Investment Outlook

Q4 2018 CIO Roundtable: Building Defenses to Withstand Volatility


For quite some time, we’ve observed the world’s central banks pursuing divergent fiscal policies as local economies recovered from the 2008 financial crisis at their own pace. However, even with these differences, global economic growth was steady (though slow) and synchronized. In that environment, investing was less challenging as rising growth rates lifted all markets. As the global economic growth cycle matures, we expect more divergence between major economies worldwide. In 2018, we’re experiencing economic divergence among developed markets as growth in Europe moderates while the U.S. enjoys something of a second wind fueled by unprecedented corporate tax cuts.

Signs of economic divergence reinforce our view that it’s time for investors to expect—and prepare for—periodic bouts of volatility, which is normal.

Some of those signals are coming from emerging markets. EM were already experiencing a challenging year when a series of damaging political and policy decisions sent Turkey’s currency and financial markets into a tailspin. Meanwhile, Argentina struggled with mounting debt, causing the peso to plunge. Contagion fears fueled sell-offs in other countries and dampened investor enthusiasm for riskier assets.

Global trade tension is another potential source of volatility. So far, trade disputes have affected soybean farmers along with steel, aluminum, automotive, and electronics companies. There’s a lot of bluster from all the parties, so it’s hard to differentiate between negotiating tactics and trade policy. We can’t predict whether there will be a prolonged trade war or the outcome, but it’s hard to imagine a clear winner.

None of this is to suggest that investors should be fearful. To us, economic divergence and volatility are simply reminders of the importance of applying research and judgment to investment decisions. Active selecting of asset classes, countries, and industries as well as individual securities based on research and analysis will be more valuable as the growth cycle matures. In this environment, we believe market performance will be less synchronized across regions, countries, and industrial sectors.

Now, with the slow withdrawal of monetary and fiscal stimulus and rising interest rates and trade tensions, investors and markets will be more selective, placing greater emphasis on the fundamental attributes of individual securities. This is the time to actively identify compelling forward-looking opportunities and build defenses to withstand a changing market environment and return of normal volatility.

Thank you for investing with us.

G. David MacEwen

G. David MacEwen

Co-Chief Investment Officer

American Century Investments

CIO, Global Fixed Income


Victor Zhang

Victor Zhang

Co-Chief Investment Officer

American Century Investments

  • Global Macroeconomic Outlook
  • Global Equity
  • Global Fixed Income
  • Multi-Asset Strategies
  • Key Takeaways
First Topic

Global Economy: U.S. growth outpaces other markets

Reforms Stimulate U.S. Economy

We expect the U.S. economy to continue expanding at a healthy, sustainable pace, largely due to the still-unfolding effects of tax and regulatory reform. We believe this fiscal stimulus will support capital spending and employment and should keep annualized gross domestic product (GDP) at the high end of our expected range of 2% to 3%.

Global Slowdown Fears Are Fading

With growth modestly improving in Europe and Japan, fears of a significant slowdown outside the U.S. have subsided. However, European and Japanese growth rates continue to lag U.S. GDP, and central bank stimulus continues to drive economic gains in those regions.

Emerging Markets Outpace Developed Markets

We expect global GDP to advance approximately 4% in 2018, with EM expanding faster than developed markets. Like past years, accommodative monetary policy will primarily drive global growth, as significant fiscal expansion (outside the U.S.) remains unlikely. Trade tensions and geopolitical issues remain potential headwinds.

Second Topic

Inflation: Global inflation edges higher

Energy Prices Fuel Gain

Global inflation recently hit a four-year high, topping 3%, largely due to soaring energy prices. Excluding the volatile energy and food segments, though, worldwide price gains have been more subdued, which is keeping the core rate of global inflation near a more-modest 2%.

Growth Lifts U.S. Inflation

We believe the strong U.S. economy, tight labor markets, robust corporate profits and spending, and continued wage growth will continue to push U.S. headline and core inflation higher. Additionally, it appears likely that core inflation, as measured by personal consumption expenditures or PCE, is poised to top the Federal Reserve’s (Fed’s) 2% target.

Eurozone Price Gains Hit Five-Year High

Headline inflation in Europe has steadily increased, and in the eurozone, it recently hit a five-year high. But core inflation, which is key to central bank policy, remains below target levels. Meanwhile, Japan continues to struggle with stubbornly low inflation, which prompted the Bank of Japan to abandon its 2% inflation target earlier this year.

Third Topic

Monetary Policy: Policymakers pursue different strategies

Fed Stays the Course

With its ongoing rate-hike and balance-sheet-reduction campaigns, the Fed continues to separate itself from central banks in Europe and Japan. We expect the Fed to raise rates one more time in 2018, lifting the federal funds rate target to a range of 2.25% to 2.50% by year end. We also expect additional rate hikes in 2019.

Bond-Buying Is Poised to End in Europe

The European Central Bank (ECB) extended its bond-buying program’s expiration date from September to December. The ECB left interest rates unchanged at 0%, but we expect the central bank to begin normalization in mid-2019. Meanwhile, Japan’s central bank is maintaining its aggressive stimulus programs.

Rates Rise in the U.K.

Amid firming economic growth and an improving labor market, the Bank of England raised its benchmark lending rate from 0.50% to 0.75% in August. However, policymakers noted that future rate hikes will be gradual and limited.

Fourth Topic

Interest Rates: Rates to slowly trend higher

Treasury Yields Remain Rangebound

After spiking in May, U.S. Treasury yields have declined and remained in a narrow range. Nevertheless, absent trade and geopolitical conflict, we believe yields will gradually increase as more central banks begin normalization. We expect the 10-year Treasury yield to slowly rise and trade in a range of 2.95% to 3.25%.

Central Bank Policy Keeps Non-U.S. Rates Lower

Modest global growth, muted inflation, and accommodative central banks are keeping interest rates relatively low in Europe and Japan. Rates should remain slightly higher in the U.K., largely due to inflationary pressures and recent central bank tightening.

Rate Disparity Is Wide

Fed tightening and growing U.S. Treasury issuance are keeping U.S. rates elevated versus rates in other developed markets. We are looking to markets where rates are more likely to fall or remain stable, including Canada and select emerging markets, to help diversify duration risk in the U.S. and Europe.

Victor Zhang, Co-CIO, American Century Investments: After a long stretch of highly correlated, albeit slow expansion, growth among global markets is no longer synchronized. How do you see this affecting the market, Keith?

Keith Creveling, CIO, Global Growth Equity: The divergence among developed markets growth has increased over the last few quarters, with the U.S. leading the pack. While the economic recovery has matured, unprecedented corporate tax cuts have boosted U.S. growth over the past two quarters. At the same time, European growth has moderated, and Japan continues to see pockets of improvement aided by the government’s ongoing accommodative policies. Emerging markets, which had outpaced developed markets, have been pressured by political and macroeconomic conditions, and this has furthered the divergence among global markets’ growth rates. All this will likely increase volatility. In our view, economic divergence will continue as the global recovery matures, trade conflicts escalate, and interest rates inch higher. This creates opportunities for active managers.

Keith Creveling

Keith Creveling, CFA

Co-Chief Investment Officer

Global Growth Equity

In our view, economic divergence will continue as the global recovery matures, trade conflicts escalate, and interest rates inch higher.

- Keith Creveling

Global stock markets initially took the trade disputes between the U.S. and China in stride, but the recent escalation in retaliatory tariffs has raised concerns among investors. Where are you seeing the biggest impacts?

Creveling: The trade disputes have affected companies in the steel, aluminum, automotive, and electronics industries, along with soybean farmers. It remains difficult to separate negotiating stances from actual policy intent, and it’s nearly impossible to predict the outcome of a prolonged trade war. As we formulate this quarter’s outlook, U.S. and Chinese officials are discussing plans for additional trade talks later this year. In the shorter term, we are evaluating the impact of imposed tariffs on individual companies’ earnings, as well as the companies’ ability to pass on higher costs through price increases.

We are also noting China’s evolving policy moves to support domestic demand as a hedge against the potential impact of further trade war escalation. An example is our investment in construction names, including Chinese cement companies. Such companies should be direct beneficiaries of increased infrastructure spending resulting from increased bank lending and accelerated fiscal spending.

Kevin, what's your take on tariffs?

Kevin Toney, CIO, Global Value Equity: We believe the impact will vary from company to company and could be transitory in many cases. Some companies will be hurt, some will benefit, and others will experience few or no consequences. Some will adjust their supply chains by finding different sources for inputs. Others may move production outside the U.S. For example, Harley-Davidson has said it will move some production overseas to avoid tariffs. The best scenario is that countries settle their trade differences with new pacts, such as the preliminary new agreement between the U.S. and Mexico. In any case, while we are keenly aware of tariffs and trade wars, they do not materially change how we assess individual stocks.

Kevin Toney

Kevin Toney, CFA

Chief Investment Officer

Global Value Equity

We like to see companies go beyond the foundational tech investments that simply keep the lights on. The most compelling companies make strategic investments that can give them a competitive advantage.

- Kevin Toney

Greg, should we be concerned that higher costs from tariffs will spur inflation?

Greg Woodhams, Co-CIO, Global Growth Equity: Historical context is important here. Inflation peaked in the U.S. in the late 1970s and early 1980s, before dramatic action by the Fed brought prices under control and fundamentally changed expectations for inflation.

The ensuing decades also saw the proliferation of free-trade policies worldwide that further suppressed prices. Important milestones include China’s entry into the global economy in 1980 and the ratification of the North American Free Trade Agreement (NAFTA) in 1993.

Now, however, these decades-long trends may be ending, as the free-trade regime is under threat from left- and right- wing politicians around the globe. Inflation expectations, too, are rising, albeit from a very low base. Expectations are important because what we think about future inflation colors our decisions to spend or save and at what rate. It also influences businesses’ decisions to enter into contracts with suppliers, customers, and workers.

Another link to the 1970s and ’80s is that a recent U.S. Producer Price Index report showed year-over-year price increases in nine of 10 categories. This high diffusion of producer price inflation is unusual for this stage of the economic cycle and hasn’t occurred since the late ’70s.

Greg Woodhams

Greg Woodhams, CFA

Co-Chief Investment Officer

Global Growth Equity

Secular growth companies, whose earnings are driven by innovation or an earnings dynamic that is independent of the economic cycle, should have an advantage.

- Greg Woodhams

How does this translate to companies and stocks?

Woodhams: From an investment perspective, higher producer prices—whether resulting from a stronger economy or from tariffs—will challenge companies that must pass on those incremental costs to maintain profit margins. We don’t see any relief from the Fed either. The notes from the central bank’s policy meeting show the Fed recognizes its accommodative stance won’t be appropriate if current economic conditions persist. Said differently, rates may be too low given the pace of economic growth, low level of unemployment, and uptick in inflation. The combination of reluctance to accept price increases because of a low inflation mindset and a vigilant, less-accommodative Fed implies that profit margins will face cost pressures.

Of course, this scenario won’t affect all companies equally. Cyclical growth companies, whose earnings growth depends on earnings power latent in the economic cycle, tend to have a higher percentage of their costs associated with producer price inflation. An inability to pass on those prices represents a headwind to cyclical growers. On the other hand, secular growth companies, whose earnings are driven by innovation or earnings dynamics independent of the economic cycle, should have an advantage.

The impact of U.S. tax cuts is still rippling through the economy. Are management teams making smart decisions with their tax savings windfalls?

Toney: This is something we’ve been watching closely because bad decisions on acquisitions and capital projects are all too common. Corporate technology spending has been strong, and this is expected to continue. That’s been great for the sellers, but there’s a buyer on the other side of every deal. We like to see companies go beyond the foundational tech investments that simply keep the lights on. The most compelling companies make strategic investments that can give them a competitive advantage.

For example, Zimmer Biomet, which manufactures orthopedic products such as artificial joints for knee, hip and shoulder replacements, has invested in computer-assisted robots and multi-axis grinders to precision polish medical devices. It also has automated certain manufacturing and inspection processes, including on-machine inspection and process controls.

Paychex is another U.S. company making accelerated tech investments due to tax reform. These investments will improve the company’s software offerings by allowing customers to customize the user interface and provide tighter integration with other human capital management systems. The latter will minimize duplicate entries, add mobile access, and expand employee self-service functions. These projects were all in the pipeline, but Paychex pulled them forward due to increased availability of capital from tax reform.

Political uncertainty is another key topic affecting the outlook for global markets. Keith, how do you see this affecting European stocks?

Creveling: In Europe, we’re watching two political situations that could have an impact on stock performance. The newly formed government in Italy, a coalition featuring the populist Five Star Movement and the center-right League, may pursue populist policies rather than a pro-reform, pro-business agenda that would be more attractive to investors. The appointment of a new economic minister, who immediately said Italy would remain in the eurozone and focus on debt reduction, mollified investors somewhat. However, we remain concerned about political developments in one of Europe’s largest economies.

The U.K. faces a different sort of political dilemma. If the ruling Conservative party is unable to reach a trade deal with the European Union (EU) before its scheduled exit (Brexit) from the EU next year, the economic consequences could be significant. The uncertainty around the ongoing Brexit negotiations has clouded the outlook for the U.K. economy for most of the period since the Brexit referendum in June 2016.

Several issues remain unresolved, including questions about trade arrangements, the U.K.’s bill for exiting, the possibility of a hard border between Northern Ireland (part of the U.K.) and the Republic of Ireland (part of the EU), and the free movement of citizens and workers between the U.K. and the EU. Each could have a negative impact on U.K. businesses’ ability to compete in the new post-Brexit environment. The U.K. government is currently negotiating on all these points and has suggested an adjustment period that would allow for a smoother transition if the parties can’t reach a deal by the March 2019 deadline. So, the uncertainty surrounding this complex resolution is ongoing.

Political issues, combined with macroeconomic factors, have also contributed to heightened volatility in emerging markets (EM) in recent months. Should we be worried that turmoil in Turkey will have spillover effects to other countries?

Creveling: We don’t believe all EM should be painted with the same brush. In our view, Turkey is an extreme and isolated case, and an example of poor domestic policy. The economic issues that were pressuring the Turkish lira have been in place for some time, but the recent political confrontation between the U.S. and Turkey helped exacerbate the situation. President Erdogan’s adamant stance against hiking interest rates to maintain high growth rates rather than tame inflation helped fuel the swift drop in the currency in August. While Turkey’s government does seem to be moving incrementally in the right direction on economic policies and has provided banks with additional liquidity, it remains unclear if the government is committed to the fiscal and credit policies necessary to stave off recession. 

Brazil is another EM country that bears watching as its presidential election approaches. Many investors remain on the sidelines, awaiting the outcome of the presidential election for insight into how government policy will affect the macroeconomic climate. Brazil appears to be at the low point of the economic cycle, with the potential for recovery.

Companies have deleveraged, strengthened balance sheets, and stockpiled cash. However, it remains to be seen if any incoming administration can deliver on promises for necessary reforms. In the meantime, we have found select opportunities in companies with strong individual fundamentals despite macroeconomic headwinds. An example includes home furnishings retailer Magazine Luiza, which is benefiting from its exposure to e-commerce (penetration remains at a low level in Brazil), despite the weakened consumer outlook.

Turkey and Brazil aside, EM face headwinds from trade wars, the stronger U.S. dollar, and higher U.S. interest rates. However, we don’t expect the anticipated U.S. rate hikes this year and in 2019 to significantly hamper EM performance if those rate hikes are well-telegraphed. Additionally, with stronger domestic demand, muted inflation, and improved current account balances, most EM countries appear better positioned than in recent history to withstand the effects of a dollar rally.

Cleo, at the beginning of our conversation we noted more volatility coming back into the market. Are there alternative strategies that investors should be considering?

Cleo Chang, Head of Investment Solutions: We’ve noticed that correlations between equities and bonds have ticked up with the return of volatility. Because of their low correlation to other strategies, we believe it makes sense to think of alternatives as the third piece of a portfolio. Further, among alternatives, equity market-neutral strategies tend to have the lowest correlation due to their lack of market beta. Interest in market neutral is growing as reflected in strong flows into this category during the first half of the year.

Clients are also expressing concern about downside risk. According to a recent study, 56% of investors say they believe the equity market is at its peak and think the opportunity for outperformance is going to be constrained going forward. Long/short equity strategies may be appropriate for those who hold this view. On the long side, managers can be optimistic but cautious, managing to lower levels of market exposure and higher cash balances so they can be opportunistic. Short positions can capture gains when stock prices fall and can help reduce downside losses.

Cleo Chang

Cleo Chang

Head of Investment Solutions

Because of their low correlation to other strategies, we think it makes sense to think of alternatives as the third piece of a portfolio.

- Cleo Chang

Vinod, earlier in the conversation Kevin discussed how companies are investing in technology to gain efficiency and better serve customers. These technologies are also affecting the asset management industry itself. Can you give us a peek under the hood at how investment managers are using Big Data and artificial intelligence (AI)?

Vinod Chandrashekaren, CIO, Disciplined Equity: Big Data and AI have revolutionized how the world solves problems. From radiology to e-commerce, machines are informing critical decisions more than ever, so it makes sense that we would find applications in financial services. Just consider all the information available from conference calls, annual reports, investor events, patent data, supplier networks, and competitive positioning metrics. But while the data are vast, many aren’t valuable or predictive. Uncovering signals amid this noise requires targeted algorithms and thoughtful technology decisions.

In this Big Data–driven investment landscape, we believe teams with dedicated technolo-gists (closely aligned with business needs and asking the right questions of the data) using flexible platforms (open to all the advancements around them) are positioned for success.

Vinod Chandrashekaran

Vinod Chandrashekaran

Chief Investment Officer

Disciplined Equity

Subtle shifts in communication patterns, coupled with a variety of other complementary indicators, reveal meaningful, price-predictive information.

- Vinod Chandrashekaran

How does this work in practice? For example, how can you apply it to quarterly corporate earnings calls to inform investment decisions?

Chandrashekaren: The language a company’s management uses—or doesn’t use—on an earnings call can flag potential issues in a stock. We group this language into four broad categories. The first category includes “sins of omission,” or instances of corporate management not disclosing certain details or relevant information. The second is the extent to which management resorts to exaggeration or using overly scripted language. Of course, earnings calls are rampant with corporate enthusiasm, but there’s a spectrum.

Our AI model negatively views abnormal levels of corporate spin, especially in the face of analyst uncertainty and questioning. Third, we are attuned to obfuscation, or the tendency of management to use overly complex language or details to avoid directly answering a direct question. Finally, the fourth category relates to the blame game, or management’s tendency to take ownership of successes and attribute failures to external forces or conditions beyond its control.

Starbucks makes a good case study. Once a growth darling, with consistent year-over-year double-digit comparisons, Starbucks is now a company in transition. Its fundamentals are beginning to reflect a company entering a maturation phase. While I personally appreciate having three Starbucks within 10 minutes of the office, it’s hard to ignore the pressures of cannibalization on same-store-sales. So, too, are the competitive pressures of an increasingly crowded coffee market—cheaper options from fast-food restaurants and the differentiated draw of local gourmet cafes that your hipster friend always raves about. The company ultimately issued lower guidance than it suggested in its quarterly earnings call, and the stock declined sharply as a result.

It’s in these moments of transition, when underlying fundamentals begin to shift behind the scenes, that management feels the most pressure to maintain its growth story from previous years. Subtle shifts in communication patterns, coupled with a variety of other complementary indicators (e.g., short interest, insider trading), reveal meaningful, price-predictive information. Starbucks’ calls demonstrated a gradual decline in tone relative to industry peers well before its stock price tumbled. The decrease might seem clear from this conveniently quantifiable vantage point, but from call to call, these shifts are far subtler.

Victor Zhang, Co-CIO, American Century Investments: Although U.S. interest rates have been rising, they remain relatively low. What’s the Fixed Income team’s outlook for rates?

G. David MacEwen, Co-CIO, American Century Investments, CIO, Global Fixed Income: Since the Fed started tightening monetary policy in December 2015, U.S. interest rates have been on a slow trek upward. We saw some sharp rate volatility earlier this year, due to tax reform and some stronger-than-expected economic data. But the volatility has largely subsided, and we believe solid, sustainable economic growth, higher—but not out-of-control—inflation, and continued Fed normalization will gradually drive rates higher. Absent any significant trade or geopolitical events, we expect the 10-year Treasury yield to gradually move higher over the next several months, ultimately trading in a range of 2.95% to 3.25%. We expect the two-year Treasury note to trade in a range of 2.45% to 3.00% over the next several months.

Absent any significant trade or geopolitical events, we expect the 10-year Treasury yield to gradually move higher over the next several months, ultimately trading in a range of 2.95% to 3.25%.

- G. David MacEwen

With shorter-maturity yields rising at a faster pace than longer-maturity yields, the Treasury yield curve continues to flatten. Is this cause for concern?

MacEwen: Some in the financial press worry that the yield curve is close to inverting—and an inverted yield curve has often been an indicator of economic recession. We don’t share those concerns. The U.S. is still in the early months of fiscal stimulus from tax and regulatory reform, and we believe this backdrop should support solid, sustainable economic growth. Meanwhile, inflation is not rising at a pace that would require the Fed to aggressively raise short-term rates, causing the yield curve to invert. We believe the yield curve may continue to flatten in the short term, as the Fed tightens, the U.S. Treasury issues more notes, and longer-maturity rates slowly move higher. However, once central banks outside the U.S. begin to normalize, we may see longer-maturity U.S. rates move up a bit faster.

Does the Fixed Income team expect other developed market central banks to follow the Fed’s lead and normalize monetary policy?

MacEwen: It appears central bank policy will gradually converge over time. Economic growth and inflation data are slowly improving in Europe and the U.K., which may push rates higher. Although the European Central Bank (ECB) continues to provide support, it is slated to conclude its bond-buying program in December. So far, the ECB doesn’t have any plans to begin reducing its bond portfolio, and it continues to hold the key eurozone lending rate at 0%, where it’s been for more than two years.

We don’t expect the ECB to start raising rates before mid-2019. In the U.K., normalization is underway, albeit slowly. The Bank of England has raised rates twice since late-2017, to 0.75%, and policymakers insist additional rate hikes will be gradual and limited. Elsewhere, the Bank of Japan shows no signs of tapering its stimulus program. Short-term interest rates remain -0.1%, and policymakers are targeting a 10-year government bond yield of 0.20% or lower. Growth in Japan remains sluggish, and inflation is less than 1%, suggesting the central bank will maintain its stimulus efforts.

Looking beyond the developed markets, political and economic factors are creating challenges for certain EM countries. Have these developments changed the team’s view of EM bonds?

MacEwen: Uncertainties surrounding global trade policy remain a headwind for EM assets. But much of the recent volatility is due to turmoil in Turkey, where damaging political and monetary policy decisions recently sent Turkey’s currency and financial markets into a tailspin. The central bank’s refusal to raise rates in the face of a deteriorating macro environment triggered the currency’s downturn. Escalating political tensions with Western allies, whose funding is critical to the Turkish financial system, also pushed the lira lower. Turkey has limited domestic financial resources, so it must attract U.S. dollars and other foreign money to keep its economy growing. This makes Turkey particularly vulnerable to Fed rate hikes, further exacerbating the situation.

Given the size of Turkey, negative investor sentiment has spread to other markets. However, we believe the problems are largely self-inflicted and specific to Turkey. The last significant sell-off in EM assets occurred in 2013, and it also targeted countries with high external funding needs. But compared with that period, we believe most EM countries are in better economic shape today. We have seen weakness in other countries that rely on external funding, such as Argentina, South Africa, and Indonesia. But, unlike Turkey, central banks in those and other EM countries have indicated they will raise interest rates if necessary. For example, recent weakness in the Argentinian peso prompted the central bank there to immediately raise interest rates to 60%, highlighting the difference between policy-makers in Argentina and Turkey.

Overall, we view this latest unrest as an opportunity to invest in EM bonds offering solid fundamentals and attractive risk-adjusted returns. Risk remains elevated in certain countries, but we believe the widespread negative market sentiment has unf 500 The page URL resolves to a non-existent path

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