Monthly Market Updates

"Goldilocks" economic backdrop continues

We remain overweight global equities and local currency emerging market (EM) government bonds. We also retain our underweight stance on developed market (DM) government bonds and investment grade (IG) corporate bonds

Global equities rose in September amid easing geopolitical concerns, whilst higher oil prices and DM government bond yields boosted energy and financial stock

The Federal Open Market Committee (FOMC) confirmed that it would begin unwinding its balance sheet in October and signalled another rate hike before year-end

The strength of the eurozone economy continues to be acknowledged by the European Central Bank (ECB), although there is little progress in reaching its inflation target

China's moderate growth slowdown partly reflects efforts to reduce excess capacity, leverage and housing inventory, as well as contain financial risks

Strong and synchronised global growth environment persists

The "Goldilocks" mix of good global growth but subdued inflation continues. In particular, the persistence of low wage growth in many advanced economies is puzzling when compared to the tightness of labour markets. Even so, it still seems likely that cyclical inflation pressures will build over time, especially in the US. Therefore, at current pricing, DM government bonds look vulnerable, especially as global central banks normalise monetary policy, albeit very gradually. Being underweight in this asset class continues to make sense to us.

In a Goldilocks economy, the risk for investors comes from over-paying for riskier assets that benefit from continued good growth. In many parts of fixed income, risk pricing looks quite complacent, with the prospective risk-adjusted returns for US and European IG credits consistent with our underweight positioning. We remain neutral in the high-yield credit universe, with a preference for higher-rated bonds. By far the best reward for us backing "Goldilocks" is through global equities, with relative valuations and fundamentals favouring Japan. We also continue to emphasise EM equities and local-currency debt.

This commentary has been produced by HSBC Global Asset Management to provide a high level overview of the recent economic and financial market environment, and is for information purposes only. The views expressed were held at the time of preparation; are subject to change without notice and may not reflect the views expressed in other HSBC Group communications or strategies. This marketing communication does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. The content has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. You should be aware that the value of any investment can go down as well as up and investors may not get back the amount originally invested. Furthermore, any investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in established markets. Any performance information shown refers to the past and should not be seen as an indication of future returns. You should always consider seeking professional advice when thinking about undertaking any form of investment.

Long term asset class positioning (>12 months)

Basis of Views and Definitions of 'Long term Asset class positioning' table

Views are based on regional HSBC Global Asset Management Asset Allocation meetings held throughout September 2017, HSBC Global Asset Management's long-term expected return forecasts which were generated as at 31 August 2017, our portfolio optimisation process and actual portfolio positions.

Icons:

View on this asset class has been upgraded.

No change.

View on this asset class has been downgraded.

Underweight, overweight and neutral classifications are the high-level asset allocations tilts applied in diversified, typically multi-asset portfolios, which reflect a combination of our long-term valuation signals, our shorter-term cyclical views and actual positioning in portfolios. The views are expressed with reference to global portfolios. However, individual portfolio positions may vary according to mandate, benchmark, risk profile and the availability and riskiness of individual asset classes in different regions.

"Overweight" implies that, within the context of a well-diversified typically multi-asset portfolio, and relative to relevant internal or external benchmarks, HSBC Global Asset Management has (or would have) a positive tilt towards the asset class.

"Underweight" implies that, within the context of a well-diversified typically multi-asset portfolio, and relative to relevant internal or external benchmarks, HSBC Global Asset Management has (or would) have a negative tilt towards the asset class.

"Neutral" implies that, within the context of a well-diversified typically multi-asset portfolio, and relative to relevant internal or external benchmarks HSBC Global Asset Management has (or would have) neither a particularly negative or positive tilt towards the asset class.

For global investment-grade corporate bonds, the underweight, overweight and neutral categories for the asset class at the aggregate level are also based on high-level asset allocation considerations applied in diversified, typically multi-asset portfolios. However, USD investment-grade corporate bonds and EUR and GBP investment-grade corporate bonds are determined relative to the global investment-grade corporate bond universe.

For Asia ex Japan equities, the underweight, overweight and neutral categories for the region at the aggregate level are also based on high-level asset allocation considerations applied in diversified, typically multi-asset portfolios. However, individual country views are determined relative to the Asia ex Japan equities universe as of 29 September 2017.

Similarly, for EM government bonds, the underweight, overweight and neutral categories for the asset class at the aggregate level are also based on high-level asset allocation considerations applied in diversified, typically multi-asset portfolios. However, EM Asian Fixed income views are determined relative to the EM government bonds (hard currency) universe as of 29 September 2017.

Equities

Government bonds

Corporate bonds

Others

Asian assets

"Goldilocks" economic backdrop continues

Markets: global equities gained in September; DM government bonds fell; crude oil prices rose as US refineries reopened

Global equities rose in September amid easing geopolitical concerns, whilst higher oil prices and developed market government bond yields boosted energy and financial stocks. The MSCI AC World index closed 1.9% higher over the month.

The outperformance of European stocks was supported by a weaker euro against the US dollar, with the latter gaining on the back of renewed optimism over US tax reform. Elsewhere, EM stocks performed less well, with the MSCI EM up 0.3%.

Meanwhile DM government bonds and gold sold off as the Fed maintained its expectation of further rate hikes in the coming quarters. UK gilts saw a particularly large decline as the Bank of England struck a hawkish tone at its September meeting.

Finally, crude oil prices rose over the month as US refineries reopened, and as OPEC and its allies signalled another extension of their output-cut deal (all data above as of close of 29 September in local currency, price return, month-to-date terms).

US: Trump unveils tax plan; Fed signals another rate hike in December

At its September meeting, the Fed left interest rates unchanged and confirmed that it would begin unwinding its balance sheet in October. The new "dot plot" still points to one more rate hike by year-end, whilst the terminal rate was reduced to 2.75%.

US President Trump unveiled a "framework" for tax reform, proposing to cut the official corporate tax rate to 20% from 35%. The plan would also simplify the tax code, reducing the number of individual income tax brackets to three from seven.

Disappointingly for the Fed, core personal consumption expenditure (PCE) unexpectedly fell to 1.3% year-on-year (yoy) in August (1.4% previously). Nevertheless, Fed chair Yellen warned in a speech against tightening policy "too gradually".

Other hard data for August (non-farm payrolls, retail sales and home sales) were softer than expected while Q2 GDP was revised up. Meanwhile, sentiment data for September, such as ISM and consumer sentiment surveys, remain at healthy levels.

Europe: ECB sets the stage for October announcement on next step for QE policy; Bank of England strikes hawkish tone

The ECB continues to acknowledge the strength of the eurozone economy. At its September meeting, it upgraded this year's growth forecast to 2.2%. Importantly, the European Commission's measure of consumer confidence is at a multi-year high.

However, the ECB is making little progress in reaching its inflation target. Core inflation has failed to breach the 1.2% level since early 2013. Most significantly, the continuing strength of the euro presents a significant headwind to inflationary pressures.

Nevertheless, the ECB remains likely to taper its QE programme in 2018. This decision will be supported by (i) robust economic growth; (ii) scarcity in the government bond market and; (iii) Draghi's conviction that inflation will eventually converge to target.

The "bulk" of decision on QE is expected at the October meeting. However, given the inflation backdrop, the ECB is likely to act very cautiously, for example by not pre-announcing the end-date of the programme, or the profile of tapering down to zero.

In the UK, the Bank of England struck a hawkish tone at its September meeting, with the minutes stating "a majority" of members believed that "some withdrawal of monetary stimulus is likely to be appropriate over the coming months".

Asia: India mulls policy levers to help boost growth; Bank of Japan is likely to maintain ultra-loose policy stance

China's moderate growth slowdown partly reflects efforts to reduce excess capacity, leverage and housing inventory, as well as to contain financial risks. These efforts should help improve the quality and sustainability of the country's economic development.

India's economic activity has been weakened by the transient supply shock from demonetisation and implementation of the Goods and Services Tax (GST). Consequently, the Indian government is mulling policy levers to help boost economic growth.

In Japan, given the lack of progress in terms of boosting inflation, and the uncertainty surrounding the sustainability of the recent pickup in GDP growth, the Bank of Japan is likely to maintain its ultra-loose monetary policy stance.

Other EM: growth continues but pockets of weakness linger

Brazil's economy grew for the second straight quarter in Q2, although the pace (+0.2% qoq) was lower than in Q1. Nevertheless, upbeat data for July (industrial production and retail sales) suggest economic activity has had a solid start to Q3.

Russia's central bank cut rates by 50bps to 8.5% in September as inflation fell to a post-Soviet low of 3.3% yoy in August. A stabilising economy and prudent fiscal policy prompted a major rating agency to upgrade the country outlook to "positive".

Turkish assets (equities, bonds, lira) fell sharply in August on renewed political instability at the border. Meanwhile, the central bank left rates unchanged, stating that policy needs to be kept tight until the inflation outlook improves.

The South African Reserve Bank (SARB) left the repurchase rate unchanged at 6.75% as it assessed that the "balance of risks has deteriorated". The decision was a close call, with three out of six voting for a reduction by 25 basis points.

Global Strategic Asset Allocations

Global Strategic Asset Allocations (as at 31 August 2017)

Global equities rose for a seventh straight month in May, supported by continuing robust economic data releases and generally upbeat earnings reports. The implied equity premia on offer continues to warrant a neutral positioning for global equities, in our view, and we maintain our relative preference for European and Japanese equities which offer a better carry opportunity.

In the credit space, spreads have compressed substantially over the past 12 months amid the risk of tighter than expected US monetary policy. However, a mix of good growth and low inflation should sustain low default and downgrade rates.

Finally 10-year US Treasuries rose (yields fell) amid doubts about the Trump administration's ability to implement pro-growth policies, with our measure of the implied term premium on 10-year Treasuries having become more negative. Overall, valuations in Bunds, Gilts and Japanese government bonds remain extreme and we continue to be structurally underweight in DM government bonds.

Within the allocations of our global multi-asset model portfolios, the underweight in DM government bonds is only significantly visible within the model portfolio for Risk Profile 2, where the lower volatility target prevents too high an allocation to global equities.

Risk Profile 2 - Global Multi-Asset Model Portfolio

Risk Profile 3 - Global Multi-Asset Model Portfolio

Risk Profile 4 - Global Multi-Asset Model Portfolio

The above 'Current Portfolio' is based on regional HSBC Global Asset Management Asset Allocation meetings held throughout September 2017. The 'SAA Portfolio' is the result of HSBC Global Asset Management's portfolio optimisation process. These model portfolios are expressed in USD.

Key Terms

Strategic Asset Allocation Portfolio: Within AMG's multi-asset investment process, the 'SAA' refers to the 'Strategic Asset Allocations', which are generated through optimising long-term estimates of both expected return and covariance. These form the portfolios' reference allocation for each risk level.

Current Portfolio: The 'Current Portfolio' represents the portfolio's current target exposure. This reflects any active positions currently held in the portfolio (i.e. 'over/under weight' positions relative to the SAA).

Portfolio Tilt: The difference between the 'Current Portfolio' and 'SAA Portfolio' allocations. Positive values reflect overweight exposure i.e. where a positive outlook on a particular asset class is currently held. Conversely, negative values reflect underweight positions i.e. where the team currently maintain a more cautious outlook.

Portfolio Tilt Change: The change in Portfolio Tilts from the previous Multi-Asset Strategy meeting.

Risk Profiles

Each of the three portfolios outlined above match different customer risk profiles, as defined by their target long-term volatility bands:

Risk Profile 2 has a long-term target volatility of 5-8%. This portfolio typically has a substantial allocation to fixed income investments and some allocations to growth-oriented investments such as equities.

Risk Profile 3 has a long-term target volatility of 8-11%. This portfolio typically has allocations to both fixed income investments and growth-oriented investments such as equities.

Risk Profile 4 has a long-term target volatility of 11-14%. This portfolio typically has a high allocation to growth-oriented investments with higher risk levels.

Note:

The 'Strategic Asset Allocations' detailed above may sometimes appear to differ from the 'Long-term Asset Class positioning' table on pages 2 and 3 primarily due to portfolio constraints which include achieving portfolio volatility within the target long-term volatility bands and minimum and maximum asset class weights.

The above 'Current Portfolio' allocations are based on HSBC Global Asset Management's current outlook and portfolio positioning. These positions are revisited on a monthly basis. The allocations are for illustrative purposes and are designed to be broadly representative of our current multi-asset positioning. Actual portfolio positioning may differ by product or client mandate due to manager discretion, local requirements, portfolio constraints and other additional factors.

The 'Current Portfolio' allocations do not consider the investment objectives, risk tolerance or financial circumstances of any particular client. They should not be relied upon as investment advice, research, or a recommendation by HSBC Global Asset Management. Asset allocation and diversification may not protect against market risk, loss of principal or volatility of returns.

The reference index for 'Equities' is the MSCI All Country World Index (ACWI), which includes both developed and emerging market equities. The reference index for 'Real Estate' is the FTSE EPRA/NAREIT Developed Index, which is designed to track the performance of listed real estate companies and Real Estate Investment Trusts (REITs).

Market Data

Sources: Bloomberg, HSBC Global Asset Management. Data as at close of business 29 September 2017.

Past performance is not an indication of future returns.

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