After years of global disinflation in developed markets, inflation pressures seem to be building up finally. Pioneer Investments believes that investors should be prepared to deal with the new inflation scenario by choosing an active and selective approach in multi-asset investing.
In the following Q&A, Sandrini reveals his views on key investor issues concerning multi-asset.
From a multi-asset perspective, where do you see value in a reflation scenario?
According to our models, we are currently experiencing a period of asset reflation with possible elements of a late cycle scenario. Here the favourite asset classes have historically been global equities, credit and commodities. In the current environment, we need to consider whether the long bull market, induced by central banks’ unconventional policies, has distorted market valuations.
We think credit still offers some opportunities in relative terms, especially on higher yielding securities. The asset class remains supported by the ongoing search for income and, in the Eurozone, by the ECB’s bond purchasing programme. However, we are aware that valuations look expensive in a possible reflationary scenario characterized by higher interest rates, the over-crowded investment grade segment in particular. Within high yield, energy and materials look less vulnerable than one year ago thanks to the commodity recovery.
We are cautiously positive on emerging market (EM) bonds, with a preference for hard currency debt, while being wary of possible pressures on EM currencies from the strong US dollar. In the short term, however, headwinds to the asset class are strong because the Fed’s effort to cool down mounting inflation pressures is making the Dollar Trade Weighted Index stronger.
On the equity side, we have a positive view on a cyclical earnings recovery, favouring US and Japan and with a constructive view on European equity. On EMs, we prefer a country-specific approach, favouring countries like India that are less vulnerable to external threats.
Sector-wise, the reflationary environment should be supportive for financials: the steepening of curves supports the return on equity. Less litigation, expanding credit and a peak in the regulation wave could also boost the return of equity and, on the other side, less uncertainty would lower the cost of equity. We tend to prefer cyclical sectors – energy, materials, financials – while maintaining a cautious stance on interest rate sensitive sectors, such as utilities, telecoms, staples and real estate.
As mentioned above, your base scenario for 2017 is constructive on commodities. Which assets could be favoured in this context?
Most commodity fundamentals have improved and prices for some commodities are already anticipating widening deficits in supply/demand dynamics. Global demand for energy and industrial metals should remain supported by the fiscal expansionary plans in emerging and developed economies alike.
A boost for infrastructure spending in the US and in EMs – LATAM especially – should support demand for metals. Zinc inventories are already declining, while global demand for copper and nickel is rising. We are more cautious on global crude oil as the market has discounted the productions cut agreed by OPEC (1.2mln barrel/d) and major non-OPEC producers and we don’t foresee a strong upside from current levels. In a context of a stable/positive commodity outlook, opportunities could be found in EM commodity currencies, which our internal quantitative models suggest are attractive in terms of valuation – such as the Russian ruble and the Chilean peso.
How can multi-asset investors deal with changing inflation expectations?
In periods of inflation surprises, real assets can offer interesting inflation protection opportunities. Here we can include inflation-linked bonds, which offer good diversification and inflation protection; commodities or specific instruments such as MLPs – master limited partnerships, which benefit from more stable oil and gas prices and infrastructure spending. Despite their historical outperformance in periods of inflation surprises, we prefer to stay cautious on REITs because the search for income induced by abundant central bank liquidity has led their valuation at historically high levels.
In conclusion, we do not foresee a new phase of structurally high global inflation – such as the one that characterised the 80s and 90s – because some deflationary forces remain active at a global level. However, we believe that 2017 will mark a period of discontinuity in the inflation outlook for developed markets, following the “lowflation” environment that has dominated since the great financial crisis. For this reason, we believe investors should be aware of the new inflation narrative in order to build portfolios that are suitably resilient to a changing market scenario.
Disclaimer: Unless otherwise stated, all information contained in this document is from Pioneer Investments and is as of March 2017. The views expressed regarding market and economic trends are those of the author and not necessarily Pioneer Investments, and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Pioneer Investment product. There is no guarantee that market forecasts discussed will be realised or that these trends will continue. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any service. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. Date of first use: March 2017
