UBS Wealth Management's Year Ahead 2017: The end game? and Asia in 2017: Reflating Asia

In 2017, investors will face a polarized political world. But global growth is expected to accelerate moderately, with US growth improving and China continuing to slow. 

Reflationary policies in the US are typically good news for Asia – we expect stronger nominal GDP, earnings growth and gradually higher lending rates. The extent of Donald Trump's future protectionist policies remains a key uncertainty regarding Asian trade. Across Asia, the region's chances of reform success is bolstered by strong political leadership.

So where are the opportunities? We like US and emerging market equities and US Treasury Inflation Protected Securities. Tactically, we continue to believe Asian equities will outperform Asian bonds, and we're overweight Chinese and Indian equities. New economy and technology leaders should continue to flourish, while beneficiaries of the Shenzhen-Hong Kong Stock Connect, select Asian financials and blue-chip cyclicals in consumer discretionary and material sectors are also preferred.

At www.ubs.com/end-game, investors can model scenarios for monetary, fiscal, and social policy changes and how they may affect economies, markets, and portfolios. UBS's Industry Leader Network of entrepreneur clients globally sees the political landscape as the biggest potential change for their business in 2017.

Hong Kong, 28 November 2016 – UBS Wealth Management's Chief Investment Office (CIO) predicts a polarized political world in 2017. Global GDP growth is likely to rise to 3.5% from 3.1% this year as US growth improves, despite the ongoing slowdown in China. With elections set for the Netherlands, France and Germany, investors will need to be conscious of increased post-Brexit division in Europe.

In the US, CIO expects the US Federal Reserve to hike rates once in December and twice in 2017, but new fiscal stimulus should support growth, and inflation is likely to rise more than rates. In the Eurozone, the European Central Bank will probably start to taper quantitative easing. China will likely continue to manage its slowdown and let the USDCNY exchange rate depreciate to 7.0 in 12 months.

Mark Haefele, Global Chief Investment Officer at UBS Wealth Management, says: "We believe that central banks in the US and Europe will continue to err on the side of loose monetary policy. This means equities can remain supported, most notably in the US and emerging markets, and that investments with a decent yield will remain sought after. Investors will also need to consider means of hedging portfolios against rising inflation."

The lessons of 2016

1. Don't confuse a base case with a done deal. The past year has been ignominious for base case forecasts. Donald Trump won the US election. The UK voted to leave the EU. And central banks were forced to ease policy more than previously thought necessary.
2. Don't panic. 2016 rewarded investors who remained calm amid uncertainty. The MSCI All-Country World Index dropped 13% early in the year on concerns over China, but bounced back by the end of March. After the Brexit vote, markets regained prior highs within three weeks.
3. Don't underestimate central banks. Central bank policy surprises this year meant that even some negative-yielding assets provided positive returns.

Top 10 ideas for 2017

1. US equities. US earnings should grow 8% in 2017, supported by stabilizing oil prices, accommodative monetary policy and potential fiscal stimulus from the Trump administration.
2. Emerging market (EM) equities. A softer US dollar, low developed market (DM) interest rates and stabilizing GDP growth and commodity prices should continue to help EM stocks next year.
3. EM FX basket. Low DM rates help make high-yielding EM FX – real, rupee, ruble, & rand – attractive versus growth-sensitive DM peers – Australian & Canadian dollars & Swedish krone.
4. Asia Pacific real estate investment trusts should also benefit from low DM rates. Yields relative to government bonds are attractive compared with global averages.
5. Dividends and buybacks. With yields ultra-low in the Eurozone, Japan, and Switzerland, companies offering reliable incomes there have become even more appealing.
6. US senior loans. Senior loan yields offer a 4% pickup over short-maturity investment-grade corporate bonds, which is attractive even if default rates rise to long-term averages.
7. US Treasury Inflation-Protected Securities (TIPs). CIO expects TIPs to benefit from higher wage growth, stabilizing oil prices, potential fiscal stimulus and a weaker US dollar.
8. Palladium and platinum. A pickup in industrial activity, political uncertainty and falling real interest rates should support both precious metals in 2017.
9. Alternatives. Traditional asset class returns are likely to be moderate in 2017. The uncorrelated exposure offered by hedge funds, private markets, and short-term investment opportunities will be more valuable than ever.
10. Sell high-grade bonds. Yields are negligible and risks are rising. Investors could consider replicating some of the asset class's insurance features with other approaches, including systematic hedging and allocation strategies.

Recommended long-term investment themes for 2017 and beyond

1. Emerging market healthcare catch-up. In developing nations, spending on healthcare is far outpacing GDP growth, creating opportunities for companies and impact investors.
2. Energy efficiency. Governments are increasing incentives to cut down on carbon emissions and lower energy consumption. Such standards now cover 30% of the fuel used worldwide.
3. The education gap. Companies are helping to meet demand for higher education and training as governments struggle to keep up.

As investors look forward to 2017, CIO's End Game offers the opportunity to play policymaker and see how solutions to the world's economic issues can affect economies, markets, and portfolios. (Find out more at www.ubs.com/end-game.) A recent survey of UBS's Industry Leader Network of entrepreneur clients globally underscored the importance of policy in investment planning: 25% named the political landscape as the biggest potential change for their business in 2017, compared with 19% who cited technology upgrades, 12% who cited a different shift, and 44% who saw no change.

Asia in 2017: Reflating Asia

Asia is ending 2016 on a strong note and the region is likely to enter a reflationary environment in 2017. While we anticipate China economic growth to moderate to 6.3% in 2017 from 6.7% in 2016, stronger producer and consumer prices, improving terms of trade and better G3 demand raises the likelihood that the recent pickup in corporate earnings can be sustained. A key risk remains the potential for punitive trade measures by the new Trump administration which could weigh on global and regional trade.

We are positive on risk appetite going into 2017 on the back of improving fundamentals globally and regionally. This bodes well for Asia ex-Japan equities where we see an improvement in the earnings outlook while valuations remain attractive – trading at a 20% price-to-earnings discount to their developed market peers. We remain cautious on Asian investment grade credit relative to equities in view of tight valuations and deteriorating fundamentals.

Min Lan Tan, Head CIO APAC Investment Office at UBS Wealth Management, says "Investing in Asia in 2016 was not for the faint-hearted. Investors need to recognize that sound investing mustn't be tied to any one political or event outcome and that broadly diversified strategic asset allocation will pay off over the longer term. But things are looking up for 2017. We stay positive on Asian risk assets though we recognize that US policy remains in a state of flux and a key risk factor we are watching."

Top questions in Asia for 2017

1. What does a Trump presidency mean for Asia? Policy uncertainty will remain elevated. US reflation is typically good news for Asia. Maybe on the flip side, a substantially stronger US dollar, faster-than-expected Fed policy normalization or a lurch into trade protectionism will be a major drag on Asian risk assets.
2. Can China strike a balance between reforms and growth? China remains determined to push for a rebalancing of its economy toward consumption and services and away from heavy industries. However, as 2017 is a critical year for political transition, the focus will likely be on maintaining stability and reasonable growth, while reforms will be gradual.
3. Could politics derail structural reform in Asia? On the surface, Asia appears to be a political hotspot. But we would argue otherwise. Slowly but surely, the economic transformation in Asia is likely to continue. Deep structural reforms, led by strong governments, bode well for the next phase of economic growth in Asia.
4. What is the optimal yield strategy in Asia amid higher global interest rates? The search for yields among Asian investors is likely to remain. For dividend investing stocks, the strategy should be to focus on yield with cyclical growth. And in fixed income, we like to focus on selected Chinese BBB government-related issuers, and fundamentally stronger BB high yield issuers; avoid duration and credit risks.
5. Is Asian real estate still in a bubble? This year’s UBS Global Real Estate Bubble Index found more cities at bubble risk compared to last year, with Vancouver topping the index. Among major Asian financial centers, Hong Kong remains at bubble risk, while Tokyo is still overvalued. Singapore moved out of overvalued territory to fair-value this year. We see no let-up in macro-prudential policies going forward among key Asian cities.

Top ideas in Asia for 2017

Tactical six-month horizon

1. Overweight on Asia ex-Japan equities over bonds. Within equities, we are overweight on China and India versus an underweight on Taiwan and the Philippines.
2. "Yield with growth" stocks amid higher rates environment. We like high yield stocks with positive earnings momentum typically found in Asian cyclical sectors, including consumer discretionary, materials and IT. Selected REITs from Australia, Singapore and Hong Kong with growth potential, conservative debt-hedging profiles and low gearing levels are likely to be well-supported in a gradually higher yield environment.
3. "Growth at reasonable price" stocks. These companies ride on Asia's innovative growth potential. This includes India, and exposure to new economy and technology leaders.
4. Deep value cyclicals. Strong correlation between Asian equities and a rising US ISM cycle bodes well for cyclicals in 2017. We like particularly those with imminent earnings catalysts like Asian financials, and blue-chips in consumer discretionary and materials.
5. Beneficiaries of the Shenzhen-Hong Kong Stock Connect. Select mid/small-cap Hong Kong-listed stocks present good value versus Shenzhen growth stocks.
   
   Beyond 2017
   
   
6. Private markets & alternatives. In a low yielding world, private markets capture returns beyond traditional public markets and offer a return premium to compensate investors for forfeiting liquidity. We forecast average yearly returns of 8.5-12.0% over the coming decade.
7. Beneficiaries of the evolution of Asian millennials. Asia’s 1.3 billion millennials are now generating USD 4.3 trillion in annual income. Get exposure to growth companies in technology, consumer discretionary and services, and stay selective in old economy.
8. Riding the fourth industrial revolution. Industry leaders in the automation and robotics industries, and those exploiting connectivity with new business models offer opportunities.

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Fiona Chan
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