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Market Outlook | January 2016

Global Strategic Outlook - 1st Quarter 2016

Economic outlooks for the major asset classes and regions provided by our Global Policy Council (GPC) as well as contributions from non-GPC members.

Andreas E F Utermann

Global Chief Investment Officer, Allianz Global Investors

Raymond Chan, CFA

Chief Investment Officer Equity Asia-Pacific

Neil Dwane

Global Strategist

Stefan Hofrichter, CFA

Head of Global Economics and Strategy Group

Ingo Mainert

Co-CIO Multi Asset Europe

Franck Dixmier

Global Head of Fixed Income

David Tan

Chief Investment Officer, Fixed Income Asia

Klaus Teloeken

Chief Investment Officer Systematic Equity, Frankfurt

Executive summary

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Strategy Summary

Key points

  • Returns are likely to be muted in 2016 for both global equities and global bonds.
  • We continue to prefer equities for investors with a medium- to long-term investment horizon. European equities, in particular, are likely to benefit from favourable cyclical and structural developments.
  • Dividends remain an important source of equity returns in this low growth environment.
  • Global growth is likely to be around potential, while monetary policy will remain highly expansionary globally for years.
  • Active investing across and within asset classes, rather than just a buy-and-hold strategy, will be key to superior performance in 2016.
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Thematic piece

Low yields and shrinking mountains of debt

Key points
  • Financial repression can help to shrink debt burdens.
  • In the euro zone, if the European Central Banks (ECB’s) inflation target of 2% is met and yields increase as expected, our analysis indicated a balanced primary budget is not going to be sufficient to bring the debt ratio back down to 60%.
  • However, if inflation rises to 4%, the euro zone as a whole would meet the 60% target, as specified in the Maastricht Treaty, in 2032, or in 2024 if inflation reaches 6%.
  • A similar picture is seen in the US. However, here the primary budget offers more scope for action as it impacts the debt ratio more quickly and deeply.
  • Our analysis implies that the low interest rate environment will persist for some time, and increases the attraction of real assets.
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Equities Outlook – US

Equities Outlook – US

Key points
  • Real GDP growth appears to be decelerating, and households are lifting their savings, rather than spending the windfalls afforded by lower energy prices.
  • Company earnings are slowing and the prospects for upside surprises on S&P 500 earnings in 2016 look questionable.
  • This leaves Price/Earnings multiple gains as the driver of returns. At roughly 16 times 2016 analysts’ expected earnings, the Federal Reserve will need to go slower than expected as it raises the policy rate if equity multiples are going to expand.
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Equities outlook – Europe

Equities outlook – Europe

Key points
  • Politics are likely to be a source of volatility for European equities during 2016, given the uncertainty caused by the recent Spanish election, the ongoing Greek debt problems and the upcoming Brexit referendum in the UK.
  • The European economy looks well placed to benefit from a positive spiral of less austerity, greater employment, more retail sales and increased consumption.
  • The European Central Bank looks committed to its quantitative easing programme and will take the steps needed to promote lending.
  • European companies are well placed to benefit from cross-border merger and acquisition activity.
  • The weak euro is also boosting the earnings prospects of many sectors.
  • European equities remain attractively valued on a global basis.
  • They offer tremendous relative opportunities when compared to negatively-yielding euro cash and low-yielding euro bonds.
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Equities outlook - Asia-Pacific

Equities Outlook – Asia Pacific

Key points
  • Japan was the best performing market in Asia Pacific in 2015, recording returns approaching double digits. Elsewhere, markets tended to fall.
  • After a volatile 2015, the focus in China will be on sectors expected to benefit from secular trends of innovation, industrial upgrade, environmental protection, energy conservation, social service and entertainment.
  • India is being supported by domestic buyers, but key reforms are still being delayed.
  • Japan’s adoption of the corporate governance code has prompted companies to use cash more wisely – either investing for future growth, increasing dividends or buying back shares.
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Equities outlook – style

Equities outlook – style

Key points

  • 2015 has been a solid year for style investors as most investment styles, like price momentum, earnings revisions, stable growth and high quality, all posted very solid gains.
  • Among the major investment styles, only value and small caps lagged as renewed worries over a hard landing in China pushed down these more cyclical investment styles.
  • Many investors have benefitted over the past three years from the strong performance of non-cyclical investment styles like growth, quality or momentum. These investment styles are all relying on crowded macro trades, such as a strong US dollar, weak oil prices and Emerging Market weakness.
  • The investment style value is the only real diversifier to these crowded trades from an investment style perspective, and, in the absence of any strong conviction that those macro trends will persist, we suggest investors add value for diversification.
  • In addition, the relative cheapness of value stocks, coupled with institutional underweights and investment style seasonality, suggests that investors should review an underweight in value stocks.
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Fixed income outlook – Global

Fixed income outlook – Global

Key points

  • The Federal Reserve indicated that its base scenario is that growth will continue and underlying domestic inflationary pressures will rise.
  • However, market participants appear to believe there is a far greater likelihood of an emergence of negative external factors weighing on the US economy. This is supported by evidence of a weakening of selected leading indicators and declining profitability within the corporate sector.
  • In contrast, we anticipate that the Fed is inclined to build a larger buffer between the fed funds rate and the “zero bound”, resulting in more hikes in 2016 than are currently priced in by the markets. This could potentially result in a significant increase in volatility, especially for lower rated securities or “risky assets”.
  • In the euro zone, the front end of curves should be anchored by the ECB’s policy, but medium and longer term sectors may be exposed to upward pressure stemming from the US market, as well as a potential stabilization of inflation/inflation expectations should the oil price stabilize.
  • While inflation dynamics in Japan have been disappointing, the Bank of Japan continues to expect (core) inflation to move towards the target going forward, and the hurdles for more policy easing remain low in our view.
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Fixed Income outlook – Europe

Fixed Income outlook – Europe

Key points

  • Given the divergence in monetary policy on either side of the Atlantic, euro-zone interest rates are likely to be pulled in two directions.
  • The most likely scenario for 2016 would be a slight upward trend in core euro-zone yields, leading to weak returns on fixed income markets.
  • The convergence trade between yields in the periphery – Spain, Italy and Portugal – and the core has not yet played itself out.
  • Inflation-linked bonds also look interesting, an inflation break-even rate of around 1% on 10-year core yields.
  • Investors in the credit market appear to be well remunerated for credit risk. However, active management remains key to identifying attractive entry points and avoiding negative credit events.
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Fixed Income outlook – Asia-Pacific

Fixed Income outlook – Asia-Pacific

Key points

  • The search for yield is likely to remain a theme for 2016 and will provide a constructive backdrop for Asian credits.
  • With relatively better overall fundamentals and technicals, we expect Asian credits to continue to show resilience within the emerging market universe.
  • In addition, some Asian central banks still have room to cut policy rates, which will provide selective opportunities.
  • However, the weaker macro backdrop will likely result in a more challenging operating environment for high yield corporates and we expect to see an uptick in defaults as a result.
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Multi asset outlook – Retaining a cautious bias on risk

Multi asset outlook – Retaining a cautious bias on risk

Key points

  • We maintain our cautious stance in risky assets. The US recovery remains fragile, and there is a genuine downside risk.
  • We have a preference to overweight those regions supported by non-standard monetary policy, such as the euro zone and Japan.
  • We retain a broad based underweight in developed market sovereign bonds.
  • The lack of liquidity and rising default risk from shale energy related US debt has spilt over into the investment grade sector. Our negative stance on the US high yield sector reflects our expectation of a further deterioration.
  • Structural weakness is expected to weigh on emerging countries with ageing populations, while China’s restructuring is proving problematic and productivity growth is decelerating.
  • We expect the oversupply in oil to persist during 2016.
  • It is likely that the US dollar will see one further bout of strength, given the polarisation in US monetary policy compared to the rest of the world, but thereafter a reversal is likely.
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Environmental Social Governance (ESG) outlook

Environmental Social Governance (ESG) outlook - COP21 implications

Key points

  • The agreement is legally binding and Nationally Determined Contributions (NDCs) must be reviewed and tightened every five years from 2020. This will be crucial in bringing emissions down from the 2.7°C of warming implied by current NDCs, to the 1.5°C aspirational target agreed upon.
  • Actual decarbonisation policies will not, however, be legally binding, so as to avoid a veto by the US Senate.
  • Countries will have to measure emissions and report progress against their targets every two years.
  • NDCs can be reviewed in 2018 (raising the risk of commitment creep), prior to a start date of 2020.
  • Countries that fail to hit their targets will be named and shamed, but a strict enforcement framework is still lacking.
  • USD 100 billion will be allocated to climate financing every year.

Global Strategic Outlook Q1 2016 - Full version

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Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. Investments in commodities may be affected by overall market movements, changes in interest rates, and other factors such as weather, disease, embargoes and international economic and political developments. Investments in smaller companies may be more volatile and less liquid than investments in larger companies. Investments in emerging markets may be more volatile than investments in more developed markets. Dividends are not guaranteed. Bonds are subject to interest rate risk and the credit risk of the issuer. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Convertible securities involve the added risk that securities must be converted before it is optimal. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. Forecasts are inherently limited and should not be relied upon as an indicator of future results. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission (SEC); Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; and Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan. Unless stated otherwise, all data is as of 31 December 2015.

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