CIO Weekly Letter
Transcription
CIO Weekly Letter
C IO REPORTS The Weekly Letter Office of the CIO • FEBRUARY 10, 2015 unging for Yield: We expand the discussion of income assets to international markets, highlighting potential L opportunities in higher-quality European equities and Emerging Markets debt. However, with higher yield typically comes greater volatility, and investors should consider the relevant risks. They should not abandon high-quality bonds in their search for income, and remain within their tolerance for risk. arkets In Review: Equities rallied last week, with the S&P 500 rising 3.1% on another strong week of earnings, and the M MSCI EAFE Index up 1.7%. The employment report for January showed an unexpectedly large pickup in both new jobs and wage growth, leading to increased expectations that the Federal Reserve will begin to raise interest rates sooner. Treasury yields rose sharply, with the 10-year yielding 1.96% from 1.64% the prior week. WTI crude oil rose by 7.2% to $51.70 per barrel on further signs that U.S. producers were meaningfully scaling back production, while gold fell 3.9% to $1,234 per ounce. ooking Ahead: January retail sales in the U.S. are expected to be dragged down by the decline in gasoline prices, and L consumer sentiment is expected to moderate from the 15-year high in December. Euro-area gross domestic product (GDP) is expected to increase, led by strong growth in Germany. In our last Monthly Letter, “Low for Longer,” we highlighted ways to diversify income strategies, some through equities. With many international markets looking increasingly attractive, we now expand the hunt for yield overseas (see Exhibit 1). Central banks are driving down yields In the past year, choppy global growth and declining inflation have led central banks around the world to implement ultraaccommodative monetary policies, bringing interest rates to zero or even below, and pushing bond yields down. 7% U.S. High Yield 6% 5% 4% 3% Higher Yield During the decade leading up to the financial crisis, 10-year Treasuries yielded 5% on average, but now yield less than 2%. In a yield-starved world, finding reliable sources of income is proving increasingly challenging. In the past, high-quality bonds have been the preferred place to look. However, in today’s zero interest rate environment, clipping coupons from fixed income securities is proving insufficient for most investors. We have been forced to expand our horizons in seeking yield, and we find that several areas within the global markets offer opportunities – but with added risks. Exhibit 1: Increasingly, investors looking for yield will need to take more risks Current Yield* Lunging for Yield 2% BONDS MLPs EQUITIES European Equities U.S. IG Credit Global REITs S&P 500 U.S. Treasuries 1% 0% 0% EM Sovereign Debt (USD) Intl Govt Bonds More Risk 10% 20% 30% 40% 50% 60% 70% 80% 10yr Maximum Drawdown Source: Bloomberg, MLWM Investment Management & Guidance, data as of February 5, 2015. Proxies: Intl Govt Bonds – BofAML Global Sovereign ex U.S., U.S. Treasuries – BofAML Treasury Master, U.S. IG Credit – BofAML U.S. Corporate, EM Sovereign Debt (USD) – BofAML USD EM Sovereign, U.S. High Yield – BofAML U.S. High Yield, European Equities – MSCI Europe, Global REITs – S&P Global REIT, MLPs – Alerian MLP While most discussions of accommodative central banks have centered on the Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BoJ), more recently Canada, Australia and Singapore have joined the ranks of countries where central bankers are cutting rates. BofA Merrill Lynch (BofAML) Global Research strategist Michael Hartnett recently wrote that over half of all government bonds in the world currently yield 1% or less. As a result, finding fixed income yields at pre-crisis levels without taking substantially more risk is nearly impossible. Merrill Lynch Wealth Management makes available products and services offered by Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S), a registered broker-dealer and member SIPC, and other subsidiaries of Bank of America Corporation (BofA Corp.). Investment products: Are Not FDIC Insured Are Not Bank Guaranteed © 2015 Bank of America Corporation. All rights reserved. May Lose Value Equities offer yield but with higher volatility In recent years, the hunt for yield has pushed income-seeking investors into previously uncharted territories (see Exhibit 2). This “portfolio effect” of assets moving into riskier investments in search of yield will likely only accelerate given the growing amount of bonds with zero or negative yields. Within U.S. equity markets, the sectors that traditionally have provided higher dividend yields are Utilities, Telecom, Tobacco and Real Estate Investment Trusts (REITs). They have benefited from this trend over the past year, far outpacing the broader market. Investors have flocked to these sectors, ignoring the fact that many of the stocks may be overvalued. However, given the lack of alternatives, they may continue to be supported by further inflows. Exhibit 2: Global equity yields are now higher than those for government bonds Global Equities - Dividend Yield Global Govt Bonds - Yield to Worst 8% 7% 6% 5% 4% 3% 2% 1% 0% 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source: Bloomberg, MLWM Investment Management & Guidance. Data as of February 6, 2015. Global Equities – MSCI ACWI, Global Government Bonds – BofAML Global Government. More recently, Master Limited Partnerships (MLPs) have provided another income alternative. Many have attractive yields and can offer added tax advantages, while providing investors with exposure to the boom in U.S. energy. However, MLPs have been hit by the decline in oil prices over the past six months. BofAML Global Research believes overall production growth should continue in 2015 even with oil prices at current levels, and many MLPs have secured revenues by locking in projects over the next two years. Investors should be selective, and evaluate investments on a case-by-case basis as a long-term downturn in commodity prices can create the risk of distribution cuts in this space. Looking across the ocean As the field of attractive income opportunities in the U.S. has narrowed, we think investors should shift their gaze overseas. In Europe, equity dividend yields are much higher on average than in the U.S., and valuation measures (like price to book value) are generally lower. The region’s economic outlook hinges on whether the actions of the ECB can overcome significant political and demographic challenges. As growth remains feeble, it is important to select CIO REPORTS • The Weekly Letter high-quality, larger cap companies that have stronger balance sheets and global exposure. Our strategists at BofAML Global Research believe the speed of portfolio rebalancing into higher-quality European equities with yield will pick up given the dearth of fixed income opportunities there. They highlight REITs, Consumer Staples, Insurance and Pharmaceuticals as having the most companies with these attractive traits. However, the negative pressure that accommodative monetary policy has on exchange rates means hedging foreign currency risk is critical. Within Emerging Markets, we feel there are opportunities for yield in EM debt. While geopolitics and deteriorating conditions in China are risks to the view, there are areas of the asset class that seem compelling based on widening rate differentials versus Treasuries and additional liquidity from accommodative central banks. However, EM debt is a volatile asset class, and investors should be cautious when adding it to portfolios. EM currencies add another layer of risk, and we therefore favor U.S. dollar-denominated bonds. Given the variability of fundamentals between countries and even sectors within those countries, we prefer active over passive strategies in this space. Expanding the investor toolkit For some investors, additional approaches can supplement income, such as covered call writing and other option overlay strategies that can also reduce the volatility of equity portfolios. While the increased market turbulence we have experienced in the past several months is generally unfavorable for investors, higher volatility increases option premiums, generating more income from such strategies. However, these approaches can limit upside potential and may not be suitable for everyone. Portfolio Strategy: The bottom line is that in a lowinflation, low-yield environment, which may be with us for a while, yield-seeking investors may have to consider alternatives to traditional fixed income portfolios that may involve more risk. The desire for higher yields should be balanced with the potential for loss of capital. We believe that investors should not abandon fixed income in their search for yield, and that they should remain within their risk tolerance. Risk-averse investors with a focus on capital preservation may need to stay with lower-yielding investments such as Treasuries and high-grade corporate bonds. 2 Markets in Review Equities Trailing Economic Releases n A strong employment report for January showed that nonfarm payrolls increased by 257,000, above expectations of 228,000. Additionally, there was a net positive revision of 147,000 to prior months. Because of a pickup in the labor force participation rate however, the U.S. unemployment rate rose to 5.7% while expectations were for no change from 5.6%. n Average hourly earnings for January rose a greater-than-expected 0.5% from December, reversing the decline from that month. This put the annual growth rate at 2.2% after positive revisions to prior months. While this is a positive sign for tightening of slack in the labor market, wage growth remains relatively low, not strong enough to significantly change the narrative of declining inflation in the U.S. n DJIA Nasdaq S&P 500 S&P 400 Mid Cap Russell 2000 MSCI World MSCI EAFE MSCI Emerging Mkts S&P 500 Sector Returns (as of last Friday’s market close) Consumer Discretionary Consumer Staples Energy Financials Healthcare Industrials Information Technology Materials Telecom Utilities -3.6% -5.0% Total Return in USD (%) WTD MTD YTD 3.9 3.9 0.2 2.4 2.4 0.3 3.1 3.1 0.0 2.9 2.9 1.8 3.5 3.5 0.1 2.6 2.6 0.7 1.7 1.7 2.2 1.8 1.8 2.4 Yield (%) 2.05 1.96 2.14 3.07 6.29 Total Return in USD (%) WTD MTD YTD -1.1 -1.1 1.1 -2.2 -2.2 2.3 -0.7 -0.7 1.1 -1.2 -1.2 1.5 1.0 1.0 1.7 Fixed Income Looking abroad, German Industrial Production for December was down 0.7% YoY, despite an upward revision to November’s decline. Factory orders rose a greater than expected 3.4% after falling 0.4% in November. While manufacturing and construction have remained weak in Germany, this is being slightly offset by stronger retail sales and a pickup in the services sector. Level 17,824.3 4,744.4 2,055.5 1,476.9 1,205.5 1,720.6 1,812.1 978.6 ML U.S. Broad Market U.S. 10-Year Treasury ML Muni Master ML U.S. Corp Master ML High Yield Commodities & Currencies 4.2% 2.2% 5.6% 4.9% 0.8% 3.0% 2.6% 4.7% 6.9% 0.0% 5.0% Prior Week 10.0% Bloomberg Commodity Gold Spot 1 WTI Crude $/Barrel 1 Level 206.7 1,233.9 51.7 Level EUR/USD USD/JPY Current 1.13 119.1 Total Return in USD (%) WTD MTD YTD 1.8 1.8 -1.6 -3.9 -3.9 4.1 7.2 7.2 -3.0 Prior Prior 2014 Week End Month End Year End 1.13 1.13 1.21 117.5 117.5 119.8 Source: Bloomberg. 1Spot Price Returns. All data as of last Friday’s close. Past performance is no guarantee of future results. Looking Ahead January retail sales in the U.S. are expected to be dragged down by the decline in gasoline prices, and consumer sentiment is expected to moderate from the 15-year high in December. Euro-area gross domestic product (GDP) is expected to increase, led by strong growth in Germany. S&P Outlook 2015 E S&P 500 Target EPS 2,200 $119.50 On Thursday, retail sales in January are expected to be down 0.6% due to a drop in spending at gasoline Real Gross Domestic Product 2015 E stations. Core control sales, which exclude spending on gasoline and autos, are expected to be up 0.4%, reversing an equal decline in December. This would be consistent with the large increase in job growth in the retail trade sector for January. Global 3.5% U.S. 3.3% Euro Area Emerging Markets 1.4% 4.2% Upcoming Economic Releases n n n BofA Merrill Lynch Global Research Key Year-End Forecasts On Friday, the University of Michigan Consumer Sentiment Index is expected to moderate slightly to 97, from 98.1 in January – a 15-year high. After a steep decline in gasoline prices over the past six months, they rose slightly in January, which should weigh on the index. However, the labor market continues to see solid improvement, as shown by last week’s employment report. U.S. Interest Rates Looking abroad, on Friday euro-area fourth-quarter GDP is expected to be up 0.3% from the prior quarter, Commodities a 0.8% annual increase. Growth in Germany is expected to push the reading for the overall region higher, while Italy should weigh on the number. While the Eurozone economy is expected to improve in 2015, growth remains weak and expectations are high for the recent expansion of the European Central Bank’s Quantitative Easing program to stimulate growth and inflation. CIO REPORTS • The Weekly Letter Fed Funds 10-Year T-Note Gold WTI Crude Oil 2015 E 0.50-0.75% 2.35% 2015 E 1,238 $57 All data as of last Friday’s close. 3 Office of the CIO Ashvin B. Chhabra Chief Investment Officer, Merrill Lynch Wealth Management Head of Investment Management & Guidance Mary Ann Bartels Christopher J. Wolfe CIO, Portfolio Solutions, U.S. Wealth Management CIO, Portfolio Solutions, PBIG & Institutional Hany Boutros Emmanuel D. “Manos” Hatzakis Niladri “Neel” Mukherjee Adon Vanwoerden John Veit Vice President Director Managing Director Asst. Vice President Vice President GWM Investment Management & Guidance (IMG) provides investment solutions, portfolio construction advice and wealth management guidance. The opinions expressed are those of IMG only and are subject to change. While some of the information included draws upon research published by BofA Merrill Lynch Global Research, this information is neither reviewed nor approved by BofA ML Research. This information and any discussion should not be construed as a personalized and individual recommendation, which should be based on your investment objectives, risk tolerance, and financial situation and needs. This information and any discussion also is not intended as a specific offer by Merrill Lynch, its affiliates, or any related entity to sell or provide, or a specific invitation for a consumer to apply for, any particular retail financial product or service. Investments and opinions are subject to change due to market conditions and the opinions and guidance may not be profitable or realized. Any information presented in connection with BofA Merrill Lynch Global Research is general in nature and is not intended to provide personal investment advice. The information does not take into account the specific investment objectives, financial situation and particular needs of any specific person who may receive it. Investors should understand that statements regarding future prospects may not be realized. No investment program is risk-free, and a systematic investing plan does not ensure a profit or protect against a loss in declining markets. Any investment plan should be subject to periodic review for changes in your individual circumstances, including changes in market conditions and your financial ability to continue purchases. Asset allocation and diversification do not assure a profit or protect against a loss during declining markets. Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions. The investments discussed have varying degrees of risk. Some of the risks involved with equities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Bonds are subject to interest rate, inflation and credit risks. Investments in high-yield bonds may be subject to greater market fluctuations and risk of loss of income and principal than securities in higher rated categories. 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. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risk related to renting properties, such as rental defaults. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Income from investing in municipal bonds is generally exempt from federal and state taxes for residents of the issuing state. While the interest income is tax exempt, any capital gains distributed are taxable to the investor. Income for some investors may be subject to the federal alternative minimum tax (AMT). © 2015 Bank of America Corporation ARQ8T7M4
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