For professional use only May 2021

Multi Asset Monthly

Global Strategy

Rational exuberance
Economic outlook Model portfolio
Macro data are increasingly heralding the start of the
economic normalization process in regions where the
vaccine roll-out has been smooth. In the US more
infrastructure spending has been announced. Inflation
numbers and expectations have risen, but we see this as a
temporary phenomenon that will not lead to tighter
monetary policy. In the medium term, the sustainability of
the recovery will depend on how long it takes to attain herd
immunity, how willing policymakers are to continue
providing stimulus, and how much permanent damage the
economy has suffered.

Market outlook
Investors have fully embraced the reflation story. Ample
liquidity, fiscal support and strong earnings offer support to
equity markets. We expect this strength to continue
through the second half despite high levels of investor
optimism and some signs of exuberance. The cyclical
commodity markets are also benefiting from this trend. On
the other hand, the rise in government bond yields is Current active views are shown by coloured circles; circles with thick grey
putting pressure on fixed income returns. We think that edges represent previous views. The five rankings for the views are (from
monetary policy support and further economic progress will left to right): strong underweight, moderate underweight, neutral,
moderate overweight, strong overweight.
contain the impact.

1
For professional use only May 2021

Contents

Asset allocation and scenario update ________________________ 3

Asset allocation ________________________________________ 3
Background: Spring scenarios update ______________________ 4

Market review __________________________________________ 6

Bull market in risky assets driven by strong fundamentals ______ 6
Equities ______________________________________________ 6
Fixed income __________________________________________ 6
Commodities __________________________________________ 7

Economic outlook ________________________________________ 8

Back to secular stagnation, or on to a better equilibrium? ______ 8
The regime shift faces some formidable political constraints ____ 8
Economic constraints are unlikely to bite anytime soon ________ 9

Emerging markets _______________________________________ 10

Strong external demand, fragile domestic demand ___________ 10
Pressure on EM currencies may intensify ___________________ 10

Fixed income outlook ____________________________________ 11

Markets are calm, but volatility could be around the corner ___ 11
Timing is crucial in tactical positioning _____________________ 11
EMD hard currency sovereigns benefit from stabilizing rates ___ 12

Equity outlook __________________________________________ 13

From early recovery to mid-cycle _________________________ 13
Investor behaviour ____________________________________ 14
Positioning ___________________________________________ 14

Commodity outlook _____________________________________ 15

Recovery theme keeps commodities buoyant _______________ 15
Correlation breakdown signals normalization _______________ 15

2
Asset allocation and
scenario update
• Normalization path is becoming more tangible
as vaccination roll-outs pick up pace
• Economic policy support remains supportive
• We maintain our pro-cyclical stance
Asset allocation
We retain our preference for cyclically sensitive assets in our tactical
asset allocation. This preference is driven by a benign combination of
several factors. First, in developed markets the normalization path
has become more tangible, thanks to the rapid progress of the US
and UK in their vaccination roll-outs.
We expect the speed of vaccinations in continental Europe to
increase as more vaccines become available in the second quarter.
Secondly, earnings growth exceeds consensus expectations by a wide
margin across all sectors and full year estimates are being revised
higher.
A third factor is economic policy support. On the monetary side,
central banks in developed markets will remain accommodative for a
long period, even in the wake of rising inflation data. Inflation rates
may indeed rise as the economy re-opens and because of base
effects, but this should be a temporary phenomenon.
The Fed’s reaction function has turned more dovish and taper talks
are not expected any time soon. On the fiscal front, the US is taking
another leap forward with the “Build Back Better” programme, a
package aimed at helping the US to regain or even surpass previous
trend growth. This package encompasses broad infrastructure
spending and support for the welfare state.
We consequently maintain our moderate overweight in equities, as
well as our large overweight in EUR and USD high yield and in cyclical
commodities like Brent and WTI. In the rates market, volatility has
made us more cautious. We closed the overweight in German Bunds
but maintained a moderate underweight in US Treasuries. From a
fundamental perspective, we think the spread between the two
regions has room to widen further.
Fixed income
In government bonds, we moved US Treasuries from a large to a
moderate underweight and closed the overweight in German Bunds.
With this trade we seek to capture the different macro and supply
dynamics between the two regions, although at a lower conviction
level than before. In spreads we have large overweights in EUR and
USD high yield. High yield offers an asymmetric return profile,
outperforming when government bond yields drop and stabilizing
when they rise.
Equities
Our equity allocation is tilted to benefit from the twin themes of
rising bond yields and rising commodity prices. In sectors, we
Multi Asset Monthly
maintain a cyclical preference for industrials and materials at the
expense of consumer staples and healthcare.
We previously downgraded financials from a large to a moderate
overweight to reduce our sensitivity to increased bond market
volatility This month we went overweight in the technology sector.
The tech sector underperformed in Q1 as investors turned towards
purer reflation trades, but it offers superior long-term profitability
and growth and is well-placed to benefit from structural economic
changes. As we move towards the next phase of the business cycle,
investor preference may start to shift from cyclical towards secular
growth, and from weak balance sheets to strong balance sheets. The
technology sector scores well on both metrics.,
In our regional allocation, we maintain a moderate overweight in the
UK relative to Swiss equities. The UK is well-advanced in inoculating
its population, and it is sensitive to commodity prices through its oil
and mining exposure. The region is cheap on all metrics and is under-
owned by institutional investors.
Real estate
We are neutral on global real estate. Rising yields as a result of US
fiscal pulses and economic normalization are a medium-term
headwind. Banks are also tightening credit standards. In the US,
housing and labour data are on the mend, but office vacancy rates
and mortgage delinquencies are rising. Valuation of the asset class,
both absolute and relative, provides support.
Investor positioning in global and US real estate is strongly
underweight. Net flows are limited. Positioning in European real
estate is still overweight but has come down rapidly, as outflows
continue.
Real estate is undergoing structural change that is amplified by the
Covid crisis. The trend towards e-commerce reduces demand for
retail real estate while strengthening real estate logistics. Increased
working from home will continue to affect office demand. These
themes will continue to weigh on the asset class in 2021 and beyond.
Commodities
We are neutral on commodities, with a positive bias expressed via
overweights in cyclical commodities crude oil and aluminium. High
investor positioning in agriculture and industrial metals is a risk. In
precious metals the cyclical recovery continues to dent investment
demand. The agricultural segment rallied on US planting delays amid
colder weather and a lingering la Nina weather pattern affecting the
crop outlook in Brazil.
In oil we remain constructive on Brent and WTI. Recovering oil
demand as mobility increases, particularly in the US, and a forecast
rise in global refinery demand from April on (after maintenance)
should tighten the market. OPEC+’s gradual ramp-up in production
should be well digested. In industrial metals we see indications of an
increase in end-use orders after Chinese New Year, leading to
expected metal inventory draws and supporting prices. We prefer
aluminium, as environmental production curbs are coinciding with
rising green demand.
3
Table 1: Equity market forecasts First, our assumptions about the global vaccine rollout are captured
in Figure 1, which shows the portion of the fully vaccinated
Index Current +3m +6m +12m population in the US, EU, Japan and the UK in various cases.
According to our base-case analysis, we expect about 66% of the
S&P 500 4211 4300 4400 4500
population to be vaccinated by the end of the year.
Stoxx 600 437 450 460 470
Figure 1: Vaccination scenarios for population of US, EU, Japan, UK
TOPIX 1898 1950 2025 2075

FTSE 100 6952 7050 7150 7350

MSCI EM Free 1365 1370 1400 1425

Source: NN Investment Partners, 30 April

Patrick Moonen
Principal strategist
Source: NN Investment Partners
The expected strong growth of the global economy depends on
Background: Spring scenarios update
continued fiscal support as well as the reopening of businesses. This
The views embedded in our New Future scenarios are based on the
is certainly the case in for the US, where fiscal policy is moving from
idea that after the pandemic, the world will strive to “return” to
relief support to a debate on investments and social reforms. Further
some sort of normality. The political and economic environment has
fiscal support is also needed in Europe, where the rollout of the
already changed in many ways, so the post-pandemic world will be
recovery plan is slow, and in emerging markets, where fiscal
different from the pre-pandemic one and we are heading “back” to a
headroom is limited.
new future.
We need to look at two more unknowns: inflation expectations and
Our investment scenarios are designed to describe the context in
animal spirits. These unknowns allow us to explore how market
which various possible market environments might evolve. The base
participants will respond to the US Federal Reserve’s new strategy,
scenario describes what we see as the most likely outcome. The
and to better capture potential deviations from market
alternative scenarios are meant to explore a wide range of possible
fundamentals.
futures. They are not meant as forecasts.
New Future scenarios in detail
The scenarios are organized in terms of a few critical unknowns that
We maintain our three scenarios: cruise control (base case), full
span the space of possible outcomes. Our spring update features four
throttle, and idling engine. They are summarized in Figure 2.
unknowns: the global vaccine roll-out, fiscal stimulus, inflation
expectations and animal spirits. We discuss them in turn.

Figure 2: Overview of the New Future scenarios

Source: NN Investment Partners

Multi Asset Monthly 4

Cruise control
The cruise control scenario describes a world in which the
aforementioned advances in the US on the fiscal and vaccination side
warrant an upgrade of the economic outlook. We now expect the US
economy to grow by 6.6% in 2021, compared with 4.3% for the
Eurozone. This goes hand in hand with a gradual labour market
recovery in both regions. Similarly, core inflation improves only
gradually in the base scenario. This is also a positive backdrop for the
Chinese economy, which is expected to grow by 9.4% in 2021.

In this environment, financial markets price in reflation and the

comeback of the affected parts of the service sector. US yields have
some room to edge higher, but the actual inflation trajectory should
limit the rise. The Fed continues to anchor inflation expectations
reasonably well. The European Central Bank, meanwhile, finds it
more difficult to create room to manoeuvre, given the institutional
setting and the lack of further fiscal response.

The strong increase in global earnings that analysts anticipate is

materializing and might even exceed expectations. This should lead
to decent equity returns in 2021.

Full throttle
The full throttle scenario offers an alternative future in which global
growth surprises on the upside. Various factors are at play: significant
pent-up demand, strong capex growth and excessive fiscal stimulus.

The high growth comes at a price. The global economy shows signs of
overheating and labour markets recover so quickly that the actual
inflation numbers overshoot the Fed’s 2% target. The Fed might be
forced to taper early and raise rates prematurely, or they might be
tested repeatedly by the market. In either case, the FOMC might face
problems anchoring inflation expectations. This conflict paves the
way for higher yields in the US.

In this scenario, equity markets perform well, at least initially, due to

strong earnings growth. The crucial point is that equity valuations
and rates might rise sharply, because animal spirits detach valuations
from fundamentals.

Idling engine
The idling engine scenario is one in which various factors become a
drag on growth and undermine the recovery assumption that is
crucial for global growth in 2021. Major setbacks for the vaccine roll-
out in the G3 region may trigger such a negative spiral.

Policy mistakes are another possible trigger. For example, a

premature tightening of monetary policy by the Fed or the ECB might
derail the current rally. On the political side, any return to the
austerity policies of 2011 might worsen the economic outlook in the
European Union. For example, the September general elections in
Germany and the French presidential elections next April might
create opportunities for right-wing parties to force a debate about
austerity. This scenario is clearly a drag on equities and creates
deflationary pressures on bond yields.

We maintain this relatively pessimistic scenario not because we

deem it probable, but because it highlights the importance of the
sustained stimulus and the economic recovery of the sectors most
affected by the pandemic.

The scenarios are updated on a quarterly basis. The next update will
be at the end of the second quarter.

Marco Willner
Head of investment Strategy

Multi Asset Monthly 5

Market review Figure 2: Regional equity performance (EUR)

• Risky assets continued their strong

performance in April
• US bond yields retreat following last month’s
steep rise
• Strong fundamental support continues to
drive bull market
Bull market in risky assets driven by strong fundamentals
In April, risky assets continued their strong performance. Equities,
Source: Refinitiv Datastream, NN Investment Partners
real estate and cyclical commodities posted positive returns. Credit
spreads tightened. German and US government bonds converged as Sectors
Bund yields rose while Treasury yields declined following a steep rise. From a sector point of view, cyclical sectors like financials (strong
results) and materials (rising commodity prices) showed strong
The main drivers behind this bull market have strengthened due to a performance as did typical growth sectors like technology (stable US
benign combination of several developments. US President Joe Biden yields and strong results) and communication services (strong
has announced the Build Back Better programme consisting of multi- results). Utilities and consumer staples were at the bottom of the
year, multi-trillion-dollar fiscal spending on physical infrastructure league table. Sector returns were more balanced, based on a
(the American Job Plan) and on human infrastructure (the American combination of both cyclical and secular growth. This might be the
Family Plan). trend going forward as we move further along the business cycle
from the early-recovery phase to the mid-cycle phase.
Central banks in the developed world, meanwhile, remain committed
to monetary policy support, even in the wake of temporarily higher Figure 3: Equity performance by sector (local currency)
inflation data. Macro data came in strong, confirming a V-shaped
recovery and the path towards normalization.

In April the corporate earnings season started and the numbers again
beat expectations by a wide margin, in Europe and in the US and
across all sectors. Profit guidance was also positive, acting as an
additional driver for equities.

Figure 1: Year-to-date asset class performance (EUR)

Source: Refinitiv Datastream, NN Investment Partners

Fixed income
In government bonds, the spread between US and German yields
narrowed. This move was probably caused by the dovish Fed and is
likely to be temporary.

Figure 4: Long-term government bond yield trends

Source: Refinitiv Datastream, NN Investment Partners

Equities

Regions
Regional performance was mixed. The US regained its top spot driven
by a renewed interest in growth sectors like technology and
communication services. Emerging markets suffered a difficult start
to the month. Several countries in Asia continue to struggle with the
pandemic. This is denting their growth outlook. The narrowing of the
positive growth gap with developed markets is not helping either.

In the second half of April, emerging markets experienced some relief
as a result of the weakening US dollar and the stabilization of US
bond yields. Japan was the month’s worst performer. The vaccination
process is slow there and is lagging other developed economies. The
appreciation of the yen versus the US dollar was also a headwind.
Source: Refinitiv Datastream, NN Investment Partners
In fixed income spreads, global high yield performed well and spreads
tightened. Lower US yields and the rapid improvement in corporate
profitability were tailwinds.

Multi Asset Monthly 6

Figure 5: Credit spreads

Source: Refinitiv Datastream, NN Investment Partners

Commodities
Commodities posted a strong month in April. The industrial metal
and energy segments both did well, helped by high OPEC+ output
compliance and expectations of rising demand as the economy
normalizes. Precious metals lagged but still printed positive returns
for the month.

Figure 6: Commodity sector performance in USD

Source: Refinitiv Datastream, 30 April 2021

Patrick Moonen
Principal Strategist Multi-Asset

Source: Refinitiv Datastream, NN Investment Partners

Multi Asset Monthly 7

Economic outlook
• The Covid response is much different from
policy after the Global Financial Crisis
• Economic constraints are unlikely to bite
anytime soon
Even though there are some regional differences in vaccination
progress and the degree of stimulus, the global economy is set for a
strong boom in the second half of this year. In many ways this boom
is the flipside of the slump we saw over the past year. It is driven to a
considerable extent by the easing of restrictions and the release of
pent-up demand and excess savings.
Nevertheless, there is an additional element to this boom that can
potentially make all the difference in the longer term – the policy
response. Last year governments around the world quickly
implemented large-scale disaster relief programmes designed to
protect incomes and the balance-sheet quality of households and
businesses hit by the Covid shock. Central banks made strong
commitments to doing whatever it takes to keep sovereign and
private borrowing costs low for the foreseeable future.
This was very different from the response to the Global Financial
Crisis (GFC) in 2008, when discretionary fiscal easing was modest
relative to the size of the shock that was hitting the economy and
some central banks, like the ECB, allowed sovereign and private
borrowing costs to spin out of control. What’s more, fiscal easing was
quickly followed by a few years of severe fiscal tightening, which
dampened the early phase of the expansion considerably.
The lukewarm policy response and the policy mistakes made after
the GFC arguably aggravated secular stagnation forces, which had
already been slowly gaining strength before 2008. The essence of this
economic affliction is a low willingness to take risk, or, to put it
differently, an excessive demand for safety. This expressed itself in
various ways. Rising inequality caused a larger share of income to end
up in the hands of wealthy households, which tend to save a lot.
Rising market power delivered a sharp rise in profits for corporates,
but a large share of these gains was not invested in productive assets
but rather in ways to retain and increase market power and/or share
buybacks. In the financial sector there was a growing demand for
safe government bonds because of strong growth in EM countries,
which as a rule do not produce safe assets themselves, and also
because of changes in financial sector regulation. Meanwhile, the
supply of safe government bonds did not keep up with demand
because of fiscal austerity.
Back to secular stagnation, or on to a better equilibrium?
The big question facing markets is to what kind of equilibrium the
economy will return once the post-Covid boom has petered out. One
the pessimistic side of the spectrum is an equilibrium with further
enhanced secular stagnation forces, if for example the crisis leaves
permanent scars on confidence, private investment, labour supply or
worker skills. On the optimistic side of the spectrum beckons an
equilibrium with higher productivity growth, higher inflation and
higher equilibrium yields as well as higher returns on risky assets.
One of the major determinants of where we will end up is the size
and quality of the policy response. It is not enough for policy to
provide a substantial impetus for current demand. It is also especially
important that policymakers credibly commit to maintaining this until
the private sector is willing and able to support a robust nominal
growth momentum on its own. This boils down to ensuring that there
is a permanent positive shift in the private sector’s willingness to take
risk. In addition to that, the policy mix must be coordinated and
Multi Asset Monthly
balanced; i.e., fiscal, monetary, structural and incomes policies must
all participate and work towards the same goal. It is also important
that policy stimulus be targeted at improving the economy’s
institutional structure and enhancing its long-term growth potential.
Clearly there has been something of a regime shift in the philosophy
of policymakers. Several among them feel that persistently low
sovereign borrowing costs offer a unique opportunity for fiscal policy
to push the economy to a better equilibrium. They also recognize
that a persistently higher nominal growth path is the only way to
make rising sovereign debts sustainable. Of course, low borrowing
costs are no accident, but rather the inevitable consequence of an
excessive demand for safety; i.e., stimulus becomes very cheap just
when the economy needs it the most.
Meanwhile, central banks have tacitly accepted that they cannot
attain a higher inflation equilibrium all on their own; they need the
help of fiscal and other policies to achieve that. The best way for
central banks to contribute to the recovery is to keep sovereign
borrowing costs low until the baton of assuring debt sustainability is
passed to persistently better nominal growth.
The regime shift faces some formidable political constraints
Not all policymakers share this new philosophy. This is an important
reason why the success of the regime shift is far from assured; there
are potential political constraints which could stop this shift in its
tracks. US President Joe Biden seems determined to do whatever it
takes to cement the regime shift more strongly. In this respect, he
seems very much aware that the regime shift contains a political
dimension as well as an economic one. The former must change
dramatically for the latter to succeed. To achieve that, the vast
majority of Americans must experience a visible improvement in
their standard of living so as to increase the probability that the
Democrats will retain their majority in Congress after the 2022
midterm elections.
Biden’s public investment initiatives are in fact a double-edged
sword. On the one hand, they intend to improve physical and digital
infrastructure and to make the economy more green; at the same
time these initiatives will create a lot of jobs. Similarly, investment in
“social” infrastructure – programmes such as childcare and child
benefits, care for sick and elderly and easier access to education –
will improve the lives of especially disadvantaged groups in society
and increase labour supply as well as skills within these groups.
In Europe the political constraints are of a somewhat different
nature. One of the key underlying tensions in the institutional design
of the euro area is the need for an area-wide safe asset, on the one
hand, and the need to constrain national fiscal policy, on the other. A
safe asset is valued by the private sector as a hedge against bad times
and its existence allows the public sector to stimulate the economy
when such bad times arise. In a monetary union, central bank and
market disciplining mechanisms to constrain profligate national fiscal
policymakers are weaker. The ECB’s targets for area-wide inflation
are one reason. The fatal design flaw was the failure to recognize that
binding the hands of national policymakers deprives them of the
means to stabilize their economies in the face of idiosyncratic shocks.
Some degree of fiscal risk-sharing is thus inevitable. The European
Stability Mechanism and the Next Generation EU fund are important
steps in this direction, but they are as yet insufficient. This has forced
the ECB to make national sovereign bonds safer by acting as a
conditional lender of last resort. Because of its flexibility with respect
to the capital key, issuer and issuance limits, this conditionality is
virtually absent in the ECB’s Pandemic Emergency Purchase
Programme (PEPP), which is precisely why this instrument has been
so successful in containing peripheral spreads. Virtually all
policymakers agreed that the combination of large-scale fiscal and
monetary easing was necessary to fight the fallout from the Covid
8
pandemic. However, a rift is likely to open up between the hawks and
the doves. The hawks would like PEPP flexibility to be dialled back as
soon as possible and do not mind a rise in real yields driven by better
growth outlook. In fiscal space, they may well advocate a return to
the pre-Covid fiscal rules, which were all about fiscal austerity for
high-debt countries without much in the way of fiscal risk sharing.
Meanwhile the doves would like the ECB to retain maximum
flexibility to keep sovereign yield curves low and flat until the
economy is well on its way to a better equilibrium. In fiscal space
they would like to see a change in the rules to make more room for
public investment coupled with growth-enhancing structural reforms
and a larger degree of risk sharing. It is still uncertain how all this will
play out. Nevertheless, in 2022 there is the possibility of a dovish
window of opportunity. In Germany, the relatively dovish Greens
may well play a key role in the formation of a new government. If
Emmanuel Macron wins the French Presidency again, and if Mario
Draghi remains Italy’s Prime Minister, the big three EMU nations may
become very reform-minded.
Economic constraints are unlikely to bite anytime soon
Along with political constraints, there are also economic ones. The
essence of these constraints has much to do with the
aforementioned trade-off between stimulus and safety. When the
economy is in an excessive safety regime, stimulus is very cheap and
effective. As more and more stimulus is added, safe government
bonds will gradually become less safe -- their supply will increase and
a structural rise in private sector risk appetite will over time reduce
demand for them. This will be expressed in rising inflation
expectations and a rise in the term premium. The rise in the term
premium would be triggered by an upward shift in the balance of
inflation risks, which reduces the attractiveness of Treasuries as a
hedge against lowflation, and by a structural shift in investor
portfolios away from safe towards riskier assets.
It is easy to see that this process can overshoot towards a regime of
excessive stimulus. This actually happened in the 1970s, when safe
government bonds lost their safety to a considerably degree.
Multi Asset Monthly
Inflation expectations accelerated upwards and term premiums rose
to very high levels. As a result, policymakers lost their ability to use
stimulus to stabilize their economies and had to embark on a painful
process to make bonds safer again by restricting their supply (fiscal
austerity) and anchoring inflation expectations to a low target.
Obviously these economic constraints are much likelier to bite in the
US than they are in Euroland. The US is less mired in secular
stagnation and is benefiting from bigger stimulus as well as a more
credible commitment from policymakers to continue along this path
until the economy has attained a better equilibrium. Several pundits
worry that this may result in excessive stimulus, in which case US
inflation expectations and term premiums would rise significantly.
Needless to say this would be very ugly for risky assets globally. One
can never exclude such a scenario. In a sense, the Biden regime
change is a big macro experiment which probes the inflationary limits
of the US economy as well as the willingness of investors to hold US
Treasuries.
On the other hand, the experience of the past decade suggests that
these limits could be much further away than many experts thought
possible. Before the Covid crisis, US unemployment fell to very low
levels without triggering inflation and Japan shows that debt-to-GDP
ratios can rise to very high levels without triggering a rise in real
rates. Hence, we view the possibility of moving into a regime of
excessive stimulus to be a tail risk. The key driver in this respect will
be the behaviour of inflation expectations. These expectations have
spent most of the past decades at the lower end or even somewhat
below levels consistent with the inflation target, so it seems unlikely
that the post-Covid boom (by definition a temporary phenomenon)
will unmoor them to the upside. This argument is strengthened by
the fact that a combination of more public and private investment
could push US supply limits out substantially.
Willem Verhagen
Senior Economist
9
Emerging markets
• Global trade and commodity prices remain
positive exogenous factors
• Pandemic is frustrating EM domestic demand
• Rising US yields and spiking global price
inflation create headwinds
Strong external demand, fragile domestic demand
With most of the developed world either in a strong recovery mode
or easing mobility restrictions, global trade growth remains well-
supported. This is reflected in solid EM export growth, with most EM
exporters benefiting from current developments. The East Asian
countries are well-positioned for the strong demand for electronics
and IT-related goods linked to the spectacular trend from offline to
online economic activity. The Central European countries are
benefiting from strong Chinese capital goods demand and the
recovery in global auto demand. Mexico is the prime beneficiary of
the rapid US demand recovery. Finally, export revenues are spiking in
the commodity-exporting countries elsewhere in the emerging world
thanks to the rising metal and energy prices.
For 2021 as a whole, we forecast average EM export growth of 26%,
which would more than offset the -6% of 2020. The last time annual
average EM export growth reached a similar level was in the period
of unprecedented policy stimulus by the Chinese authorities after the
global financial crisis. It is still early days, but the ambitious
infrastructure investment plans of the Biden administration and the
EU post-pandemic recovery fund could push DM fixed investment
growth to levels compatible with further rises in commodity prices
and double-digit EM export growth. We do not expect a situation
comparable to the 2003-2008 EM export boom, when annual EM
export growth averaged 24%. The US and Europe combined are
unlikely to match China’s construction activity of that period, but we
should not underestimate the potential positive impact of high DM
infrastructure investment growth on EM exports.
Export growth in emerging markets
US$, yoy % change, 50 main markets (source: NNIP, Datastream)
Figure 1: EM export growth (USD, YoY % change, 50 main markets)
50
40
30
20
10
0
-10
-20 purple = NNIP
projections until
-30 end-2021
-40
-50
Apr-01 Apr-05 Apr-09 Apr-13 Apr-17 Apr-21
Source: Refinitiv Datastream, NN Investment Partners
Expectations of high EM export growth for more than one or two
years contrast sharply with the poor prospects for domestic demand
growth. In the short term, the still-raging pandemic is impeding a
swift recovery. If we look beyond a post-pandemic recovery, we have
to take into account the widened macro imbalances, the shift
towards more unorthodox economic policies, a structurally higher
level of political risk, and low working-age population growth. These
factors will make it difficult for EM economies to resume a growth
path comparable to that of 2003-2008.
In the short term, the pandemic is preventing a swift pick-up in
consumption and fixed investments in much of the emerging world.
Even in Asia, where the virus had been well-contained in past
quarters, the rapid increase in infections is causing a serious growth
setback. India and the Philippines are the hardest-hit countries, but
Thailand and Malaysia are also under pressure due to a sudden surge
Multi Asset Monthly
in new cases. Elsewhere the pandemic is creating the most problems
in Turkey, Iran, Russia and most Latin American countries.
The slow pace of vaccinations and the limited room for policy
stimulus mean the EM post-pandemic recovery is likely to be slower
than that in DM in the coming quarters. It will be also be important
to see whether EM policymakers will be able to regain the confidence
of their own electorates, to prevent a further shift to more populist
and interventionist economic policies, and of foreign investors, to
secure foreign capital to finance current account deficits.
The experience of recent years has shown that EM policymakers are
not always mindful of macroeconomic stability and the business
climate. In countries such as South Africa and Brazil, it will be very
difficult to narrow fiscal imbalances again to slow the deterioration in
public debt ratios. And in countries such as Turkey and Mexico, after
a clear shift to more state interventionism, much will have to change
to restore the business climate and boost private investment.
Pressure on EM currencies may intensify
EM policymakers can no longer count on low US interest rates to
sustain the global search for yield. Given the improving US growth
outlook and the increasing chances of US inflation moving higher, we
expect US yields to keep rising. This would mean that investors will
be less inclined to take on more risk by investing in higher-yielding
EM paper. We have seen this already in the past months, with EM
capital flows turning more negative. US yields started to rise last
August. In seven of the nine months since then, broad capital flows
to EM have been negative. Negative EM capital flows increase the
risk of currency depreciation. The EM export boom has limited the
damage so far. Only in the countries with the largest policy credibility
issues, such as Turkey and Brazil, have currencies weakened sharply.
But with EM export growth likely to soften in the coming months, US
yields still grinding higher and the EM growth recovery lagging the US
recovery, the pressure on EM currencies can easily intensify.
In this context it is important to also keep a close eye on global food
price inflation. The surge in recent months is comparable to what we
saw in 2010-2011 (see Figure 2). For EM, where the share of
foodstuffs in the CPI basket is generally high, rising food prices tend
to lead to more inflation overall. With inflation on the rise already,
this is not really compatible with the current historically low level of
EM interest rates. Currency markets might have to force hesitant
policymakers into more decisive action.
World food price inflation
year-on-year
Figure 2: World food % change
price inflation (source:
(YoY FAO)
% change)
80
60
40
20
0
-20
-40
-60
Jan-91 Jan-95 Jan-99 Jan-03 Jan-07 Jan-11 Jan-15 Jan-19
Source: Food and Agriculture Organization
M.J. Bakkum
Senior Emerging Markets Strategist
10
Fixed income outlook
• We expect global interest rates to continue to
rise, with growing risk of a less-dovish Fed
have chosen not to change our positioning and to use our global
macro view as our medium-term anchor. Higher volatility always
creates opportunities, especially when we look at exploiting yield
curve dislocations.
Figure 1: PCA residuals show yield curve dislocations

• EMD HC sovereigns seem attractive tactically;

headwinds may arise in the medium term
Markets are calm, but volatility could be around the corner
“Stable” is the best word to describe developments in global rates
markets over the past month. After a sharp, volatile rise in yields in
the first quarter, US Treasury yields have declined somewhat and
gradually risen again. We continue to expect stable rates markets in
the near term, with a gradually rising yields in developed markets.
With the expectation of higher US headline inflation in the coming
month the question now is to what extent this will overshoot
expectations and how this will filter through to actual inflation
expectations going forward.
Higher US inflation prints due to base and transitory effects – such as
higher commodity prices and supply disruptions – appear well-
flagged and largely priced in. However, US inflation break-evens have
risen significantly for shorter-term maturities, and longer-dated
maturities have also been catching up recently. This could be the first
indication that inflation expectations are generally rising in the US,
following the economic recovery fuelled by fiscal and monetary
policy stimulus. We doubt, however, that this will lead to structurally
higher inflation in the long run.
More important is how the Federal Reserve will respond to stronger
inflation, growth and unemployment data over the next few months.
We don’t expect the Fed to change its dovish tone in the near term.
We do see a risk, however, that the Fed could come to terms with
the robust economic recovery sometime in the summer or early
autumn. This could give a clearer picture on the roadmap to tapering
asset purchases. With fed funds futures pricing in a 25bp rate hike by
the of end 2022 and another hike in the second half of 2023, the
market has probably partially taken into account decreasing Fed
asset purchases. This is mainly because tapering should be concluded
well before the rate hike cycle begins. The Fed will try to avoid a
taper tantrum and will try to communicate its path as clearly as
possible. We still see decent gradual upside moves in yields, with the
risk of more volatility in the second half of the year as the market
further discounts the path to higher policy rates for the next few
years and the risk of the taper-tantrum narrative.
In our model portfolio we maintain a bearish tilt to global interest
rates. We are holding on to our moderate underweight in US
Treasuries and see a clear asymmetry in potential yield moves. In the
current stage of the business cycle with an already dovish-sounding
Fed, another negative shock would be needed to materially push
yields lower from current levels.
Source: NN Investment Partners
Figure 1 shows the results of our principal component analysis (PCA)
on the US, German and UK sovereign yield curves. The chart shows
the PCA residuals, which reflect the differences between the
observed and estimated yield changes. By assessing these mean-
reverting residuals, we can determine when sharp yield moves have
gone too far and are prone to a correction. This proves very helpful in
timing entry points for conviction trades, identifying levels for profit-
taking and exploiting short-term distortion on the yield curve. The
current residuals represented by the coloured bars show that yields
are fairly or slightly cheaply valued with little room for large
corrections, commensurate with the current stable yields.
The chart also shows the residuals when yields spiked higher on 25
February as green circles tracked on the right-hand scale. High
volatility clearly creates opportunities across yield curves – for
example, the large distortion in the UST 5y-30y sector showed a
sharp 20bp bear flattening move. This overshoot corrected sharply
afterwards and was well-flagged by our analysis.
Finally, given our global macro view for the rest of the year and the
expectation for a gradual move higher in yields, we have taken a
closer look at how yield curves would behave in such a scenario.
Figure 2 shows the three key drivers for yield curve behaviour: level,
slope and curvature. Based on the typical behaviour of the US
Treasury curve, we can conclude that higher interest rates will
generally push yields higher across the yield curve as shown by the
first principal component indicated as “level”.
Figure 2: Key PCA drivers for yield (change in yield, bps)

We have a neutral position in German Bunds, but clearly see Bund

yields moving higher even with the recent significant step-up in the
ECB’s weekly net asset purchases. However, we are unsure to what
extent the ECB will allow the continued tightening of financial
conditions as measured by the European GDP-weighted average yield
curve. If medium-term core inflation projections continue to
undershoot the ECB’s target, then monetary policy could keep a lid
on further European yield rises. Instead, we prefer to maintain our Source: NN Investment Partners
large underweight in 10y Canada as a cyclical tilt and to further
benefit from a more hawkish-sounding Bank of Canada. Figure 2 shows that the short end of the yield curve tends to decline
while the longer ends tends to rise with higher yields, leading to
Timing is crucial in tactical positioning
steeper yield curves. The least important driver for yield curve
A key challenge in stable interest rate markets is the lack of tactical
changes is curvature and it shows that with rising yields the US
trade opportunities. In the current relatively stable environment we
Treasury curve should experience a larger sell-off in the 5y sector,

Multi Asset Monthly 11

especially in relation to the 2y and 30y sector. Understanding these
typical yield curve dynamics helps us to understand what we can
expect when yields continue to rise and how to optimally position
ourselves going forward.
EMD hard currency sovereigns benefit from stabilizing rates
Last month we updated our view on developed market high yield
credits and we largely continue to stick to that thesis today. This
capture political tension. Revisiting that indicator, we see that the
international political situation is not looking bad and certainly not in
extreme territory.
Figure 4: The G3 political turmoil and trade sentiment are still neutral
2
1

month we looked at allocating to EMD HC sovereign (EMD HC Sov) 0

credits, given the recent stabilization in global rates markets.
-1

Our machine learning analysis shows that the rates market dynamics -2

play an important role for the medium- and shorter-term EMD hard -3
currency sovereign excess returns. The models indicate that
-4
macroeconomic signals derived from commodity prices, Chinese
economic demand, and cyclical survey data play a less important role -5
Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Apr-21
in the medium term than in the shorter term.
G3 Trade Indicator G3 Political Sentiment

Similar to the “search-for-yield indicator” we developed for
developed market credits, we created one for EMD HC Sov to assess
how economic growth, DM monetary policy and interest rates could
affect spread returns in such a way that they would overshadow the
carry returns over the next six months.
The indicator contains three broad components: economic and
cyclical signals, monetary policy signals and rates market signals. The
economic and cyclical component contains data such as the
economic surprise signals, commodity prices and inflation. The
monetary policy component contains data such as the acceleration in
the change of Fed excess reserves or ECB balance sheet and the big
data sentiment on the dovishness or hawkishness of the Fed and the
ECB. The rates markets component is based on data such as changes
in the steepness of the Treasury curve, and the big data sentiment on
the direction of DM rates.
Source: NN Investment Partners, Refinitiv
Going forward, the biggest possible headwind for EMD HC Sov in the
medium term could come from the rates markets, despite the other
worrying signs of new strains and outbreaks of Covid in the region.
While the rates markets remain on a slow and stable upward trend,
this can keep the asset class attractive from a carry perspective.
At the same time, with the rising vaccination rate and the continued
strong prints on inflation, growth and unemployment, we could see a
higher risk that markets will start discounting a less dovish Fed. This
could become a headwind for EMD HC Sov, which in combination
with our analysis makes us neutral on the asset class in the medium-
term. Tactically EMD HC Sov is an attractive asset class to overweight,
until the next sharp repricing in interest rates kicks in again.

Figure 3: Divergence among signals results in neutral total view Fouad Mehadi, CFA
Senior Investment Strategist Fixed Income
3

2.5 Alireza Kahali

2
Multi-Asset Strategist
1.5

0.5

-0.5

-1
Jul-20 Sep-20 Nov-20 Jan-21 Mar-21

Aggregated EMD Signal Rates Market Signals (35%)

Monetary Policy Signals (35%) Economic and Cyclical Signals (30%)

Source: NN Investment Partners

Figure 3 shows that the indicator has shifted from negative to neutral
since the stabilization of rates-market dynamics around mid-March.
The monetary policy component is the most negative one, in line
with the tapering and rate hike expectations. We also see the
monetary policy indicator bottoming out around the same time that
the rates market stabilized and EMD flows recovered. All in all, we
conclude that neither the rates nor the monetary policy dynamics are
in supportive territory. In conjunction with a positive economic
outlook, this leaves the indicator at neutral.

Generally the movements of EMD HC Sov and US high yield are quite
closely correlated in terms of direction and magnitude, except in
certain situations. One of those situations is the sudden rates market
shifts and turmoil. The other situation is that of extreme
international tensions as were seen in 2018. In our monthly of August
2020, we introduced an indicator based on big-data sentiment to

Multi Asset Monthly 12

Equity outlook
• Earnings show strong, V-shaped recovery
• Yields are a key factor for equities
• The next phase of the cycle will bring a more
balanced sector performance
From early recovery to mid-cycle
Global equity markets moved higher again in April. The composition
of this performance, however, was different from previous months.
The full-fledged reflation trade has made way for a more balanced
upward move. One of its main drivers was the stabilization of long-
term US bond yields. This translated into a strong performance for
growth stocks, which are negatively correlated with bond yields. The
technology sector was among the best performers in April. Cyclical
sectors like materials also outperformed, while utilities and consumer
staples lagged the broader market. So where do we stand today?
The news on the pandemic front is mixed. On the one hand, the
vaccination roll-out is gaining momentum and the path towards
economic and social normalization has begun, especially in the UK
and the US. On the other hand, it is a bumpy road, given the
discovery of more contagious virus strains and vaccine delivery
problems. New infections are soaring in emerging markets like India
and Brazil that are not getting the virus under control. In Europe, we
expect the delivery issues to be resolved as more vaccines are
approved, which will also speed up the rate of inoculation and a
gradual re-opening of the economy, hopefully by the summer.
Fiscal policy will continue to provide support. The Biden
administration has announced a huge investment plan both in
physical and “human” infrastructure via the USD 2.3 trillion American
Jobs Plan and USD 1.8 trillion American Families Plan. The plan will
probably be passed using the reconciliation process, precluding the
need for bipartisan support if all the Democrats back the plan. The
debate is also focussing on the revenue side. A corporate tax increase
and higher capital gain tax are in the pipeline. Despite this headwind,
equity markets did not react much to the prospect of higher taxes.
In Europe, the German constitutional court has dismissed objections
regarding the European Recovery Fund. Member states have already
submitted their investment projects for approval and disbursement
of the funds could start sometime in the summer. If these plans are
well-executed and trigger more private investment, this could turn
out to be a once-in-a-decade opportunity to lift the economy out of
its secular stagnation. For equities this would mean lower risk
premiums and structurally higher earnings growth. Monetary policy
remains easy, despite a likely acceleration in inflation in the coming
months. These temporary upticks are driven by base effects and one-
off items such as spending of excess savings.
Companies have published strong first-quarter results. In the US, 85%
of companies beat estimates so far, by more than 28% on average.
The absolute earnings growth number is expected to be over 40%.
Eurozone results are equally positive. Guidance is also optimistic and
is reflected in an upward revision of the next quarters’ earnings
consensus. Even so, we believe that full-year estimates are still too
low given the GDP forecasts for this year.
The market reaction to these numbers has been somewhat
lukewarm, which could indicate that company guidance figures were
well above the consensus numbers. This is comparable to what
occurred in previous reporting periods: a weak start that gains
traction as the season progresses. The second quarter will show the
biggest growth acceleration due to base effects and in the second
Multi Asset Monthly
half of the year, the numbers will start to normalize.
In the past few months, equity markets have also been driven by the
volatility in the bond market. Rising yields led to a strong
performance of value stocks and cyclical sectors. As this upward
momentum faded in April, a partial reversion of the value-versus-
growth trade occurred. The technology sector, which was a laggard
at the beginning of the year, rebounded and financials hit a speed
bump despite very strong first-quarter results.
It is clear that yields matter for certain sectors, but are rising yields a
risk for equity markets as a whole? We make two observations.
First, the correlation between yields and equity markets is not stable.
However, in the early phase of a recovery, both often move in
tandem as a better growth outlook compensates for higher yields.
Secondly, the cause of the rate rise is important. Is it linked to a shift
in monetary policy expectations, to the improvement in the growth
outlook, or to rising inflation expectations?
All these factors play a role, but we think the rapidly improving macro
outlook is the most credible and sustainable driver. Central banks will
be extremely careful how they communicate their exit strategy from
unconventional monetary policy measures and keep a close eye on
financial conditions, as the rise in inflation is still considered
temporary.
Figure 1: Risk premium proxy: earnings yield minus bond yield
Source: Refinitiv Datastream, NN Investment Partners
The net impact will ultimately depend on two factors: expected
earnings growth and the speed at which yields rise. One way to
illustrate this is to relate the equity risk premium to the market
performance one month, three months and six months ahead.
Based on this metric, the risk/return trade-off for the US market
deteriorated rapidly in March. It fell dangerously close to levels that,
since the global financial crisis, have produced negative results three
months ahead. However, these periods of negative returns often
coincided with tighter monetary policy (2017-2018), which is not in
the cards today. In April, the equity market also received some
oxygen from the yield factor as well as from the growth factor.
This makes us believe that if yields rise in an orderly way and are
justified by improving macro data, they will not derail the bull
market. Taking into account consensus earnings estimates for 2021
(+28%) and 2022 (+12%), US 10-year bond yields could gradually rise
to 180 bps by the end of this year. A higher earnings growth number
would push this threshold even higher. The key word here is
“gradually”. A more rapid increase in yields would lead to either a
long consolidation period or a short correction in order to push the
equity risk premium back up to levels consistent with a positive
risk/return trade-off.
13
Investor behaviour Equity Sector Allocation
Investor sentiment indicates a high level of optimism, which is Figure 3: Equity sector allocation
understandable but not irrational, given the sharp improvement in Energy
the underlying fundamentals. But optimism in itself is not enough to Health Care
Technology
trigger a market correction. It simply means the market has become Materials
more vulnerable to bad news. In the absence of such news, markets Staples
can consolidate, or they can grind higher. Consumer Disc.
Financials
Utilities
Of course, there were signs of exuberance earlier in the year, Real Estate
especially in hard-to-value assets like special-purpose acquisition Industrials
companies (SPACs) and crypto currencies, and we witnessed a strong -2 -1 0 1 2
rise in IPOs, including SPACs, and secondary offerings. A positive sign Source: NN Investment Partners Allocation preference

is that the frenzy in these types of assets has faded over the past few
weeks, illustrating a more rational exuberance that makes investors
discriminate between fundamentally driven and speculation-driven
asset prices. So it seems premature to talk about a widespread equity
market bubble at this point.
Figure 2: Investor sentiment indicator (Z-score)
From a regional perspective we maintain a moderate overweight in
the UK and a moderate underweight in Switzerland. We kept our
overweight in US small-cap stocks following the sharp pullback, as we
think the earnings growth for these types of company will be very
strong over the current and next quarters, given their higher
cyclicality. The biggest risk for this trade would be a shift to quality
and a sharp rise in real yields.

Finally, we maintain our value versus growth overweight. We have

entered the phase in the cycle where earnings growth is not a scarce
asset. Low valuations however are much harder to find, hence our
value overweight.

Patrick Moonen
Principal Strategist Multi Asset

Source: Refinitiv Datastream, NN Investment Partners

Moreover, equity inflows are accelerating and equity buybacks will

probably jump this year, following the strong increase in expected
cash flow generation by companies. If companies in the financials
sector meet minimum regulatory requirements, they too will be
allowed to buy back shares again.

Positioning
In the light of the strong fundamentals and the absence of a taper-
tantrum type of move in real bond yields, we maintain our moderate
overweight in global equities.

One focus point in the coming months will be the gradual shift from a
pure reflation and cyclical trade towards a more balanced trade.
History shows that as the economy moves from the recovery phase
to the mid-cycle phase, sector performance starts to shift from
cyclical-growth sectors towards secular growth and quality. This cycle
has not reached its midpoint but it is advancing very quickly due to
the event-driven nature of the preceding downturn and the
unprecedented policy support that followed. With this pattern in
mind, we made some changes in April. We downgraded energy to
neutral, upgraded technology to a moderate overweight and
consumer staples to neutral. Materials remains our preferred sector
as it is a beneficiary of higher commodity prices and more
infrastructure spending.

Multi Asset Monthly 14

Commodity outlook
• Most prices rebound to pre-pandemic levels
• Correlation breakdown signals normalization
Recovery theme keeps commodities buoyant
Commodities continued to rise in April with the help of cyclical
sectors, particularly agriculture. The energy sector continued its
upward trend and industrial metals rallied even more robustly
against a backdrop of strong demand in China, supply restraint and
broad economic recovery data in developed markets. In contrast,
precious metals underperformed but found support against further
downward pressure. The rally in the agriculture sector was driven by
bad weather that affected crops and by massive orders from China.
With more than 80% of individual commodities rebounding to pre-
pandemic levels, the economic recovery theme in most developed
regions is still dominating commodity markets. Investors are willing
to look through headwinds caused by the resurgence of Covid-19 in
some developing countries, so we have maintained our cyclical
positions in WTI, Brent and aluminium.
Figure 1: Commodity sector performance YTD (USD)
Source: Bloomberg, NN Investment Partners
Correlation breakdown signals normalization
Although commodity investing is usually considered an effective way
to diversify a traditional portfolio, certain correlations with some
equity and fixed income assets do exist. The negative relationship
between gold and US real yields is one example. Intuitively, higher
real yields simply make the US dollar a more attractive asset than
gold as non-yielding asset. However, real yield is not the only driver
of gold prices, so the relationship might break down when other
intrinsic drivers prevail, such as demand and supply dynamics.
From a top-down perspective, the commodity sector as a whole also
tends to move together with other risky assets. Figure 2 illustrates
the correlation between commodities and equities since 2001
through April 2021 on a 6-month rolling basis. Unsurprisingly, the
correlations stayed positive but below 0.5 for most of the time, which
validates the potential diversification effect of commodity investing.
The correlations showed a strong cyclical pattern and sometimes
went above 0.5, however, indicating that the diversification benefit is
not constant.
Multi Asset Monthly
Figure 2: Correlation (BCOM vs MSCI World, daily return series)
Source: Bloomberg, NN Investment Partners
To capture the cyclical traits, we employed the Pettitt test, a non-
parametric test that detects sudden changes in central tendency of a
time series, and identified seven structural change points during the
sample period. In periods when systemic risk accumulates and both
equities and commodities sell off, such as during the 2008 financial
crisis and last year’s Covid crisis, the correlation between the two
asset classes is high. In other words, certain shared global drivers of
risky assets could result in high correlation. Conversely, correlations
tend to be lower during periods of recovery or normalization.
The most recent structural change point was a downturn on 8
January, indicating that the market has started to overlook the
pandemic and has stayed in normalization mode despite the
repetitive virus resurgences in EU, US, and emerging markets. In
contrast, gold serves as a much better candidate for hedging purpose
under those circumstances. As Figure 3 shows, the correlation
between gold and equity moved around zero in the same sample
period and the relationship usually turned to negative in a crisis.
Figure 3: Correlation (gold vs MSCI World)
Source: Bloomberg, NN Investment Partners
Having confirmed the normalization trend in the commodity market
with the evidence from our correlation analysis, we anticipate that
towards the end of 2021, commodities, being less synchronized with
the equity market, will be supported by the current cyclical tailwind
and catch-up with equities to some degree after a decade of
underperformance.
Chengbo Yang
Junior Data Scientist
15
Authors

Ewout van Schaick Marco Willner

Head of Multi Asset Head of Investment Strategy

Maarten-Jan Bakkum
Willem Verhagen
Emerging Markets Strategist Multi Asset
Senior Economist

Patrick Moonen Aviral Utkarsh

Principal Strategist Multi Asset Multi Asset Strategist

Fouad Mehadi, CFA Alireza Kahali

Senior Investment Strategist Fixed Income Multi Asset Strategist

Koen Straetmans Chengbo Yang

Senior Strategist Multi Asset Junior Data Scientist

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Multi Asset Monthly 16