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10 Hot Investment Themes for 2018: Deutsche Bank

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It’s more than halfway through the first month of the new year; how’s 2018 shaping up?

Larry Adam, Americas CIO and global chief investment strategist for Deutsche Bank Wealth Management, outlined 10 thinks to look out for in 2018.

During a recent press briefing in New York, Adam shared his views and outlook on the markets with Deutsche’s 10 Themes for 2018:

Forewarned is forearmed

1. Forewarned is forearmed

Deutsche addresses and assesses several market risks and geopolitical concerns that may be ahead.

In the U.S., failure to pass pro-growth reforms could challenge equities. Meanwhile, North Korea remains “the most sensitive geopolitical risk out there.”

Deutsche thinks the Italian elections in March have the potential to spark volatility in global markets. The midterm elections in the U.S. could also pose a risk.

Latin America will see elections in Mexico and Argentina, and the front runner right now in Mexico opposes President Donald Trump.

“The bottom line is that while these may create some bumps, we would view any type of volatility as a buying opportunity,” Adam said.

Growth overshadows geopolitics. (Photo: AP)

2. Growth overshadows geopolitics

According to Deutsche, 2018 is expected to see a record low number of countries in recession. According to Adam, only six countries are expected to be in recession this year.

“And they’re countries such as Venezuela, Sudan, Swaziland, Puerto Rico,” Adam said. “The point is that they’re very small. In fact … 99.6% of the global economy is expected to be in global expansion in the upcoming year.”

In most parts of the globe, positive economic data continues to unfold.

Central banks in transition (Photo: AP)

3. Central banks in transition

The Federal Reserve is changing. Jerome Powell is replacing Federal Reserve Chair Janet Yellen when her term ends in February. Vice-chair William Dudley, who will retire this year, will also need to be replaced. And there are two more open vacant positions at the Fed.

“The point is, incrementally, the Fed could becoming more hawkish,” Adam said. “The question is: Can they work together in a coordinated fashion to keep the economy moving as quickly as the previous team?”

That same scenario is going to take place over at the European Central Bank.

Over the course of the next two years, five of the six main members of the executive boards of the ECB are going to be replaced (Sabine Lautenschlager, Yves Mersch, Peter Praet, Mario Draghi, Benoit Coeuré and Vitor Constancio).

Draghi’s term is up in 2019. According to Adam, we may see who will become the next leader of the ECB by the second half of this year.

“That could potentially lead to more volatility if a more hawkish leader takes the helm of the ECB,” Adam said.

“Flashlight” fixed income

4. “Flashlight” fixed income

According to Deutsche, there are few opportunities in fixed income.

“Opportunities are a lot smaller than what they’ve been in the past,” Adam said.

Spread levels in all major fixed income sectors are well below average and near historical lows. Relative to all other credit sectors, emerging market bonds have the largest scope for further spread compression.

Deutsche forecasts emerging market sovereign bonds to have the highest total return in the fixed income space in 2018.

Meanwhile, Deutsche’s forecast for the 10-year U.S. Treasury is around 2.6% to 2.7% by the end of this year.

According to Deutsche, yields in the U.S. should move higher as it expects stronger economic growth, tax reform and a tightening Fed to be supportive of rates moving higher.

Deutsche thinks that — while the ECB has announced the continuation of their bond purchasing program — yields should move higher there too, as the pace of purchases slowed beginning in January.

Still some oxygen for equities

5. Still some oxygen for equities

The MSCI AC World hit 84 record highs in 2017, which is by far the largest number on record. Meanwhile, the S&P 500 rallied for the ninth consecutive year.

Yet Deutsche thinks there may still be some oxygen for equities.

However, Deutsche’s forecast for the equity market this year is “a lot more boring than what you’ve seen in the past,” according to Adam.

“If you look at our official forecast for the S&P 500 — at 2750 — we’re not that far from where that is right now,” Adam said.

Deutsche thinks that earnings growth will continue to be the driver of the upward ascent in equity prices, but that will be tamped down by P/E multiple contractions, leading to more muted performance in the equity space.

They key to finding value this year will be selectivity, according to Deutsche.

“This is a year when you need to be more tactical, when selectivity will be critical,” Adam said. “I think this is a year where active money managers will outperform the passive indices.”

The “new” EM Asia equity market (Photo: AP)

6. The “new” EM Asia equity market

Emerging markets are likely to outperform — particularly the Asian emerging markets, according to Deutsche.

“Now some people will disagree,” Adam explained. “They’ll say that the Asian emerging markets did so well last year that you’re bound to see a reversal.”

The MSCI Asia ex Japan outperformed the MSCI AC World by 17% in 2017. However, the MSCI Asia ex Japan has underperformed the MSCI AC World since 2008, indicating the index still has room to run.

According to Adam, the growth premium that everyone associates with emerging markets is back.

“You’re seeing emerging markets growing faster than developed markets and you see that trend moving slowly upwards,” he said.

Explore hybrids and investment alternatives

7. Explore hybrids and investment alternatives

Deutsche highlights four hybrid and investment alternatives in particular.

The first is floating-rate notes. Deutsche likes floating rate notes because they’re less sensitive to move higher interest rates as they have lower duration risk. And, the periodic reset of its variable rate actually benefits from a short-term rise in interest rates.

Convertible bonds, which have a coupon associated with them, can be important in a low-return environment. Convertible bonds are debt instruments that have the option to be converted into a predetermined number of equity shares. In general, the right to convert into equities results in lower coupon payments than comparable nonconvertible bonds.

Hedge funds tend to benefit from increased volatility, the need to be selective, and the desire to reduce some downside risk exposure. Styles that reduce the beta of a portfolio (i.e. market neutral) and/or provide additional diversification (i.e. commodity trading advisors) are preferred, according to Deutsche.

Real estate is an asset class that provides the potential for cash flow. However, given the recent rally in real estate prices, selectivity remains critical, according to Deutsche. One particular sector that remains attractive is the industrial sector, which continues to benefit from the renaissance of industrial parks as fulfillment centers for e-commerce.

Dynamic dollar drivers

8. Dynamic dollar drivers

The dollar and currencies are by far the hardest asset class to predict in the short term, according to Adam.

Deutsche thinks specific drivers in 2018 could include U.S. earnings repatriation benefiting the U.S. dollar and fears around the Italian election impacting the euro.

With markets looking for clues from a wide range of political, policy and economic indicators, currencies could be more vulnerable to volatility in 2018.

According to Deutsche, U.S. policy remains a major dollar driver. For example, tax holiday on offshore earnings could drive FDIs as companies are required to pay taxes on all offshore earnings, which should drive flows back to the U.S.

Oil déjà vu

9. Oil déjà vu

Deutsche doesn’t expect a further surge in oil prices.

“We call it déjà vu because once again we think this year it’s going to be range-bound, roughly between $50 and $62 per barrel,” Adam said. “We think the fundamental value of oil is going to be around $55 a barrel.”

According to Deutsche, oil prices are currently well above estimated break-even levels for sources of U.S. shale and non-shale output, which range from $46 $55 a barrel.

Short-term spikes in prices are possible, but Deutsche continues to believe that U.S. production will likely accelerate in response to higher prices, ultimately keeping a lid on them.

Tomorrow’s themes today

10. Tomorrow’s themes today

Deutsche continues to look at long-term investments that benefit from evolving secular trends.

Many of these long-term secular themes were introduced last year, including infrastructure, cybersecurity, global aging and millennials,

This year Deutsche add two additional themes: smart mobility and artificial intelligence (AI).

Smart mobility is a new tech theme focused on the multiple implications of self-driving cars and other technological advances in transport. AI has an impact on multiple sectors, including smart mobility.

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