Deutsche Asset & Wealth Management CIO Stefan Kreuzkamp, who evaluates asset classes using a top-down approach, is positive on European equities and non-energy US high yield bonds. To achieve decent gains in 2016, investors have to take a nimble, active approach, he says.

Global financial markets, already reeling from the sudden downturn in 3Q2015, could face more headwinds in 2016 on the back of interest rate hikes from the US Federal Reserve, slower-than-expected economic growth from China and rising geopolitical uncertainties.

Nonetheless, decent gains could still be achieved with equities and bonds in the coming year if investors carefully select where they want to put their money in within these two broad asset classes, according to Stefan Kreuzkamp, the newly appointed global chief investment officer (CIO) at Deutsche Asset & Wealth Management (Deutsche AWM), which is the investment and wealth management division of Deutsche Bank.

As Kreuzkamp sees it, non-energy US high-yield bonds and European equities particularly German stocks and financial counters may still turn in positive gains next year while emerging markets (EM) and US equities could struggle. He emphasises the importance of looking at asset classes from a top-down ‘helicopter’ perspective, given the numerous influencing macro factors out there. Indeed, monetary policies of central banks, dynamics of global economic growth as well as geopolitical events, all have implications on prices of global financial assets, he points out.

“I think from a helicopter perspective, you have to talk about growth, respective key drivers of growth and key risks to your projection. These are just key factors for investment decisions. This will also have implications on monetary policies and, finally, what this means for fixed income, equities, currencies and alternative assets. That means we also take risks like external shocks or global debt overhang closely into account,” Kreuzkamp tells Personal Wealth in a recent interview.

Deutsche AWM’s investment process starts with in-depth research, which is then translated into investment recommendations for its portfolio construction teams. Model port folios will then be created to serve as templates for individual clients’ portfolios, which will be adjusted to accommodate client guidelines and risk profiles.

“In every step, there is quality control. For research, we check the quality of the signals. We cannot allow bad signals as input for portfolios. Otherwise, performance will suffer at the end of the day,” says Kreuzkamp, who has two decades of investment experience. “We ensure that portfolios are implemented properly with respect to our fiduciary duties and best execution.”

Kreuzkamp, who is based in Frankfurt, is supported by a team of regional CIOs overseeing Asia-Pacific, US, and Europe, the Middle East and Africa. He himself rose to his current role from EMEA CIO and after having been with the firm for 17 years and establishing himself as a house expert on fixed income and cash.

Bond and equity bets
Within fixed income, Kreuzkamp is favouring US corporate credits such as high yields, where he still sees “some value left” with yields straddling between 8% and 9%. But he would avoid junk bonds issued by companies in the energy, metals and mining sectors, given depressed commodity prices. That is why he recommends that investors take an active strategy in their bond investments rather than passively track broad fixed income indices.

“Roughly 15% of US high yields are energy- related and oil-producing companies that may face default risk,” warns the CIO. Global oil prices could stay at low levels for a long period of time and that could put pressure on energy-related high-yield bonds, which will see a higher level of default rate going forward. “That makes a selective approach in managing US high yields especially important. Simple replication of the whole index might expose you to 15% potential default risk going forward,” he says.

On the equities front, he is expecting midsingle digit returns from global stocks, with periods of volatility in 2016. Global equities are at a maturing stage in the cycle, and companies such as those in the US are facing difficulties to organically grow their revenues above 3%, he says.

On the whole, Kreuzkamp remains cautious on EM stocks and prefers to take his bets on European equities versus those in the US. Stocks with decent dividend yields are also attractive in the face of the current low or negative interest rates environment, he points out.

“We prefer developed market equities over EM equities. EM equities are currently trading at a significant valuation discount. Still, we believe EM earnings estimates are too high and will have to be revised down even further,” says Kreuzkamp. EM equities, measured by the MSCI EM Index, were down 12.36% this year as at Nov 26.

Bullish on European stocks
“Regionally, we prefer Europe over US. US is trading rather rich right now. We have seen peak performance at [price-to-earnings] multiples of 18 times for the US markets. That was the peak. We expect the US dollar to strengthen and the euro to weaken. So, for export-oriented European companies, this is something that can improve their earnings situation. This is one of the reasons we prefer European stocks above US stocks,” he explains.

European stocks, measured by the Euro Stoxx 50 Index, were up more than 11% this year as at Nov 26. Local investors of European equities, however, are advised to hedge their exposure to the euro, which could continue to weaken against the greenback and other major currencies.

For European equities, German stocks look most attractive to Kreuzkamp. “There is always the risk of idiosyncratic events like the Volkswagen discussion in Germany recently. However, at the end of the day, we expect the growth in Germany to pick up slightly as it is one of the key export nations. We are still running our overweight position [in German stocks],” Kreuzkamp says. Stocks in Germany, as measured by the DAX Index, were up more than 15% on a year-to-date basis as at Nov 27.

He also likes high-dividend-paying European stocks. MSCI Europe currently has dividend yields of around 3%, he points out. Looking ahead, he expects higher dividend yields from European telecoms stocks and lower numbers from pharmaceutical counters.

The investment expert also makes a case for European financials, which have been doing relative well this year on the back of better- than-expected loan growth. Indeed, European banks have been bogged down by a slew of regulations in recent years, and that has hampered their ability to lend, Kreuzkamp says. But he now believes that a breather could be in the offing for European banks as stringent banking regulation eases to promote credit growth in the eurozone.

“There’s still a lot of discussion on regulations... more regulations [are] coming. But I smell some change of mind. The question has now risen [on whether] the banking sector is already over-regulated. We will definitely see some additional debate on this topic down the road.

“European banks’ limitation in their risk bearing capacity is already priced in. At current levels, you don’t have to buy their stocks from a dividend perspective, but from a price-appreciation perspective.”

Taking a step back, Deutsche AWM is not the only house advocating European equities. In fact, most institutional investors now have an overweight stance on European assets on the back of the [European Central Bank’s] ultra- loose monetary policy. Are European stocks an overcrowded trade? Kreuzkamp does not think so.

“From the perspective of Germany (where he is based), if you look at the share of equities in private-client portfolios, it’s below 10%. There should be more demand for European equity due to investors’ home bias, especially as European fixed income still remains at very low yield levels. Further, there are also retirement products in Germany that have to [be allocated] into risky assets, so there’s much more [funds] to come, but gradually,” he says.

Economic outlook
Kreuzkamp sees global economy growing over the course of the next year, but at a very slow pace. Still, this would be the seventh consecutive year of growth since the 2008 global financial crisis. Historically, economic expansion cycles last on average about five years.

Deutsche AWM’s estimate of 3.5% global economic growth next year is slightly below the International Monetary Fund’s estimate of 3.6% that was released in October. A key factor underpinning this cautious outlook is the growth problem that China is facing. Kreuzkamp is of the view that the world’s second-largest economy will grow at just 6% in 2016, lower than IMF’s 6.3% estimate. Following a high-level government planning meeting in late October, China’s president Xi Jinping said on Nov 3 that the country needs at least 6.5% annual growth in the coming years. According to some media reports, that was an indication of a lower official annual growth target under China’s five-year plan starting next year.

Kreuzkamp, however, is sceptical of China’s ability to achieve 6.5% growth in the coming years. “We have to dig a bit deeper. China is in a transition from an old production-type economy into a more consumption-based, technology-oriented economy. If you assume China has already made 50% of the way, and the old economy, which is energy-intensive, is not growing anymore, then the new economy has to grow by at least 13% to 14% to reflect the statement of the Chinese politicians. We think it is overly optimistic. We see 6%, rather.”

He also notes that since the global financial crisis, the US economy is still growing below its long-run average or potential growth rate, indicating underused resources. According to data from the US Federal Reserve, the output gap as at 3Q2015 is around US$509 billion ($719 billion), or 3% of potential GDP. Kreuzkamp projects the US economy to grow at 2.5% in 2016. That is lower than IMF’s estimate of 2.8%.

Time to hike rates
Nonetheless, judging from other key economic data, Kreuzkamp believes there is sufficient growth in the US to justify a modest rate hike by the Fed in December. Growth has accelerated in the past two years even though it has not regained the rates prior to the financial crisis. Third-quarter domestic demand grew briskly and is likely to remain supported. Labour market slack is being reduced by gains in non-farm payroll or the number of paid business employees.

With the US economy expected to grow at 2.5%, the inflation rate standing at roughly 1.5%, plus a robust labour market, interest rates in America should not be at a near-zero rate, he points out.

That is why he expects the Fed to hike rates in December by moving the Fed funds rate corridor from between 0 and 25 basis points to between 25 and 50 bps. He also expects two more hikes next year, with the Fed funds rate ending 2016 at 1%.

Will there be disruption to financial markets? Kreuzkamp thinks not. “The market already has enough time to prepare for the 25 bps-move in the next meeting. As long as the decisions this year and next year are strict and stringent, we do not expect a disruption in financial markets,” he says.

Furthermore, with the ECB and Bank of Japan still implementing quantitative easing (QE), the Fed will probably be among the handful of central banks in the world that will tighten monetary policy next year. “Given that we are expecting growth to be moderate and inflation to remain pretty low globally, the Fed might be the only central bank which is in the process of changing their monetary policy. This will not be a U-turn, but a slow ‘back-to-normal’. And we expect the Bank of England to follow later in 2016. One thing pretty clear to us is that the ECB and BOJ will still remain ultra-loose in their monetary policy,” says Kreuzkamp, who isn’t too bearish on bonds.

Ample liquidity in the global financial markets on the back of large-scale QE policies in Europe and Japan will be supportive of bond prices despite rate hikes in the US, he reasons. Besides, he adds, there is still a lot of demand out there for fixed-income investments, particularly from the US, given that US equity markets are trading at rich valuations now while dividend yields are low. Citing his study of investor behaviour in the US, he points out that investors tend to go into fixed income when dividend yield of Standard & Poor’s 500 Index goes below the yield of 10-year US treasuries. Average dividend yields for S&P 500 companies currently stand at 2.1%, while 10-year US treasuries are currently yielding 2.2%.

Deutsche Bank to split its fund and wealth management units
Stefan Kreuzkamp’s recent promotion to the position of chief investment officer of Deutsche Bank’s asset and wealth management division (Deutsche AWM) comes as the international banking group undergoes fundamental reorganisation.

The German bank announced in October that starting 1Q2016, its funds business will be split from the wealth management business, with the latter being moved to another existing division — private and business clients. What remains is Deutsche asset management, which will become a standalone business division that focuses exclusively on institutional clients and the funds business. Kreuzkamp’s predecessor, Asoka Wöhrmann, went on to become head of retail banking at Deutsche Bank’s private and business clients division.

“Asoka is leaving the house — and in fact the house is in a very good shape. The fact that he has built the platform below him and not around him ensures a really great transition of his work load onto me,” says Kreuzkamp. The Frankfurt-based CIO, who was in Asia recently, did not want to say much on the recent corporate development at his company, but assures that it will be pretty much “business as usual” at the division’s investment office.

The investment office at Deutsche AWM is responsible for the equity, fixed income and multiasset portfolio management teams worldwide, as well as the global research team. It is responsible for the performance of Deutsche AWM’s active investment strategies, as well as overseeing its investment processes. It also generates Deutsche AWM’s global investment outlook. As at end-June, Deutsche AWM managed €1.1 trillion ($1.6 trillion) assets, of which €656 billion were managed under active strategies.

Kreuzkamp has been with Deutsche AWM since 1998, working at the firm’s money market desk before moving into fixed-income fund management. Most recently, he was Deutsche AWM’s regional CIO of Europe, the Middle East and Africa, overseeing equities, fixed-income and multi-asset investments. Before joining Deutsche Bank, Kreuzkamp was a researcher at Dekabank in Frankfurt.

This article appeared in the Personal Wealth of Issue 706 (Dec 2) of The Edge Singapore.