and another in November 2018 from the current 0.50%, while the BoJ is likely to incorporate a modification in yield curve control by raising the target for 10- year government bond yields to 10 basis points from zero in the final quarter of 2018.

• In the emerging markets, there is a huge disparity across regions in terms of inflation and interest rates. We found the Central and Eastern Europe’s economic cycle is quite mature with inflation starting to pick up. But not all of the central banks have acknowledged the need to reduce monetary accommodation at this point. Still, we feel interest rates are far more likely to go up on the outskirts of the euro zone.

• Looking at Latin America, the output gaps remain negative. Brazil has started to recover but still lacks the inflationary pressure, suggesting the slack in the system which indicates a disinflationary environment. Inflation has been trending lower in Mexico, and we expect the central bank to start cutting rates.

• Developing Asia is somewhere between these two poles of inflation and interest rates, though with a clear bias towards higher rates. China has been maintaining a tight policy with the central bank’s stance focusing more on deleveraging than inflation concerns.

• For Malaysia, while the base case remains with one rate hike in total for 2018, which materialised in January by 25bps, we have placed a low 30% chance of a second rate hike in September or November, with much depending on the pace at which demandpull inflation kicks in and the number of rate hikes by the US Fed.

Source: AmInvest Research - 18 Apr 2018