PARTNER INSIGHT: Shaniel Ramjee, Senior Investment Manager Multi Asset at Pictet Asset Management, gives his market outlook.
Political cracks in the foundations of Europe have re-emerged in 2018, having been masked by better than expected economic growth in 2017. Given the high levels of debt in Europe, the continent is much more dependent on economic growth than other regions. This is not just the case with respect to budget deficits and the constraints they put on governments, but also applies to corporates whose balance sheets are highly operationally geared.
We observe higher risk premia on European assets than elsewhere and would suggest this is a function of political uncertainty. Unlike several years ago, when populist parties were just fringe movements, they are now increasingly setting the agenda, which is inevitably more domestically focused. So politics continue to weigh on European markets' ability to outperform.
Elsewhere, the work we have done suggests that many emerging economies have improved their economic positioning. Even China, where we now see nascent signs of economic stabilisation. This bodes well for the entire emerging complex, with domestic demand and corporate profitability holding up well.
We have espoused Japan's improving corporate sector and sustained earnings for some time. Its companies are relatively insulated from margin threats. Looking at the cyclical sectors, these trade at a large discount to their global peers, and have much less leverage, which is favourable as the interest rate cycle progresses.
The performance of the market has been lack lustre given these attributes. However, any resurgence in risk appetite, and tempering down of global trade fears should lead to renewed investor appetite.
Listening to companies
Consumer-focused companies are facing pressure from changing spending habits, while nimble competition erodes margins. Those companies that can grow revenues, have more insulated margins, and are exposed to lower leverage are attractive. The fact that only a handful of high growth companies in the US have been responsible for the bulk of overall returns leaves a market which is too narrow and vulnerable.
One risk that worries us, is the low expectation of defaults implied in credit spreads, given that corporate and government sectors globally are highly leveraged. Credit markets are larger today, but the ability to manage credit risk is much lower given the market structure.
Private debt markets have grown as investors have sought the illiquidity premium; however during stresses this premium quickly turns into a discount and, although investors may not have to face the mark to market volatility, they cannot hide from the defaults. We attempt to identify catalysts which could cause a repricing of risk, knowing that those with the biggest ramifications defy the markets' conventional wisdom.
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