By Ineke Valke, Senior Investment Strategist, Theodoor Gilissen, a member of KBL European Private Bankers
The 2015 outlook for equities – supported by favorable economic policies, a narrowing output gap and ongoing profit growth – remains positive, especially compared to expected yields on other asset classes. The US and Japan should both outperform, while listed real estate continues to appear satisfying.
Over the past several years, equity prices have decoupled from the global economy, far outpacing the rate of macroeconomic growth. Moving forward, we expect that trend to continue, although returns may be below historical averages – particularly as market volatility increases. Given that the global economy is expected to witness continued expansion in 2015, we see little risk of market collapse.
In fact, there are additional underlying factors that should continue to support equities, including increased M&A activity, a lack of high-yielding alternatives and the further strengthening of the US dollar.
Indeed, although bonds and equities are both inversely correlated to interest rates, the relationship tends to be stronger with the former: while bond prices almost always fall when interest rates rise, equity prices do not necessarily behave the same way. Equities tend to be well-suited to dollar bull markets, so we anticipate that equity markets will strengthen throughout 2015 along with the dollar.
For 2015, we have a preference for US and Japanese equities, although this view may need to be revisited over the course of the year due to changes in valuations and overall momentum, including potential surprises from Japan.
US equities have outperformed for six of the last seven years, but we still see room for further outperformance. Given the low recovery rate following an unusually severe decline, the US business cycle remains in its initial growth phase – even though that cycle is now entering its sixth year. Meanwhile, American firms will continue to benefit from sustained US GDP expansion, which we forecast to reach 3% in 2015.
Historically, US equities trend in four-year cycles, with the strongest performance during the third year after a presidential election. (As the last such election took place in 2012, this provides further, albeit anecdotal, support for our bullish view on US equities in 2015.)
A number of analysts have pointed out that, as profit margins at US firms are high by historical standards, they will inevitably decline over the next 12 months. It is true that margins have been steadily climbing since 2000 – with the exception of one very steep decline in 2010 – and we agree that a slight decline is possible in 2015, exacerbated by the strong US dollar. However, given current cost controls and efficiencies, we believe that US corporate margins will generally hold up.
As mentioned earlier, we are also positive on Japanese equities. Increased support from the BoJ combined with decreases in corporate tax rates are key factors in that regard. At the same time, labor costs continue to decline by more than 4% annually, as pricey full-time workers are retiring and being replaced by younger, less-expensive and/or part-time staff.
Recently, Japanese companies have generally chosen to expand margins and profits – rather than increase market share. That is primarily because Japanese exporters have not yet adjusted dollar-linked prices downward in line with the falling yen.
Indeed, since the start of 2013, profits on the Tokyo Stock Price Index (Topix) have risen nearly 50%. As exports are likely to continue to improve, companies could realize satisfying profit growth of 13% in 2015.
It is also important to note that the GPIF, Japan’s massive state pension fund, will increase exposure to Japanese equities in 2015.
In that regard, the GPIF will be tracking the newly launched Nikkei Index 400, which focuses on companies with good corporate governance and high and recurring profitability.
Overall, however, profitability levels remain low in Japan, as does labor-force productivity, which stands at some 40% below the level of France on an hourly basis. Japanese companies also have the world’s highest level of operating leverage – due to the cost of both fixed expenses and the country’s inflexible workforce.
Compared to other advanced nations, Japan’s corporate sector also has extremely high cash holdings as a percentage of market capitalization; while that provides a cushion against potential shocks, it is also serving as a drag on the economy, as insufficient liquidity is being unlocked for investment.
That said, Japan boasts a high level of innovation, and return on equity is improving. Dividends are also increasing, while valuations remain attractive, offering a 10% price-to-earnings (PE) discount to US equities.
We have identified two equity styles that we believe will prove especially appealing in 2015: first, stable, high-dividend companies, particularly from the eurozone; and second, large caps, with a focus on companies with strong price-setting power.
The former category – stable, high-dividend firms from the eurozone – already offers significant spreads, which will likely remain wide moving forward.
As well, eurozone-based, high-dividend stocks are trading at a discount to the overall market – partly a consequence of value traps due to recent dividend cuts by telecom and utility companies.
Meanwhile, major listed firms with dominant market share will benefit from increasingly favorable macroeconomic conditions in 2015. Indeed, during a period when small caps are trading at considerable price-to-earnings premiums, we see special opportunities in such large caps.
In 2015, European companies, half of whose sales are made outside Europe, are likely to benefit from a lower euro. Such equities should likewise profit from an undervalued currency, given that a 10% decline of the euro against the dollar provides additional 8% growth in earnings per share.
An improvement in the US will prove a further benefit, though with a time lag. Nevertheless, we maintain a neutral position on European equities in 2015.
The declining eurozone growth outlook is one of the main reasons for our caution. We also expect earnings estimates to be adjusted further downward, as the profitability track record of European companies remains far from convincing.
Over the course of 2015, as macroeconomic growth rates start to pick up, our view on European equities is likely to become more positive: Europe can outperform when the euro weakens or inflation rises. This could be a trigger for a re-rating of corporate profitability. Moreover, dividend yields remain attractive vis-à-vis bond yields.
EMERGING MARKET EQUITIES
Our position on 2015 emerging markets equities is also neutral.
A range of emerging-market countries are being hit by reduced energy exports to the US. This has led to increased inflation (which will accelerate if the dollar rises further), additional state spending on dollar-denominated subsidies and lower commodity prices. At the same time, however, commodity importing EM countries are benefiting from those low prices.
Across the EM universe, unit labor costs have been increasing faster than in developed countries, leading to a deterioration in emerging market labor expenses and, more broadly, a decline in the competitive advantage of this broad region of the world. At the same time, too few EM countries and companies are successfully transitioning away from manufacturing.
Emerging market equity indices are similarly marked by a lack of diversity, with too much energy, materials and industry. An additional drag on profits is the fact that the non-working segment of the population is rising faster than the working age population.
We therefore view EM equities as less attractive than US, Japanese and even European shares. However, there are at least two notable exceptions to this view: India and China.
India, a commodity importer, is set to benefit from a range of government-led reforms and, of course, lower oil prices. In turn, Indian consumers will see a rise in disposable income rates, supporting the country’s nascent equity market.
China is in the midst of a major shift away from industrial production towards services, and is also now tackling corruption. These changes will dampen short-term growth and could lead to shocks. To avoid a hard landing and attendant social tensions, Beijing has injected a series of what the state terms “mini-stimulus” measures over the course of 2014.
More important for Chinese equities is further reform and diversification of the country’s capital markets, which is positively impacting both foreign and domestic investors. Consequently, China’s weighting in emerging market indices could be boosted, triggering additional investment.
LISTED REAL ESTATE
We remain positive on the outlook for global real estate. Quantitative easing continues to support asset-price inflation, and property as an asset class will benefit from this ongoing trend.
Over the last several years, construction activity has been sluggish. As a consequence, especially in markets such as the US, UK, Canada and Australia, real home prices are now accelerating at healthy levels. (That said, prices continue to decline in markets like France, Spain, Italy and Japan, reflecting underlying structural concerns.)
Globally, however, sectoral supply and demand are increasingly at equilibrium, thanks to lower unemployment levels and higher income growth, as well as a balancing of affordability rates.
Moving forward, gradual macroeconomic improvement will lead to a concomitant increase in demand – and higher prices. Already, transaction volumes are recovering, and both rents and prices are rising.
Today, dividend yields for real estate companies are very attractive compared to bond yields. Such dividend payments are likely to increase in future, including by at least 8% for listed property companies in the United States.
However, when central banks start hiking interest rates (and interest yields begin to rise), the market may react negatively.
We believe that such a scenario is nevertheless not imminent, and expect monetary policies to remain accommodative in the near future, with yields rising only modestly over the same period.
Taking control of compliance: how FS institutions can keep up with the ever-changing regulatory landscape
By Charles Southwood, Regional VP – Northern Europe and MEA at Denodo
The wide-spread digital transformation that has swept the financial services (FS) sector in recent years has brought with it a world of possibilities. As traditional financial institutions compete with a fresh wave of challenger banks and fintech startups, innovation is increasing at an unprecedented pace.
Emerging technologies – alongside the ever-evolving concept of online banking – have provided a platform in which the majority of customer interactions now take place in a digital format. The result of this is a never-ending stream of data and digital information. If used correctly, this data can help drive customer experience initiatives and shape wider business strategies, giving organisations a competitive edge.
However, before FS organisations can utilise data-driven insights, they need to ensure that they can adequately protect and secure that data, whilst also complying with mandatory regulatory requirements and governance laws.
The regulation minefield
Regulatory compliance in the FS sector is a complex field to navigate. Whether its potential financial fraud or money laundering, risk comes in many different forms. Due to their very nature – and the type of data that they hold – FS businesses are usually placed under the heaviest of scrutiny when it comes to achieving compliance and data governance, arguably held to a higher standard than those operating in any other industry.
In fact, research undertaken last month discovered that the General Data Protection Regulation (GDPR) has had a greater impact on FS organisations than any other sector. Every respondent working in finance reported that the changes made to their organisation’s cyber security strategies in the last three years were, at least to some extent, as a result of the regulation.
To make matters even more confusing, the goalpost for 100% compliance is continually moving. In fact, between 2008 and 2016, there was a 500% increase in regulatory changes in developed markets. So even when organisations think they are on the right track, they cannot afford to become complacent. The Markets in Financial Instruments Directive (MiFID II), the requirements for central clearing and the second Payment Service Directive (PSD2), are just some examples of the regulations that have forced significant changes on the banking environment in recent years.
Keeping a handle on this legal minefield is only made more challenging by the fact that many FS organisations are juggling an unimaginable amount of data. This data is often complex and of poor quality. Structured, semi-structured and unstructured, it is stored in many different places – whether that’s in data lakes, on premise or in multi-cloud environments. FS organisations can find it extremely difficult just to find out exactly what information they are storing, let alone ensure that they are meeting the many requirements laid out by industry regulations.
A secret weapon
Modern technologies, such as data virtualisation, can help FS organisations to get a handle on their data – regardless of where it is stored or what format it is in. Through a single logical view of all data across an organisation, it boosts visibility and real-time availability of data. This means that governance, security and compliance can be centralised, vastly improving control and removing the need for repeatedly moving and copying the data around the enterprise. This can have an immediate impact in terms of enabling FS organisations to avoid data proliferation and ‘shadow’ IT.
In addition to this, when a new regulation is put in place, data virtualisation provides a way to easily find and access that data, so FS organisations can respond – without having to worry about alternative versions of that data – and ensures that they remain compliant from the offset. This level of control can be reflected even down to the finest details. For example, it is possible to set up access to governance rules through which operators can easily select who has access to what information across the organisation. They can alter settings for sharing, removing silos, masking and filtering through defined, role-based data access. In terms of governance, this feature is essential, ensuring that only those who have the correct permissions to access sensitive information are able to do so.
Compliance is a requirement that will be there forever. In fact, its role is only likely to increase as law catches up with technological advancement and the regulatory landscape continues to change. For FS organisations, failure to meet the latest legal requirements could be devastating. The monetary fines – although substantial – come second to the potential reputation damage associated with non-compliance. It could be the difference between an organisation surviving and failing in today’s climate.
No one knows what is around the corner. Whilst some companies may think they are ahead of the compliance game today, that could all change with the introduction of a new regulation tomorrow. The best way to ensure future compliance is to get a handle on your data. By providing total visibility, data virtualisation is helping organisations to gain back control and win the war for compliance.
TCI: A time of critical importance
By Fabrice Desnos, head of Northern Europe Region, Euler Hermes, the world’s leading trade credit insurer, outlines the importance of less publicised measures for the journey ahead.
After months of lockdown, Europe is shifting towards rebuilding economies and resuming trade. Amongst the multibillion-euro stimulus packages provided by governments to businesses to help them resume their engines of growth, the cooperation between the state and private sector trade credit insurance underwriters has perhaps missed the headlines. However, this cooperation will be vital when navigating the uncertain road ahead.
Covid-19 has created a global economic crisis of unprecedented scale and speed. Consequently, we’re experiencing unprecedented levels of support from national governments. Far-reaching fiscal intervention, job retention and business interruption loan schemes are providing a lifeline for businesses that have suffered reductions in turnovers to support national lockdowns.
However, it’s becoming clear the worst is still to come. The unintended consequence of government support measures is delaying the inevitable fallout in trade and commerce. Euler Hermes is already seeing increase in claims for late payments and expects this trend to accelerate as government support measures are progressively removed.
The Covid-19 crisis will have long lasting and sometimes irreversible effects on a number of sectors. It has accelerated transformations that were already underway and had radically changed the landscape for a number of businesses. This means we are seeing a growing number of “zombie” companies, currently under life support, but whose business models are no longer adapted for the post-crisis world. All factors which add up to what is best described as a corporate insolvency “time bomb”.
The effects of the crisis are already visible. In the second quarter of 2020, 147 large companies (those with a turnover above €50 million) failed; up from 77 in the first quarter, and compared to 163 for the whole of the first half of 2019. Retail, services, energy and automotive were the most impacted sectors this year, with the hotspots in retail and services in Western Europe and North America, energy in North America, and automotive in Western Europe
We expect this trend to accelerate and predict a +35% rise in corporate insolvencies globally by the end of 2021. European economies will be among the hardest hit. For example, Spain (+41%) and Italy (+27%) will see the most significant increases – alongside the UK (+43%), which will also feel the impact of Brexit – compared to France (+25%) or Germany (+12%).
Companies are restarting trade, often providing open credit to their clients. However, there can be no credit if there is no confidence. It is increasingly difficult for companies to identify which of their clients will emerge from the crisis from those that won’t, and whether or when they will be paid. In the immediate post-lockdown period, without visibility and confidence, the risk was that inter-company credit could evaporate, placing an additional liquidity strain on the companies that depend on it. This, in turn, would significantly put at risk the speed and extent of the economic recovery.
In recent months, Euler Hermes has co-operated with government agencies, trade associations and private sector trade credit insurance underwriters to create state support for intercompany trade, notably in France, Germany, Belgium, Denmark, the Netherlands and the UK. All with the same goal: to allow companies to trade with each other in confidence.
By providing additional reinsurance capacity to the trade credit insurers, governments help them continue to provide cover to their clients at pre-crisis levels.
The beneficiaries are the thousands of businesses – clients of credit insurers and their buyers – that depend upon intercompany trade as a source of financing. Over 70% of Euler Hermes policyholders are SMEs, which are the lifeblood of our economies and major providers of jobs. These agreements are not without costs or constraints for the insurers, but the industry has chosen to place the interests of its clients and of the economy ahead of other considerations, mindful of the important role credit insurance and inter-company trade will play in the recovery.
Taking the UK as an example, trade credit insurers provide cover for more than £171billion of intercompany transactions, covering 13,000 suppliers and 650,000 buyers. The government has put in place a temporary scheme of £10billion to enable trade credit insurers, including Euler Hermes, to continue supporting businesses at risk due to the impact of coronavirus. This landmark agreement represents an important alliance between the public and private sectors to support trade and prevent the domino effect that payment defaults can create within critical supply chains.
But, as with all of the other government support measures, these schemes will not exist in the long term. It is already time for credit insurers and their clients to plan ahead, and prepare for a new normal in which the level and cost of credit risk will be heightened and where identifying the right counterparts, diversifying and insuring credit risk will be of paramount importance for businesses.
Trade credit insurance plays an understated role in the economy but is critical to its health. In normal circumstances, it tends to go unnoticed because it is doing its job. Government support schemes helped maintain confidence between companies and their customers in the immediate aftermath of the crisis.
However, as government support measures are progressively removed, this crisis will have a lasting impact. Accelerating transformations, leading to an increasing number of company restructurings and, in all likelihood, increasing the level of credit risk. To succeed in the post-crisis environment, bbusinesses have to move fast from resilience to adaptation. They have to adopt bold measures to protect their businesses against future crises (or another wave of this pandemic), minimize risk, and drive future growth. By maintaining trust to trade, with or without government support, credit insurance will have an increasing role to play in this.
What Does the FinCEN File Leak Tell Us?
By Ted Sausen, Subject Matter Expert, NICE Actimize
On September 20, 2020, just four days after the Financial Crimes Enforcement Network (FinCEN) issued a much-anticipated Advance Notice of Proposed Rulemaking, the financial industry was shaken and their stock prices saw significant declines when the markets opened on Monday. So what caused this? Buzzfeed News in cooperation with the International Consortium of Investigative Journalists (ICIJ) released what is now being tagged the FinCEN files. These files and summarized reports describe over 200,000 transactions with a total over $2 trillion USD that has been reported to FinCEN as being suspicious in nature from the time periods 1999 to 2017. Buzzfeed obtained over 2,100 Suspicious Activity Reports (SARs) and over 2,600 confidential documents financial institutions had filed with FinCEN over that span of time.
Similar such leaks have occurred previously, such as the Panama Papers in 2016 where over 11 million documents containing personal financial information on over 200,000 entities that belonged to a Panamanian law firm. This was followed up a year and a half later by the Paradise Papers in 2017. This leak contained even more documents and contained the names of more than 120,000 persons and entities. There are three factors that make the FinCEN Files leak significantly different than those mentioned. First, they are highly confidential documents leaked from a government agency. Secondly, they weren’t leaked from a single source. The leaked documents came from nearly 90 financial institutions facilitating financial transactions in more than 150 countries. Lastly, some high-profile names were released in this leak; however, the focus of this leak centered more around the transactions themselves and the financial institutions involved, not necessarily the names of individuals involved.
FinCEN Files and the Impact
What does this mean for the financial institutions? As mentioned above, many experienced a negative impact to their stocks. The next biggest impact is their reputation. Leaders of the highlighted institutions do not enjoy having potential shortcomings in their operations be exposed, nor do customers of those institutions appreciate seeing the institution managing their funds being published adversely in the media.
Where did the financial institutions go wrong? Based on the information, it is actually hard to say where they went wrong, or even ‘if’ they went wrong. Financial institutions are obligated to monitor transactional activity, both inbound and outbound, for suspicious or unusual behavior, especially those that could appear to be illicit activities related to money laundering. If such behavior is identified, the financial institution is required to complete a Suspicious Activity Report, or a SAR, and file it with FinCEN. The SAR contains all relevant information such as the parties involved, transaction(s), account(s), and details describing why the activity is deemed to be suspicious. In some cases, financial institutions will file a SAR if there is no direct suspicion; however, there also was not a logical explanation found either.
So what deems certain activities to be suspicious and how do financial institutions detect them? Most financial institutions have sophisticated solutions in place that monitor transactions over a period of time, and determine typical behavioral patterns for that client, and that client compared to their peers. If any activity falls disproportionately beyond those norms, the financial institution is notified, and an investigation is conducted. Because of the nature of this detection, incorporating multiple transactions, and comparing it to historical “norms”, it is very difficult to stop a transaction related to money laundering real-time. It is not uncommon for a transaction or series of transactions to occur and later be identified as suspicious, and a SAR is filed after the transaction has been completed.
FinCEN Files: Who’s at Fault?
Going back to my original question, was there any wrong doing? In this case, they were doing exactly what they were required to do. When suspicion was identified, SARs were filed. There are two things that are important to note. Suspicion does not equate to guilt, and individual financial institutions have a very limited view as to the overall flow of funds. They have visibility of where funds are coming from, or where they are going to; however, they don’t have an overall picture of the original source, or the final destination. The area where financial institutions may have fault is if multiple suspicions or probable guilt is found, but they fail to take appropriate action. According to Buzzfeed News, instances of transactions to or from sanctioned parties occurred, and known suspicious activity was allowed to continue after it was discovered.
How do we do better? First and foremost, FinCEN needs to identify the source of the leak and fix it immediately. This is very sensitive data. Even within a financial institution, this information is only exposed to individuals with a high-level clearance on a need-to-know basis. This leak may result in relationship strains with some of the banks’ customers. Some people already have a fear of being watched or tracked, and releasing publicly that all these reports are being filed from financial institutions to the federal government won’t make that any better – especially if their financial institution was highlighted as one of those filing the most reports. Next, there has been more discussion around real-time AML. Many experts are still working on defining what that truly means, especially when some activities deal with multiple transactions over a period of time; however, there is definitely a place for certain money laundering transactions to be held in real time.
Lastly, the ability to share information between financial institutions more easily will go a long way in fighting financial crime overall. For those of you who are AML professionals, you may be thinking we already have such a mechanism in place with 314b. However, the feedback I have received is that it does not do an adequate job. It’s voluntary and getting responses to requests can be a challenge. Financial institutions need a consortium to effectively communicate with each other, while being able to exchange critical data needed for financial institutions to see the complete picture of financial transactions and all associated activities. That, combined with some type of feedback loop from law enforcement indicating which SARs are “useful” versus which are either “inadequate” or “unnecessary” will allow institutions to focus on those where criminal activity is really occurring.
We will continue to post updates as we learn more.
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