Staying on course despite headwinds

---

Investment Outlook 2019

Staying on course despite headwinds

The unrest on the stock market in recent months may well persist. In our outlook you can read how to deal with this.

Contents 4 Macroeconomics

Less “more”, but not a recession

8 Asset class analysis

Waves becoming a bit higher

13

Sustainable investment

CO2 emissions and human resource policy: important themes

18 Investment strategies policy

For the time being: light emphases

20

Commodities

We are maintaining a neutral weighting for commodities

23

Technical analysis

The end of the ten-year bull market in the AEX?

ING’s outlook by sector 29

Consumer discretionary

32

Consumer staples

38

Utilities

40

44

42

Real estate

46

Energy

52

Information technology

Materials

Financials

Industrials

35

Healthcare

54

Communication services

49

Simon Wiersma Investment manager

Macroeconomics

Less “more”, but not a recession As we wrote in our update of Outlook 2018, the peak of economic growth is now behind us in most regions. As central bank support is expected to decline, there will be more pressure on governments to stimulate growth. And for various reasons that will be difficult. Therefore, whether the current relatively strong global growth is sustained depends very much on business investment and consumer spending with everything depending upon confidence. The confidence of households and businesses is an uncertain factor as this is being put to the test by (geo)political unrest, such as the protectionist policy of the Trump administration and Brexit. The US-Chinese trade conflict in particular is expected to have a (small) negative effect on global economic growth in the coming year. In addition, bond yields will rise slightly. This is due to rising inflation and the fact that the central banks are turning off the money tap a little further. All in all, economic growth remains at a relatively high level and there is certainly no impending recession. Almost the longest growth period ever Economists have recently been discussing the timing of the next recession more and more often. The United States (US) is regarded as a yardstick in this respect. After all, it is the world’s largest economy, which has a major influence on what happens in the rest of the world. The sustainability of the growth of the US economy is increasingly being questioned,

which is understandable considering that it has been growing continuously for almost ten years. If growth continues until at least the summer of 2019, it will be the longest growth period ever! Only in the period 1991-2001 has there been a longer period of economic growth up until now. This will have to come to an end sometime, right? For investors, the question when the next recession will be is at least as important. The S&P 500 Index, which includes the largest listed US companies, is the most important stock market indicator. Since 2009, this index has been in the throes of the longest ever bull market (period of mainly rising prices). Only during the period before the Internet bubble burst in 2001 did the S&P 500 rise even faster in percentage terms. Larger portion of profit to providers of capital Nevertheless, for many people the last ten years have been very different from previous periods of

4

economic prosperity. Thus, for example, the average annual economic growth in the US (and many other regions) has been much lower than we were used to since the start of the recovery in 2009. The fact that the stock markets have substantially recovered is mainly due to the distribution of the profits made. In the Western world, an increasing proportion of these profits is in fact benefiting the providers of capital. The profit is mainly distributed to the shareholders in the form of price gains and dividend. In the past decade, a smaller part went to the employees, in the form of wages. Despite the economic prosperity, there is considerable dissatisfaction. To a large extent this explains the rise of populism in countries like the US and Italy. Brexit too is a sign of dissatisfaction. This time it’s different But does this mean that we now have to prepare ourselves for a global recession? We don’t believe so. There is growth, but the average growth rate is lower than it was previously after recessions. As a result, an imbalance in the economy does not arise as quickly and the growth period may well last longer than we are used to. This is our baseline scenario for the coming year as economic cycles do not end simply because of age. More is needed than that. The end of the party is often heralded by strongly rising interest rates, in combination with excessive lending. In our opinion, it is still too early for this. Trade war and higher interest rates making themselves felt in US We expect that the stimulus measures of the Trump administration will continue to generate growth in the US in 2019, although the higher policy rate of the US central bank – the Federal Reserve, or the ‘Fed’ – is causing headwinds and thus holding back growth somewhat. However, the positive effect of tax cuts, in combination with less restrictive rules (‘deregulation’), will be stronger. At the same time, the influence of the trade war started by President Trump with China, among other countries, will become more perceptible. The reciprocal import levies are weighing heavier and heavier. Exporting companies may experience problems with their sales, and input costs (raw materials and other production costs) will increase. Nevertheless, we expect companies to invest more and consumers to continue to spend, as we saw in the third quarter of this year. The labour market is also expected to become even tighter, with higher wages and rising inflation as a result. To counterbalance inflationary pressures, the Fed will turn off the money tap a little further. We therefore

expect US growth to cool down from 2.9% this year to 2.4% in 2019. Clearly slowing growth, but certainly not a recession. Political uncertainty casts a shadow over the Eurozone We also anticipate declining economic growth for the Eurozone. We already saw the peak of growth in this region in 2017. In Europe we see a much less stimulating fiscal policy from governments than in the US. Those Eurozone countries that do want stimulus, such as Italy, are not allowed to or are unable to do so. The euro countries that are able to do so, either do not want to or are only doing so to a limited extent. Unlike the US, Europe is dominated by the pursuit of counter-cyclical budgetary policy. In other words: spend less when the economy is doing well, spend more when it is getting worse, in order to let the economy grow more gradually. In addition, geopolitical concerns such as Brexit, the political direction of the Italian government and the trade war hang above the market. These concerns remain, and can lead to increasing uncertainty among consumers and businesses. We can already see some signs of this. For the Eurozone, we expect GDP growth to fall from 1.9% in 2018 to 1.4% in 2019. This is more in line with potential growth. But also for the Eurozone, our base case (the scenario we consider most likely) does not assume a recession. Growth in emerging markets is stagnating... Emerging markets are having a difficult year. The rising bond yields in the US are an important factor. The dollar, which has strengthened partly as a result of this, also weakened the currencies of emerging markets. On top of this, higher oil prices and specific problems in, for example, Turkey and Argentina were important causes. Oil-exporting countries such as Russia are benefiting from the high oil price. For these countries, we expect stronger economic growth next year. As mentioned above, the trade-restricting measures will become noticeable. It is clear that these have an inhibiting effect on Chinese growth, especially because Trump’s arrows are mainly focused on China. More stimulus measures from the Chinese government are therefore to be expected in response. We expect the Chinese economy to slow down from 6.6% this year to 6.3% in 2019. But still no ‘hard landing’ of the economy.

5

… but still much stronger than in the developed markets For emerging markets as a whole, we expect growth next year to remain at 4.7%, the same as in 2017 and 2018. Note however that this percentage is significantly higher than the expected growth of 2.1% for developed economies. More importantly, the growth differential between emerging and developed countries is widening again. Dangers lurking here and there All in all, the economic outlook outlined so far is not so bad at all. Nevertheless, we are reasonably cautious with our expectations for 2019. And we are not the only ones to see negative factors. Recently, we have seen many growth forecasts being adjusted downwards.

Growth differential between emerging and developed countries is increasing Both the International Monetary Fund (IMF) and the Organisation for Economic Cooperation and Development (OECD) warn of the consequences of protectionism and the absence of structural reforms in countries where they are needed. Factors such as Brexit, Trump’s protectionist policy and developments in Italy, for example, call for caution. Potential growth under pressure Moreover, it is almost inevitable that potential growth in large parts of the world will structurally decline in the coming years. This will be felt most where the working population is shrinking the most. If no solution is found for the decline in labour productivity growth within the foreseeable future, a lower maximum growth rate cannot be avoided. The development of artificial intelligence, for example, is promising. Nevertheless, it remains to be seen whether we are on the eve of a new technological revolution, leading to structurally stronger growth. For 2019, we expect the global economy to grow by 3.6%. That is slightly lower than the 3.7% expected by the IMF. However, we are slightly more positive for 2018: 3.9% growth compared to 3.7% according to the IMF. The final growth figures for 2018 will not be known until next year.

ECB to increase policy rate after the summer - at the earliest We believe that the baton controlling developments in 2019 is again in the hands of the central banks. In the event of an undesired slowdown in growth and too low inflation, they can offer support by keeping capital cheap for even longer, i.e. keeping interest rates low. But this instrument is starting to become less effective in various regions. If we are to believe the European Central Bank (ECB), economic growth will lead to a tighter labour market, higher wages and rising inflation. Against this background, the ECB will, as planned, terminate its bond buy-back programme at the end of 2018. We consider this to be a positive development, but the increased inflation (2.2% year-on-year in October) is mainly caused by higher energy prices as a consequence of the more expensive crude oil. We do not see structurally higher core inflation in the short term. Therefore, we expect the ECB to announce a first increase in policy rates at the earliest after the summer of 2019, depending upon inflation developments. Few doubts about Fed policy There is less doubt about the Fed’s future policy. This central bank is expected to raise policy rates further to prevent overheating of the US economy. Since December 2015, the Fed has raised interest rates in eight steps to a range of between 2% and 2.25%. We expect a further 0.25%-point increase in December and at least two more such steps in 2019. Chinese authorities on the ball We expect the Bank of Japan to leave the money tap open and to pursue an unchanged policy. Depending upon growth and inflation developments, Chinese government bodies (such as the People’s Bank of China, the Chinese central bank) will stay on the ball and closely monitor economic developments. For the time being, we assume that accommodating rather than restraining measures will be taken in China, taking it for granted that companies and consumers will continue to run up debts. As long as we do not see a large outflow of capital from China, such as in the summer of 2015, we trust that Chinese policymakers will be able to steer the economy reasonably well.

6

Political developments leave their mark on the sentiment Whether the scenario we have outlined becomes a reality depends to a large extent on the confidence of consumers and businesses. This confidence also determines consumer spending and business investments, and thus the direction of the economy’s development. Crucial in this context are the political developments, however frustrating they sometimes can be. It has been a long time since politicians left such a strong mark on economic sentiment. Geopolitical developments are widely reported in the media and sometimes lead to substantial price fluctuations. At the same time, the influence of political rhetoric should not be overestimated. It is important to distinguish between main and side issues. Political conflicts are of all times. In general, they only become clearly visible in stock market returns when the conflicts coincide with a deterioration of the economy. There has hardly been any sign of this up until now, but of course the big question is whether this will continue to be the case. Yes, politics will continue to leave its mark on sentiment. We also expect economic growth to slow down slightly, but to remain at a healthy level. At the same time, central bank policies are gradually becoming less accommodating. The combination of these factors makes a repeat of the attractive returns of recent years unrealistic. What this means for our return expectations can be found in the ‘Asset class analysis’ section.

Growth of the global economy

Rate of growth of global gross domestic product (GDP, annualised) and IMF forecast. Source: Thomson Reuters Datastream, November 2018

ING’s expectations for GDP growth

Source: ING, November 2018.

7

Simon Wiersma investmentmanager

Asset class analysis

Waves becoming a bit higher Investors have already had some time to get used to increasing price movements – so-called volatility – in 2018. We expect the financial markets to show large price fluctuations rather more often in 2019. In general terms, this means that the capricious market of recent months remains. Nevertheless, our return expectations are not so bad. At present, we have no clear preference for marketable securities, such as equities and real estate, over fixed-income securities (bonds). However, we do expect that equities, including dividends, will be able to achieve a return of around 8% in 2019. A small increase in bond yields will put pressure on fixed-income returns. Nevertheless, we believe that it is possible to achieve a positive return on fixedincome securities, for example with short-term government bonds and emerging market bonds.

No devastating hurricane Will 2019 see the end of the long-standing ‘bull market’ for equities? We don’t think so. The most important cause of the end of a bull market is not its duration, its age. History teaches us that the combination of strongly rising interest rates and the bursting of soap bubbles plays the greatest role. We do expect interest rates to rise a little further, but this shift will not lead to a devastating hurricane, which causes all asset classes to sink.

Tension increases for investors As the economy continues to progress in its cycle, investor tensions are increasing. At a time when the US is going through one of the longest periods of economic growth ever, and when growth in other regions is slowing down, the question increasingly being asked is “when will the next recession be?” Because the consequences of the previous global recession, that of 2009, are still deeply engraved in our memories, the increasing nervousness among investors is easy to understand. Especially for the large group of relatively new investors, who have never experienced a longer period of rising interest rates, it will not be easy to keep their nerves in check.

We do not see widespread, excessive credit growth among individuals and businesses – as was the case in the period up to and including 2007. Since the global financial crisis, debts have mainly ended up on the books of governments and central banks. And furthermore, the borrowing conditions for consumers and businesses have become stricter. But as usual, we also see exceptions. Consumer and business loans in China and car and student loans in the US are examples of markets with strong credit growth. These markets are therefore closely monitored. The global financial crisis of 2007-2008 was also preceded by strong credit growth, but we do not see any major similarities with the developments at the time.

8

Equities have become less expensive We expect the most important central banks to adopt less accommodating policies, following the path that has already been taken. This will lead to higher bond yields, which will keep bond prices under pressure. As we saw in 2018, higher interest rates also lead to lower equity valuations, such as the price/earnings ratio (P/E). During the past twelve months up to and including October 2018, global equities have on average become some 16% less expensive, based on P/E. This is because expectations for corporate earnings growth have risen more strongly than stock prices (which even fell slightly this year). The average P/E ratio of the MSCI All Country World Index, the bestknown indicator of global equities, is now 13.6. This is well below the average of 15.7 during the period from 1985 onwards. For the rest, it is also possible that equities will become even cheaper. Corporate data closely scrutinised With the prospect of higher interest rates, government bonds (such as German and Dutch) that are deemed safe may become relatively more attractive compared to other asset classes. Following the series of interest rate hikes by the Fed, shortterm US government bond yields have exceeded the average dividend yield of S&P 500 Index equities for the first time since 2008. With a view to slightly higher bond yields, corporate earnings figures are therefore closely scrutinised. Disappointing earnings figures are severely punished, better than expected figures are sometimes received with a lot of scepticism. Partly for this reason, we expect the volatility on the financial markets to increase, rather than rapidly decrease. Currently no preference for equities or bonds As in 2018, we are moderately optimistic about the expected equity returns in 2019. However, the outlook has become slightly more positive following the recent correction. By mid-September, the return on global equities (MSCI All Country World Index, dividend net reinvested, in euros) had risen to the annual return of 6% that we expected. As we felt that the outlook, especially in geopolitical terms, became somewhat more uncertain, we decided to take some profit in the investment strategies we manage for our clients. Since then, we have applied a neutral weighting to both marketable securities (such as equities and real estate) and fixed-income securities (bonds). At the beginning of October, the price gain rose to just below 8%, before evaporating completely

during the stock market correction. Corporate earnings growth will gradually diminish In our baseline scenario, the major central banks cautiously continue to turn off the money tap and economic growth levels off. As in 2018, we foresee that the occasional geopolitical upheaval will not disrupt this scenario. Against this background, we expect average earnings growth of listed companies in 2019 to be around 6%. This is well below the more than 15% earnings growth expected for 2018. Our expectation is also clearly below the earnings growth of almost 10%, which analysts expect to see on average for 2019. The expectation that earnings growth will fall is mainly based on the decline in the positive effect of the US tax cuts. Total return on equities of 8% is realistic For 2020 too, we also maintain a very conservative estimate of earnings growth. While analysts on average expect growth of 9.3%, we assume 0% as we believe that during the course of 2019 the economic headwind will increase a little due to slightly higher interest rates and somewhat weaker confidence data. We therefore not only assume lower earnings growth figures, but also a slightly lower valuation of equities, the P/E ratio. On this basis, in 2019 we expect a total return (including dividend) on global equities of around 8%, starting from the price level at the end of October 2018. Even within our very cautious expectations, the earnings outlook for 2019 has improved considerably with the correction in October. Slight loss for euro government bonds The rise in yields on Eurozone government bonds, which we had forecast for this year, has in the intervening period become visible on a few occasions. On balance, however, not much of that remains. The return on a basket of Eurozone government bonds – or the Citigroup Euro Government Bond Index – is around 0.9%. This is an increase of 40 basis points (0.4%) compared to last year. Higher bond yields mean lower bond prices. This year, the index therefore stands at a loss of 0.4%, which is slightly less than the expected loss of 1.5%. Higher Italian bond yield is the main culprit Yields on the government bonds from the northern euro countries, including Germany and the Netherlands, that are deemed to be very safe have hardly risen in the past twelve months. The German ten-year yield now stands around 0.35%. This is, contrary to our expectations, almost the same as the level of one year ago. The increase of the yield of the

9

abovementioned Citigroup Euro Government Bond Index by 40 basis points is therefore mainly the result of the higher yields on Italian government bonds. These yields have risen because of the increased political risks and the fear of the country’s declining creditworthiness. The Italian ten-year yield rose by almost 145 basis points in the space of one year to 3.26% (on 27 November 2018). We anticipate higher bond yields Because we expect the ECB to slowly but surely adopt less accommodating policies due to a slight increase in inflation, government bond yields in the Eurozone could rise a little further. For 2019 we are therefore taking account of negative returns on the bond categories that are considered to be the safest: government bonds and corporate bonds from issuers regarded as creditworthy, so-called ‘investment grade credits’. Riskier bonds are worth considering As with equities, the return outlook for the riskier bond categories improved somewhat after the price falls in 2018. The increase in risk premiums on highyield corporate bonds and emerging market bonds contributed to an increase in the yield. In other words, prices have come under pressure. For 2019, we are taking account of slightly increasing risk premiums and the adverse effect of higher bond yields. This effect is, however, expected to be offset by higher interest income (the ‘carry’).

Seeking a positive return on government bonds Despite our low yield forecast for government bonds, we will continue to invest in them in all our investment strategies, since they are the only asset class to offer protection in times of increasing uncertainty on the stock market. Inflation-linked bonds and bonds with a short average remaining maturity (short ‘duration’) are less sensitive to interest rate fluctuations. By including these bonds, we seek to still realise a positive return on the bond investments in 2019. Estimated index returns in 2019 In the chart on page 11 you can see our return forecasts, per asset class, for the investment year 2019 – calculated from the end of October 2018. The value of these figures should not be overestimated. These are possible outcomes, and we underline that these are index returns. The cost of investing, such as transaction costs and the service fee, still has to be deducted therefore. With an active investment policy we try to exceed the index returns.

Positive about emerging market equities and bonds At the time of publication of our Investment Outlook 2019, 27 November 2018, we maintain a neutral weighting for marketable and fixed-income securities in the tactical asset allocation of our investment strategies. Within the equities category, we maintain an underweight for US equities and an overweight for emerging market and Japanese equities. European equities have a neutral weighting. Within fixed-income securities, we maintain an overweight position in emerging market bonds and in investment grade credits. The latter position requires a little more explanation. Despite our negative return expectation, we maintain an overweight for this bond category as it contains many variable interest-rate bonds, whose interest payment therefore moves with the market interest rate. This dampens the interest rate risk. For the sake of clarity: our negative yield forecast for this category is based on investment grade credits with a fixed coupon interest rate.

10

Expected returns in 2019

The value of your investments may fluctuate. Past performance is no guarantee of future results. No account has been taken of the service fee. This must be deducted from the return. Source: ING Investment Office, 27 November 2018

11

Tactical asset allocation (November 2018)

This is our tactical asset allocation as at 27 November 2018. Our current allocation can be found in the Monthly Investment Outlook. Source: ING Investment Office, 27 November 2018

12

Jochen Harkema and Peter Tros sustainable investment analysts

Sustainable investment

CO2 emissions and human resource policy: important themes Some workers receive the minimum wage, but do not earn enough to support a family. A living wage is therefore a human right that contributes to three of the UN’s sustainable development goals. The minimum wage is the minimum remuneration employees must receive, often per hour, and is intended to protect them from being underpaid. Many countries have a minimum wage, but each country has its own legislation in this respect. More than 90% of all countries that are members of the International Labour Organisation (ILO) have a minimum wage. But that is not automatically a living wage. A living wage is defined as a wage that enables the employee to provide for himself and his family. The living wage may differ from the minimum wage. In some countries, the minimum wage for a full working week is significantly lower than the living wage. Difference between livitng wage and minimum wage sometimes as much as 50% Research by the Netherlands Institute for Social Research (SCP) shows that the number of working poor increased by 60% between 2000 and 2014. According to the SCP, a working person is poor if his net income is lower than the social minimum, the living wage. In 2014, this was the case in the Netherlands for almost one in twenty people in work. Worldwide, the difference between the minimum wage and the living wage is sometimes as much as 50%. Employees must therefore have two such jobs

in order to live a decent life. A living wage is a universal human right According to Article 23 of the Universal Declaration of Human Rights of the United Nations (UN), every working person is entitled to just and favourable remuneration ensuring for himself and his family an existence worthy of human dignity. The ILO and the Organisation for Economic Cooperation and Development (OECD) also advocate a living wage. This wage contributes to the realisation of three of the seventeen sustainable development goals (SDGs) drawn up by the UN. A living wage contributes to SDG 1: ending poverty, SDG 8: decent work and economic growth and SDG 12: responsible consumption and production. Positive side effects Receiving a living wage is therefore a worldwide human right. It not only provides sufficient income to support the family, but also for human dignity. Raising pay to the level of a living wage has positive side effects. Thanks to a higher family income, it is no longer necessary for children to work. There is also money to send children to school, which also improves their future prospects.

13

Living wage contributes to three sustainable development goals Human resource policy: an integral part of our assessment When we examine companies to assess how sustainable they are, we also look at their human resource policies. Do companies pay their employees enough wages to live on? Do they have a diversity policy? And can employees join a trade union? We also pay attention to how suppliers are doing. Many companies have parts or entire products manufactured elsewhere, for example in lowwage countries. Especially in the clothing sector, use is made of such suppliers, who often pay their employees badly. Working conditions touch on various sustainable issues We assess how companies deal with employees on the basis of various themes. For example, we examine whether companies pursue policies aimed

Employee policy scores

at good working conditions. We check whether there is freedom of association – the possibility of becoming a member of a trade union. And we verify whether employment contracts are covered by a collective labour agreement. At ING, we assess the sustainability of investments on the basis of the main themes of ‘people’, ‘environment’ and ‘society’. The assessment of employment conditions and circumstances is included within the theme of ‘people’ and partly determines the final Nfi score. Below is the score on employment conditions for some companies active in the clothing industry on our list of companies followed by our analysts. The final Nfi scores of these companies are Nfi + for Nike and Nfi ++ for the other four. Suppliers’ employee policy at least as important When selecting investments, we not only look at the employment conditions of the company’s own employees – its personnel policy – but we also pay attention to companies in the supply chain. Although it is difficult for companies to monitor personnel policy throughout the chain, we do think it is the responsibility of the end producer to ensure that a living wage is paid throughout the chain. And

Sources: ING Investment Office, Sustainalytics, October 2018

14

not only that: we also check whether companies pursue a deliberate policy in the field of occupational safety, maximum working hours, child labour and the prevention of discrimination. Moreover, they must assess this policy at their suppliers and enter into dialogue with them about it. Below you will find the relative scores on employee policy of the aforementioned companies on our master list, but then with regard to their suppliers. Because it is a relative score, compared to others in the sub-sector, and the average is zero, negative scores also occur. Scores within the sub-sector range from -1.34 to 2.33. Inditex has good policies, the best in this sub-sector.

Scores on employee policy at suppliers

The other companies score fair (LVMH) to very good (Marks and Spencer).

Good employee policy does not guarantee a living wage throughout the chain A good employee policy throughout the chain is a strong indicator of a living wage and responsible working conditions. But good policy does not offer any guarantee that a living wage will actually be paid. Especially in the clothing sector, it is very difficult to control the entire supply chain and to enforce a living wage. Thus for example, the chain lacks transparency

Sources: ING Investment Office, Sustainalytics, October 2018

due to the large number of players, the supply is very fragmented – it comprises countless small businesses – and temporary contracts are often used. Despite good initiatives, all five of the abovementioned companies have had to deal with incidents in the chain that have revealed questionable working conditions.

which includes several banks and asset managers. The participants enter into discussions with the clothing companies in which they invest. ING has also joined this initiative. In this way, we encourage companies in the clothing sector to pay a living wage and thus contribute to a more sustainable world.

ING encourages companies to pay a living wage Three Dutch asset managers launched an initiative in 2016 aimed at better remuneration in the clothing industry in low-wage countries. In 2018, this has developed into the Living Wage Financials Platform,

We only have 12 years left The warm, dry summer of 2018 has gone on record in the Netherlands as marvellous. It was very positive for tourism in the Netherlands, but the negative

15

consequences for the earth and all life on it are enormous. The Intergovernmental Panel on Climate Change (IPCC), the scientific advisory body of the United Nations on climate change, paints a clear picture in its report of October 2018. According to this report, the sharp rise in global temperatures has negative consequences. The IPCC does not mention headwinds, but more storms, drought and heat. If mankind wants to slow down the negative developments, the temperature rise must be limited to 1.5 degrees Celsius. We are already on the verge of an increase of about one degree. The IPCC comes to the conclusion that we still have 12 years to change course and keep climate disruption manageable. Taxing CO2 can work fast and be effective Unfortunately, 12 years leaves us very little time to formulate policy and implement it worldwide. Within this period, the economy should largely switch from fossil fuels to renewable energy. A global tax on CO2 emissions can be effective and work quickly. Such a tax increases the price of using fossil fuels. Price increases are immediately noticeable and encourage users to consider alternatives or reduce their fossil fuel consumption. Such a tax is a good thing economically as well, since the price of products balances supply and demand. A CO2 tax will therefore quickly be accepted and processed in the economy. Moreover, a CO2 tax will bring in money. We can use this for investments to limit global warming and for the changes that are required as a result of climate disruption. Also interest in pricing CO2 emissions outside the EU A number of places in the world are already experimenting with such a tax. Within the European Union, we have had a market for CO2 emission rights for some time. Emissions by companies in the EU were limited and a market for trading emission rights was created. In the first few years, the market did work and prices developed for CO2 emission rights, with financial consequences. But in the following years the price subsided. The price has only risen again in the last two years, as the chart below shows. This is possibly an effect of the Paris climate agreement. More importantly, non-EU countries are also showing interest in such a market. Canada will tax emissions from 2019, China from 2020 China has introduced a CO2 market for electricity producers in 2018. This market should be twice the size of that of the EU. So far, 2018 has been spent on improving the reporting by Chinese electricity

companies; 2019 will be a practice year for the market. The actual implementation will only take place in 2020. Australia, on the other hand, has decided to close the emissions trading market. This country, the world’s largest coal exporter, prioritises its short-term economic interests. Various companies, including large oil companies such as Exxon and Royal Dutch Shell, have expressed their support for a tax on CO2. Canada proves that things can be done differently. Prime Minister Justin Trudeau has kept his election promise: the country will introduce a tax on CO2 from 2019. This tax will rise from 20 Canadian dollars per tonne of CO2 in 2019 to 50 dollars in 2022.

Exxon and Royal Dutch Shell are also in favour of CO2 pricing Companies’ CO2 policy assessed by sector We have assessed per sector the extent to which companies pay attention to limiting greenhouse gas emissions. To this end, we examined CO2 emissions and the participation of companies in the Carbon Disclosure Project (CDP). This is an initiative to create transparency with respect to greenhouse gas emissions. We also took into account the usage of renewable energy and sector-specific indicators. We related the scores per company to the average in the sector, which we set at 1. DSM, for example, has a score of 1.8, which means that this company scores 80% better than the average for its sector. A company’s CO2 policy is a risk factor for investors With increasing social and political pressure, we can expect a tax on CO2 to be introduced in more places in the world. The platforms for emissions trading will also be strengthened. We expect that the 11 best companies listed above will suffer less from this and in some cases will even be able to benefit greatly from it. In any case, it is clear to us that the extent to which companies emit CO2 is a risk factor for investors. Companies that have a clear vision of reducing greenhouse gas emissions, and design their products and processes accordingly, are included in the Duurzaam investment strategy.

16

Chart showing the price of CO2 emission rights

The best scoring companies per sector

Sources: ING Investment Office, Sustainalytics, October 2018

Source: ING Investment Office, November 2018

17

Henry van Heijster, Nathan Levy and Friso Rengers Investmentmanagers

Investment strategies policy

For the time being: light emphases The policies for ING’s investment strategies are broadly consistent with one another, with for example the neutral weighting for marketable securities vis-à-vis fixed-income securities. But the strategies do have different emphases and idiosyncrasies. Actueel strategy: wide spread with emphasis on technology The focus of our Actueel investment strategy within the equity investments is on the global spread across business sectors. Technological development is an important theme that plays a major role in several sectors. By means of this investment strategy we also focus on the growth of emerging markets. Government bonds, corporate bonds and real estate are fixed elements of the broadly diversified investment strategy. Our tactical asset allocation is currently (end of November) neutral. The equity portfolio has slight emphases in the IT and financials sectors. The Japan and emerging markets regions are also overweight in relation to the neutral distribution. Relatively ‘expensive’ US equities are underweight. Within bonds we have an increased weighting of emerging market bonds. The higher risk is offset by a significantly higher expected yield. Government bonds have a reduced weight and a reduced average remaining maturity. The sensitivity to rising interest rates is consequently lower. Duurzaam strategy: more than just climate change The aim of our Duurzaam investment strategy, in addition to financial returns, is to make a contribution

to a more sustainable society. Although in the regular investment strategies we also rule out investments in companies with certain undesired activities and conduct (such as if they produce tobacco), the bar for inclusion in the Duurzaam strategy is set higher. But we do not just exclude, we also specifically select companies that score well on sustainability policy. Strongly represented are companies that are seeking solutions for the consequences of climate change, such as by means of the production of wind and solar energy or increasing energy efficiency. Other sustainable themes, such as good corporate governance, good working conditions throughout the production chain and the prevention of environmental pollution, are also reflected in the Duurzaam investment strategy. We are increasingly investing in companies that use their products to contribute to a more sustainable society. Index strategy: neutral asset allocation with emphases The Index investment strategy consists entirely of index trackers. The policy is directed towards diversified investments in efficient ETFs (exchange traded funds) and good quality index funds. The strategy follows the tactical asset allocation of the ING Investment Office. Government bonds currently

18

have an underweight position in favour of corporate bonds; the bond portion also has a reduced average duration. The sensitivity to rising interest rates is consequently lower. We also have an increased weighting of emerging market bonds with the higher risk being offset by a significantly higher expected yield. Within marketable securities, where equities are concerned we maintain an underweight of US equities against an overweight of Japan and emerging markets (such as China). The valuation of US equities is close to the upper limits in various stock market segments; Chinese and Japanese equities are valued lower. Inkomen strategy: remains attractive in a low interest environment The focus in our Inkomen investment strategy is on interest income and dividend yield. We invest mainly in ‘defensive’ equities, which are slightly less sensitive to economic deterioration. Defensive stocks generally have reasonable valuations (such as price/earnings ratio). In addition, corporate earnings are usually more predictable and they almost always pay dividends. In the geographical spread, there is a strong focus on European equities so this strategy’s exchange rate risk is low. In addition to dividend stocks, we also spread to other possible performance drivers, such as low-volatility equities, real estate equities and, to a limited extent, equities from other regions. Government bonds are currently underweight in favour of corporate bonds; the bond portion also has a reduced average remaining term so the price sensitivity when interest rates rise is smaller. We have an increased weighting of emerging market bonds with the higher risk being offset by a significantly higher expected yield.

yield. Government bonds have a reduced weight and a reduced average remaining maturity. Sensitivity to changes in the market rate of interest is consequently limited. After all, rising interest rates mean falling bond prices. Dynamiek strategy: wide spread across investment themes* Our Dynamiek* investment strategy also entails a wide spread across various asset classes, regions, business sectors and investment themes. We currently maintain a neutral weighting for marketable securities (equities, real estate, commodities and alternative investments) with respect to fixed-income securities (bonds). Within equities, we currently have a preference for equities from the emerging market and Japan regions. Relatively ‘expensive’ US equities are underweight. Equities from the financials (banks and insurers) and IT sectors are also slightly accentuated. As well as emerging market equities, we also consider that bonds from this region are attractive. Government bonds have a reduced weight and also a reduced average remaining maturity. The sensitivity to rising interest rates is consequently lower.

Comfort strategy: preference for emerging markets* Characteristic of our Comfort* investment strategy is the broad spread across asset classes and regions. We currently maintain a neutral weighting for marketable securities (equities, real estate, commodities and alternative investments) with respect to fixed-income securities (bonds). The equity portfolio has emphases in the Japan and emerging market regions. Relatively ‘expensive’ US equities are underweight. Within bonds we have an increased weighting of emerging market bonds with the higher risk being offset by a significantly higher expected

*) Available only for ING Private Banking clients

19

Friso Rengers investmentmanager

Commodities

We are maintaining a neutral weighting for commodities In 2018, the commodities index lost ground, despite the strong US and European economies. Only the oil price rose because investors took account of the US sanctions against oil exporter Iran and the declining growth of US shale oil production. Why did commodity prices fall? Demand for raw materials has increased only slightly in 2018, thus slowing down the rise in prices. The consumption of raw materials in relation to economic growth is also developing differently in the 21st century than it did in the 20th, with economic growth in 2018 consisting more of services than goods. Consider for example a city dweller who rents an apartment, has no car, occasionally goes out for dinner, is a member of a sports club, has a subscription to Netflix and does a lot on his smartphone. His consumer budget is largely spent on services. In the second half of the 20th century, an average consumer spent a larger part of his budget on physical products, such as a means of transport, household appliances, food, clothing, a television set and a stereo system. The declining population growth in the West also limits the growth in demand for raw materials. The fact that fewer new homes are being built also plays a role. China no longer the engine; stronger dollar also a factor In emerging markets, there is still a clear need for physical raw materials. More and more people

are buying modern housing there and they are also spending money on utilities, cars, household appliances, travel and infrastructure. Moreover, these countries have a relatively large manufacturing industry that uses raw materials as input. China is a good example of this. But the fact that the Chinese economy will grow less strongly in 2018 and – following the example of the more developed economies – will also use fewer raw materials, was noticeable on the commodity markets. As a result, demand for raw materials hardly increased. Most commodities are listed and paid for in US dollars. This currency initially weakened in 2018, but in the second half it strengthened against most other currencies. The strong dollar is in itself already a stimulus for the production of raw materials, while it also reduces the demand for them. Commodities divided into four subgroups Our benchmark for the commodities market is the Bloomberg Commodity Index. This index is divided into four segments. It consists of 36% agricultural commodities, 32% energy commodities, 17% industrial metals and 15% precious metals, such as gold. What is happening with these four?

20

Agricultural commodities We do not see an end to overproduction in agriculture for the time being. There are also plenty of agricultural entrepreneurs who not only keep the agricultural sector going, but also enable it to grow. Moreover, they change the production processes through innovation. Broadly speaking, overproduction is stimulated by persistent government grants and productivity improvements based on new (gene) technologies. Changes in food production can be expected as people’s diets change. Another factor is that political intervention, motivated for example by climate issues, is taking place. Few people are currently consciously concerned about nutrition. If more attention is paid to our food supply, awareness can be raised among a wider public and politicians will probably also react. This is not a development we are seeing yet. Precious metals: little demand Perhaps helped by declining economic uncertainty, precious metals, such as gold, seem to be increasingly losing the interest of investors. Low inflation and the fall in the prices of precious metals may also be causes. Precious metals are experiencing relatively difficult times, as the world’s ‘reserve currency’ – i.e. the US dollar – is strengthening and US interest rates are exhibiting a rising trend. There is also a lack of large-scale financial or industrial applications for these metals. In the past, silver was used in photography, platinum in catalysts and gold as a central bank reserve and a savings substitute. At the moment, however, we do not see any large-scale new applications. However, some ‘technical’ price recovery is to be expected following the sharp fall in the prices of precious metals. Industrial metals: what has happened to the investments? Without investments, it is not to be expected that industrial metals will rise much in price. Compared to the period before the financial crisis, few investments are being made. Geopolitical issues such as Brexit, the US sanctions policy against Iran, Chinese-US trade issues and political instability in a number of emerging markets are important causes. To further stimulate the economy in developed economies, public spending and investment in infrastructure and industrial production facilities will have to be increased. The main beneficiaries would then be the industrial metals commodities group. But before investing, the business sector needs greater stability in

import and export tariffs as well as legislation and regulations. After all, investments are based on long-term scenarios. It is therefore primarily up to the politicians, and we do see some who want to take action. However, we suspect that the industrial metals category will not yet benefit from this in the coming six months. Energy: oil prices becoming more and more volatile Although the price of oil rose sharply in 2018, it did not exceed 100 dollars a barrel. This is partly due to the strong capacity growth of the North American oil industry and the somewhat weaker economic growth in emerging markets, particularly China. The question is whether shale oil production in North America can continue to grow at this rate. And whether Russia, Libya, Venezuela and Saudi Arabia are able – and want – to increase their oil production further. It is therefore difficult to predict the future supply. What is certain, however, is that the world certainly can’t survive without oil, despite the many drawbacks of large-scale oil consumption. The future demand for oil therefore seems more stable than the future supply. The generally accepted expectation is that oil consumption worldwide will increase by 1% to 2% per year, as long as a severe economic recession does not occur. Emerging markets are by far the biggest drivers of oil consumption growth, while in the developed markets cars are turning electric or being disposed of – thus reducing fuel consumption. However, we do not believe that the price of oil does have to exceed 100 dollars per barrel, provided there is sufficient investment in oil production. This is a decisive factor. Due to the lack of spare production capacity within the OPEC, the oil price will be very volatile in 2019, just like in 2018. It appears that Russia and the US are gaining market share from the oil-producing countries in the Middle East. There is sufficient refining capacity within the oil industry worldwide. Aside from temporary peaks, fuels do not have to rise more than the price of oil.

Oil consumption continues to grow by 1% to 2% per year for the time being 21

Conclusion At the current rate of economic growth, we expect the commodities index to continue to fluctuate around its current level in 2019. After all, there is sufficient supply, given the level of consumer spending. Oil is the biggest surprise factor within the index. On the basis of our macroeconomic outlook, we believe that a neutral commodities outlook is the best fit. Investment trends and (geo)political changes can influence the supply and demand of raw materials. We will continue to pay attention to this.

Bloomberg Commodity Index

Source: Thomson Reuters Datastream, November 2018

22

Bas Heijink technical analyst

Technical analysis

The end of the ten-year bull market in the AEX? The upward trend in the AEX, or ‘bull market’, has lasted for about ten years now. But there is a good chance that it will end in 2019. Many other European equity indices, including the German DAX, have already ended their bull trend in 2018.

What is technical analysis? Technical analysis is a method of analysis where trends and recognisable price patterns are sought in price charts and other market data. Technical analysis is therefore very different from fundamental analysis, which studies financial-economic data. Bas Heijink’s technical vision will regularly deviate significantly from ING’s fundamental vision. Our vision is mainly based on fundamental analysis.

23

Downward sequel for the AEX in 2019? 2018 seems to have become a year of transition for the AEX index. At the beginning of 2018, the AEX already broke out downward from its trend channel that had been rapidly rising since 2016. It then formed a key resistance zone of around 574 points, containing three tops. Towards the end of the year, the AEX completed the lengthy top formation process with a downward break through the 516-517 zone. To finally signal the end of the bull market, the AEX must also break downward through the 498-501 zone. This zone currently contains the bottom of the long-term trend channel: the bottom line that has been rising since 2009.

AEX-index

At the time of writing, the AEX is still within the limits of the downward trend, which started at the top of July 2018. If this trend continues, a downward breakthrough of 500 points level can be expected at the beginning of 2019. And if the AEX does end the bull market with a movement below 498, the zone between 400 and 410 points will become an important target zone for 2019. The downward trend towards this is likely to be accompanied by strong interim recovery. But as long as the AEX remains above the 498 - 501 zone, a longer phase with a ‘sideways’ movement of prices may arise: a period of consolidation. However, we believe it unlikely that the bull market will be resumed.

Source: Reuters Metastock XIV, November 2018

24

DAX on its way to levels below 10,000 points In contrast to the AEX, the main German index Xetra DAX did close its bull market in 2018. This had already started in 2009 but came to an end at the beginning of October due to the downward break through the crucial rising bottom line in the long-term picture. Important resistance levels are at 11,900 and 12,500 points. It is only above this that a more sideways, interim consolidation phase appears to be possible. In 2019, a downward continuation of the current new bear market is expected.

Xetra DAX

Important targets for 2019 in the (downward) longterm picture are 9,300 and 8,700 points. At the DAX, too, we expect the decreases to be broken by strong interim recovery trends.

Source: Reuters Metastock XIV, November 2018

Bron: Reuters Metastock XIV, 29 mei 2017

25

Dutch ten-year bond yield: will it rise further in 2019? The first technical target level for the Dutch tenyear bond yield (at 0.88%) was almost reached in 2018. But 2018 appeared to produce a continuation of the consolidation (with mainly sideways price movements) that we already saw in 2017. In this phase, the yield still tested the lower end (around 0.40%) of the bandwidth several times. Nevertheless, consolidation is expected to result in an upward continuation. The next target will be 1.25%. Looking at the technical picture of ten-year bond yields in

the slightly longer term, we see that the long-term downward trend at the end of 2016 was broken upwards. This occurred after the formation of a bottom zone with several bottoms, just below 0%. If the bond yield falls below the 0.35% - 0.40% zone again, a technical weakening occurs and the decrease can continue. And for values above 0.80%, the next phase in the new upward trend commences. In that case, a higher (multiple) medium-term floor seems to have formed around 0.40%.

Ten-year yield on Dutch government bonds

Source: Reuters Metastock XIV, November 2018

26

Euro-dollar exchange rate: weaker rising long-term trend In the summer of 2015, the euro-dollar broke a strong, long-term downward trend. This led to a prolonged phase in which the euro-dollar moved sideways within a bandwidth of between $1.04 and $1.15. This phase ended in the summer of 2017, with the start of a steep upward trend, which continued in strength to the top of $1.2550 in early 2018. After this, the euro-dollar broke downward through its rising bottom line and the next long-term corrective counteraction arose. It also broke downward through the former key resistance zone of $1.15 - $1.1550, creating further downward space to the $1.12 - $1.09

Euro-dollar exchange rate

zone. We believe that these developments are in line with the scenario of the search for a first significantly higher, long-term bottom above $1.04. It is only below this level that the long downward trend is resumed. There is a real chance that the next clear bottom will emerge in the first few months of 2019. In order to confirm this, the euro-dollar rate should rise above the new resistance line, decreasing from $1.2550, which reached $1.1640 at the beginning of November. If the euro-dollar rises above that, and provides confirmation by moving above $1.1750, then the way is open to last year’s top. But the trend has weakened; a considerably less steep upward longterm trend may commence.

Source: Reuters Metastock XIV, November 2018

27

Sectors

ING’s outlook by sector Within equities, we currently have a preference for the financial sector (such as banks). We are also positive about the information technology sector. Themes that play a role in many sectors are technological innovation and sustainability.

28

Cor Blankestijn investment analyst

Consumer discretionary

Challenging times for car manufacturers If the final months of 2018 are a forerunner of the 2019 investment year, they hint of headwinds for the consumer discretionary sector. While the sector has performed well above average during the past ten years, it remains to be seen whether this will continue to be the case in 2019. Several sub-sectors are confronted with the negative effects of the trade feud between the United States and China. The loss of part of the exports will negatively impact many revenue and profit expectations. Moreover, uncertainty has arisen about the demand for luxury goods in China, as a result of stricter border controls. However, car manufacturers appear to face the greatest challenge. The automotive sector is not only faced with stricter environmental legislation, but also with formidable competitors. Manufacturers are battling it out in the field of innovation: the motoring of the future. Growth of middle class and number of super rich in Asia drives luxury goods sales Now that the economy has already been doing well for some time, and consumer confidence worldwide is high thanks to higher wages and rising house prices, more luxury consumer goods are being purchased; naturally in the rich West, with the United States, accounting for more than a quarter of all luxury goods sales, still top of the list. But consumption of such goods is also increasing in emerging markets. For revenue growth, luxury goods producers must

look to China. Thanks to the rise in wages, more and more Chinese are entering the middle classes. After spending on basic necessities, they have money left over for the purchase of luxury consumer goods. But not only the number of people belonging to the middle classes is increasing. In several emerging markets, the number of ultra-rich people, with assets of 30 million dollars or more, is also increasing. This number is rising faster than in many Western countries. While New York, with 9,000 inhabitants, previously had the most ultra rich within its city limits, Hong Kong now has 10,000. It is not without reason that Hong Kong has for several years now been one of the largest markets for the sellers of jewellery, expensive bags and watches. Nothing changed this trend. Even the Chinese government’s long-running anti-corruption policy caused only a minor fluctuation in the price chart of watch, bag and cognac manufacturers. Shift or slowdown in Chinese demand for luxury goods? Nevertheless, luxury goods shareholders such as LVMH, Kering, Swatch and Richemont were shocked

29

at the beginning of October by reports of tighter controls at the Chinese border. The Chinese border authority is going to more closely monitor products that are imported by returning tourists. Many Chinese buy luxury bags and fashion items abroad, and then resell them in China for a higher price. Intensified border controls are likely to cause the Chinese luxury brand market to cool down. The existence of this grey import market, referred to as ‘daigou’, evokes mixed feelings among luxury goods companies. On the one hand, many Chinese make substantial purchases in Paris or other European cities. On the other, these grey imports puts a brake on direct sales in China itself. The price level there is often even slightly higher than in the rest of the world. Such reports are obviously not good for the expectations for 2019. Car manufacturers are victims of the trade war The automotive sector will certainly be confronted with headwinds in 2019. China is a negative factor her as well, but car manufacturers in the US and Europe also face less favourable times. Record sales and profits were realised in 2017 and the first quarters of 2018, but the trend reversed in the second half of 2018. As a result of the trade war, cars also suffered from import duties and growth vanished into thin air. What followed was a series of profit warnings from car manufacturers, including BMW, Daimler (Mercedes) and Renault. Stricter environmental legislation squeezes sales It is no coincidence that these three companies are also the largest sellers of polluting diesel cars. The sales of such vehicles continue to decline every month, now that more and more restrictive measures are in force in various countries. In Germany in particular, a diesel-free city centre is added every month, a trend that will continue in 2019. Sales held up slightly longer in Europe than in other parts of the world. Since 1 September 2018, the stricter emission regulations of the Worldwide Harmonized Light Vehicles Test Procedure, the new more rigid testing standard, have been in force. The more polluting the car, the more tax that has to be paid. It is expected that car sales in Europe will now also weaken. To combat this, while at the same time protecting the environment, governments could, just like ten years ago during the crisis, initiate ‘cash for clunckers’ programmes. Thus with subsidies from

the government and the car industry, encourage car owners to exchange their polluting car for a smaller and cleaner model. Lower sales, so less money to invest in electrification Now that car manufacturers are selling fewer cars and therefore making less profit, fewer free cash flows are becoming available to invest in the complete electrification of the car. This is necessary in order for vehicles to comply with the European legislation that will enter into force in 2021. This legislation, which is intended to substantially reduce CO2 emissions, will fine manufacturers for cars that emit an average of more than 95 grams of CO2 per kilometre. Only a few manufacturers will comply with this, so many will have to make a choice. They can opt to pay fines, which for German manufacturers range from several hundred million to several billion euros for a large seller the size of Volkswagen. But they can also decide to invest in cleaner drive technology. For BMW, Daimler and Volkswagen, the amount involved will amount to 6 to 7 billion euros per year.

Major investments needed for the motoring of the future Formidable competition for the traditional automotive industry These investment budgets represent money that will in any case not go to the shareholders in 2018 and 2019. The declining sales volumes in the last quarter of 2018 – and also expected in 2019 – therefore come at a bad time. With Tesla, the major car manufacturers have a formidable competitor in the field of electric car driving. In 2019, almost every mass manufacturer will release electric models that can compete with Tesla’s cars in terms of range and price. Stiff competition for car manufacturers has emerged in another area of innovation, with large technology companies such as Alphabet (Google) investing heavily in autonomous driving. Unlike Tesla, for example, these IT companies have very deep pockets. Nevertheless, in practice we do not think that cars will drive entirely autonomously for the time being, especially because of the legislation: the cars

30

themselves and the necessary technology already exist in many cases. Is the peak in car sales behind us? 2019 will also be the year of the IPO of Uber, which with its taxi services is challenging the established order in the automotive sector. If the Uber services expand over an ever larger area, demand for passenger cars is expected to decline further. This raises the question whether investing in car manufacturer equities is still attractive. After all, the future of passenger transport will be very different from the past. It is quite likely that 2018 will go down in history as the ‘peak car’ year, in other words with a peak in the number of passenger cars sold. Will we see sales continue to decline from 2019 onwards? Or will masses of consumers buy electric models, so that car sales can increase for a few more years? This is a question that we cannot answer at the moment.

31

Cor Blankestijn investment analyst

Consumer staples

Strong economy does not produce the desired effects For the consumer staples sector, all conditions appeared to be right this year to make it a good investment year. Sharply rising house prices and falling unemployment were a plus point. And wages were raised above average in many countries, thereby increasing purchasing power. In addition, consumer confidence in various regions reached its highest point in years. Nevertheless, in 2018, the share prices of companies in this sector did not really make any headway. In contrast to other years, these so-called defensive equities did not appear to be a safe haven in the face of increasing uncertainty. Fluctuating stock markets and falling emerging market currencies counteracted the prices. This is not entirely unexpected. A year ago we already noticed that many companies were struggling with stagnating growth or even shrinking turnover. The expectations for 2019 are not much better. Tobacco and soft drink producers are confronted with increasingly conscious consumers. The same applies to the branded products of food manufacturers. Until now, manufacturers of personal care products have not been affected. Tobacco sector falls out of favour There are large differences per sub-sector. Tobacco producers were the biggest losers in 2018, and this sector is likely to lag behind in 2019. Cigarette sales continue to fall and product innovations are producing less rapid growth than hoped for. In

any case, these innovations are not closing the gap created by the declining sales of ‘normal’ cigarettes. Moreover, because of the many health risks associated with smoking, large investors have decided to stop investing in tobacco companies. Such investors include pension funds, banks and insurers. Prices fell by more than 30% in 2018. The sector is falling out of favour with investors. Another negative factor: the major tobacco manufacturers, such as BAT and Phillip Morris, realise more than 60% of their turnover in the emerging markets. However, the currencies of many of these countries have fallen sharply this year. When the results in these regions are converted into the currencies in which the companies report, a significant part of the turnover and profit is lost. Although most of the weakening of currencies such as the Turkish lira, the Argentine peso, the Brazilian real and the Indonesian rupiah appears to be behind us, we expect the exchange rates of these currencies to remain very volatile. Furthermore, they will not return to their former levels any time soon.

32

Positive for the tobacco sector, however: cannabis legislation is being relaxed in many states in the US. This appears to have a positive effect on the market, although it must share innovations with the beer sector, which was the first to develop products containing elements of the hemp plant.

Emerging market revenues impacted by currency depreciation

Soft drinks and beer facing strong headwind For a large part of 2018, beverage equities performed in line with the entire sector. All beverage segments faced their own specific problems. Soft drink manufacturers are confronted with increasingly conscious consumers and Governments also want to reduce sugar consumption in order to reduce healthcare costs. The development of healthier variants is desirable. But while in the past beverage producers themselves sometimes came up with new ideas, they now often make acquisitions in order to renew their product range or increase their cash flows. Thus for example, Coca-Cola bought the company Costa Coffee, the largest coffee chain in Europe, in order to increase its turnover. This of course also provides Coca-Cola with a suitable sales channel for selling various types of cola and Minute Maid drinks. Coca-Cola’s turnover growth in the last quarters was already better than average. And we expect even more with the latest member of the Coca-Cola family.

Food producers feel the heavy hands of activists The producers of packaged foods have their own problems. Many of these companies saw their identical sales increase only slightly in 2018, while a year earlier they had promised to make improvements, under pressure from activist shareholders. According to these investors, innovation in this sub-sector has disappeared, and with it part of the pricing power of the brand manufacturers since producers can often charge higher prices for new products. They could really use the resulting profits in order to finance the struggle for profit margins that producers have been waging with supermarkets for years. Activist shareholders also believe that divisions which have been underperforming for a longer period of time can better be sold or merged with parts of competitors that are experiencing the same problems.

Beer is not experiencing its best moment either. In recent years, the listed beer brewers have seen a lot of turnover drain away from the mass-market beers to the traditional breweries, which in many cases have no market listing. We do note, however, the tendency for ‘big beer’ to take over these smaller breweries in order to benefit from the growth of this beer category. In addition, beer brewers are seeing declining revenues in important, profitable countries such as the US. Many, especially young, beer drinkers are switching to wines and spirits.

This shareholder input is rarely appreciated by the companies concerned. Nevertheless, many of them, including Unilever, Nestlé and Procter & Gamble, promised measures to improve returns in the short term. They sold divisions or cut costs. They also often reduced advertising costs, based on the belief that their products sell anyway. But while this was often the case in the past, this time things turned out differently. The turnover of branded products appears to be more dependent upon advertising support than in the past.

The spirits sub-sector therefore largely escaped the downturn. The popularity of Scotch whisky and Irish whiskey in particular continues to grow. Pernod Ricard is very successful in this segment with its Jameson brand. After the strong growth in the United States in recent years, it appears that China will account for extra growth in the coming years, although the trade war poses a threat to that scenario. This is likely to lead to slightly lower identical revenue growth, although this will still be stronger than the average for the consumer staples sector.

Private labels grow remarkably fast While the turnover of branded products only increased slightly, the turnover of retailers’ private labels grew enormously – sometimes three times faster than the turnover growth of branded products. In Europe, private labels now account for a large percentage of total revenues. In the United Kingdom, for example, this is already more than 40%. Growth is also strong in the United States. The share of private labels is expected to increase to 25% of total retail turnover in the coming years.

33

Due to growing competition from discounters and online retailers, the retail trade is struggling to maintain profit growth. This is why it is particularly pleasing that private labels, with margins often 25-30% higher than those of branded products, are selling well. Branded products are often only used during promotional weeks to attract customers to the store. Consumers fill the rest of their basket with private label products. Internationally operating food companies generate a large proportion of their revenues in currencies other than the reporting currency. This is an additional problem, since a large proportion of the turnover comes from emerging markets and in recent quarters their currencies have fallen sharply against hard currencies such as the dollar, euro and pound.

trend will continue for some time to come as new groups of users are repeatedly approached. Women and the elderly, but also men, are encouraged to use products to look – or even become – younger and healthier. Here too, however, there is a rapidly growing competitive group of local suppliers of cosmetics, particularly in South Korea and Japan. It is therefore important for companies in this sub-sector to continue to advertise a lot in order to promote innovations. Otherwise, the producers of private label products will also snap up the turnover and the associated high margins. Moreover, the established names have received high stock market valuations as a result of years of price increases. A sharp slowdown in turnover growth poses the risk that these equities will be severely punished.

Do high valuations curb the outperformance of the personal care sector? Actually, there is only one segment within the consumer staples sector that is doing well. The identical turnover of manufacturers of personal care products – with examples including the brands of L’Oréal and Estée Lauder – has already been growing well above average for years. It is expected that this

34

Jenny Overman investment analyst

Materials

Little chemistry between materials companies and politicians 2018 was an unstable year for the materials sector. On the one hand, there was strong economic growth, with rising volumes and prices. On the other hand, uncertainty began to strike: is this the end of the economic cycle? Add to this rising commodity prices and the adverse effects of the trade war between the US and China. Steel producers and construction companies were the main victims of complex trade restrictions, higher costs and forced changes in the production chain. Following the sharp price correction in the summer, the equities of basic chemical companies and mining firms were also valued so low that it seemed as if we were already in the middle of a recession. Specialisation paid off in the chemical sector. Among the mining firms, especially large companies with several types of raw materials did well in 2018. Now that the end of the economic cycle is in sight, we believe that specialisation in the chemical industry and a broad product mix in the mining industry will also be the right choices in 2019. However, it is important to remain selective. The problems caused by fluctuating prices and trade restrictions for the globally linked production chains lead to adjustments and to considerable differences between companies in the materials sector.

Mining firms at the bottom? With every indication that the end of the cycle is near, the prices of mining firms take a step back. The political uncertainty on both sides of the Chinese-US trade conflict is undermining stability. The valuation of the mining firms sub-sector is now again well below that of the broad stock market. This creates opportunities. The trade barriers are for the time causing a minimal drop in demand and the Chinese government is doing everything in its power to support the domestic economy. Stricter environmental legislation is eliminating overcapacity, which is another plus point. All this can facilitate a price recovery for mining firms. However, a new round of import tariffs in the trade war or disappointing economic figures could undermine this recovery again.

35

Price/earnings ratio world index and sector index materials

MSCI All Country World Index and MSCI All Country Materials Index. Source: Thomson Reuters Datastream, November 2018

Valuation premium of chemical companies at a low point The premium in the market valuation that chemical companies normally enjoy in relation to the broad equity market shrank rapidly last year. The end of a period of acquisitions, the trade war, rising costs and the risk of overcapacity were the reasons for this correction. Although a further escalation of the trade war always remains a risk, it would appear that enough has now been deducted from the price of the chemical companies to account for this. The development of industrial activity appears to be continuing and this increases the ability of chemical companies to demand higher prices. In recent years, low wage inflation has limited the pricing power of chemical companies in the food and personal care industry. If wage inflation returns, companies in this sector can pass on more costs to their customers. Thanks to cheap shale gas in the US and China’s need to be more self-sufficient, production capacity will be added in these regions in the coming years. In Europe, investments have been limited this year.

Is there any chemistry in the sector? A period of major takeovers by chemical companies is behind us. As a result, the total outstanding debt with a BBB credit rating (only one small step above the ‘junk bond’ status) in this sub-sector has increased by 91% compared to four years ago. In comparison: mining firms have halved their debt in the last three years. Does the debt of the chemical companies represent a major risk for the sector? Not directly. With this money, the chemical companies have made acquisitions which, if all goes well, will contribute to their income. This appears to be the case, given the predominantly positive profit expectations for this year. But not all takeovers are successful. And high interest charges leave little room for new investments or dividend increases. For companies that are already weak, disappointing corporate data can therefore lead to a drop in their credit ratings. Counting on Trump When President Donald Trump took office, the US construction industry hoped for substantial investments in infrastructure. So far, no such

36

investments have been made, while the costs of personnel and raw materials are rising. With a view to a possible re-election of Trump in 2020, the infrastructure may again receive attention. This can give a welcome boost to the producers of building materials. Although US companies seem to be the most logical suppliers in that case, many European building materials companies also have a strong position in the US. Price recovery for fertiliser producers does not mean that winter is over With China as a major consumer of agricultural products, the trade war also played a role in the fertiliser market. Political uncertainty is not the biggest challenge, however. The many years of decline in crop prices, resulting in low incomes for farmers, is much more important. In 2018, US farmers had the highest interest costs in thirty years, despite the historically low capital market interest rates. With the prospect of rising interest rates, recovery will not come from the demand side in 2019 either. Things

are looking slightly better on the supply side. High coal prices made the Chinese production of nitrogenbased fertiliser unprofitable for sale on the world market in 2018. Despite higher trade prices, it does not appear that Chinese production will enter the market in 2019 either. The price development of other fertiliser products also seems to be slightly positive, but this will probably not be enough to offset the higher raw material costs. What remains are internal savings in order to maintain margins. With a view to the end of the economic cycle, fertiliser producers with access to cheap raw materials and that implement a strict savings programme can be a defensive choice. Caution is called for, however.

37

Jenny Overman investment analyst

Utilities

How do utilities respond to change? In recent years, utility stocks have been relatively popular due to low bond yields. Investors looking for a direct return – i.e. interest or dividend – often chose the stocks of utilities, which are known to be defensive. After all, the dividend is stable on average since demand for the products and services of utilities even persists in less favourable economic times. Utility stocks represented an alternative to (government) bonds. The price performance of the utilities sector was more closely linked to long-term government bond yields than before the financial crisis. Reverse correlation applied: when bond yields fell, the average price of utilities rose. Indeed, the relative advantage of the stable dividend would then increase. Safe haven for equity investors As the economy normalises, central banks continue to cut off the money supply and bond yields rise again, the relationship between interest rates and the prices of utilities will also normalise again. This has a negative effect on the price trend. Bonds offer attractive, stable income, removing some of the demand for the equities of utilities. There are excellent opportunities for investors who delve into the individual qualities of utilities. In times of increasing uncertainty, the sector can also function better as a safe haven for equity investors. This effect was visible in the final months of 2018, particularly in the United States where the average equity valuation fell sharply, although the valuation of the utilities sector held up well. In Europe, the valuation is now once again in line with the broad equity

market. However, in 2019, utility prices are expected to remain linked to bond yields and the European Central Bank’s interest rate policy. Specialisation to be expected in a changing market, especially in Europe The changing energy market is forcing utilities to review their strategies and to specialise. This can clearly be seen with major players like E.ON, RWE and Innogy. E.ON will mainly focus on the transport and supply – ‘transmission and distribution’ – of energy, while RWE will concentrate on its production. The production of energy from coal and nuclear power stations is declining, government subsidies for renewable energy are decreasing and the European energy markets are becoming more intertwined. This makes it less advantageous for utilities to be active in all areas at the same time. On the contrary: thanks to lower costs and superior technology, specialisation offers a competitive advantage. We would not be surprised if more utilities made pronounced strategic choices in 2019. Such specialisation has already taken place in the US. In the coming years, generation capacity in the free market will come under pressure, while regulated capacity can count on support by the government. Traditional production model undergoing overhaul The structure of energy markets must change due to the necessary transition from fossil to renewable energy. The so-called capacity market is an auction involving the sale of production rights for the expected energy demand. This is already happening

38

in the United Kingdom and Italy, and other European countries are considering doing the same. The capacity market makes it possible to generate renewable energy without subsidies. At the same time, this system offers the guarantee that sufficient (regular) energy is generated. In France, the regulator establishes supply contracts whereby large producers have to offer part of their energy production at a fixed price. This stabilises prices for other market players. In the US, local production agreements are used. Large parties, together with the utility concerned, finance sustainable (renewable) energy production and purchase the entire production. This method is also receiving increasing attention in Europe. It is clear that the traditional energy production model of the utilities sector will change and we anticipate that its pace will be faster than most utilities expect.

Oil companies are also looking for a place under the sun

Competition from a new quarter Not only the organisation of the energy market will be overhauled. The competitive relationships will also change. In more and more European regions, foreign producers can join the bidding for energy projects. This is taking place gradually, but may eventually become a challenge for large, domestically-oriented utilities. Competition from outside the sector is also increasing. Various oil and gas producers are looking for a place under the sun in the utilities sector. For example, by means of the acquisition of an existing gas network, the construction of a gas storage facility, or through the transport capacity for renewable energy. These entrants – so-called challengers – from outside the sector naturally represent a threat. But for many newcomers, this is only an extra activity for the time being. Without the necessary scale, focus and long-term investments, we believe the impact on the sector will be less than expected for the moment.

Investment and further digitisation needed The changes in the market also require a modification of the energy infrastructure. Digitisation is needed to charge electric cars, to integrate wind and solar energy and to facilitate the European switched energy network. Grid operators in particular will benefit from this development. More network investments generally mean more revenue for utilities. Increasing digitisation will help utilities to improve the balance of supply and demand on the network, to develop new services and to save on maintenance. This will significantly reduce operating costs in the coming years. Given the plans and investments that have been announced, European utilities are ahead of their US counterparts.

World index price/earnings ratio and utilities sector index

MSCI All Country World Index and MSCI All Country Utilities Index. Source: Thomson Reuters Datastream, November 2018

39

Mike Mulders investment analyst

Financials

Banks return greater share of interest income to customers US interest rate rise favourable for banks’ interest income.... The US central bank, the ‘Fed’, is also expected to raise policy interest rates several times in 2019. Most analysts expect interest rates to move to 3% in three steps of 25 basis points. This policy rate mainly determines the interest on short-term loans (up to two years), including credit card loans. Higher interest rates mean that banks can charge higher interest rates on new loans and existing loans with a variable interest rate. As a result, their interest income will rise. We do see, however, that due to competitive pressure US banks are increasingly having to share more of this interest advantage with customers, for example by raising the interest rate on savings. The extent to which banks pass on the central bank’s interest rate increase to their customers is referred to as the ‘deposit beta’. Competitive pressure increases this deposit beta. The benefit of the interest rate increases therefore diminishes and the net interest income will increase less rapidly than with the previous interest rate increases. Nevertheless, the US banks are still expected to benefit from this. ... but the increase in interest rates also has drawbacks Higher interest rates in the US lead to an increase in borrowing costs and gradually make it more difficult for borrowers to meet their payment obligations. So far (end of 2018), the effects of interest rate increases

on consumers and businesses have been limited, but this may change in 2019. The cost of credit for businesses will therefore be closely monitored each quarter. The banks naturally also look at the financial health of their debtors. Nevertheless, rising overdraft rates are not immediately alarming. The average level of the credit costs is still historically low and (slightly) higher interest rates do not immediately cause problems for most companies. Creditworthiness of debtors adequate As long as banks’ risk costs – such as provisions for bad loans – do not rise faster than the interest margin, the bank will continue to benefit from higher interest rates. In addition, compared to before the crisis, the large banks have less risky loans on their balance sheets. For example, in the case of loans to private individuals, the average creditworthiness is considerably better than the national average. The creditworthiness of the business loan portfolios is also high on average. US banks are therefore generally quite resistant to increases in the cost of credit for their debtors. Strong capital positions permit higher dividend payments US banks currently have healthy capital positions. They have a considerable buffer to take hard knocks, for example should the economic situation deteriorate. The regulatory authorities perform annual stress tests, during which these capital buffers

40

are checked. If a bank has a stronger capital position than required by the regulator, this gives it financial scope to distribute more profit to shareholders. The results of the stress test are published annually in June. Banks that do not pass the stress test are forced to reduce their capital distribution and thus keep more capital on the balance sheet. The test should be an important brake on the increase in capital distribution, but until now, US regulators have been very accommodating to US banks. And it is expected that the favourable, flexible regime for US banks will remain in place under the current Republican administration. Consequently, there is room for the banks to share a larger part of their profits with the shareholders. End of low interest rates in Europe coming into view Following the termination of the bond buy-back programme at the end of 2018, the European Central Bank (ECB) is expected to start raising policy rates in 2019. This will have an impact on many of the banks’ interest rates. We expect that the ECB will only announce the first hike in the deposit rate of a quarter of a percentage point after the summer. For European banks, an interest rate rise is good news, because low interest rates weigh on their earnings model. But there is a long way to go; we are still a long way from the 3-4% interest rates from before the financial crisis. Some banks will choose not to directly pass on the higher interest rates in the loan rates so they can challenge the competition and gain market share. Although improvement is in sight, we expect the positive effect of the rise in interest rates in 2019 for the banks to remain limited.

every bank at the same time. Brexit puts pressure on British insurers Globally active non-life insurers have survived the hurricane season well, thanks to strong capital buffers and fewer claims than expected. Furthermore, robust economic growth is helping to sell policies. For the reinsurers, who therefore insure the risks of the regular insurers, this is disadvantageous because their services are less in demand and there is no opportunity to increase prices. British insurers are under pressure due to all the attention being paid to Brexit. In the case of a no-deal Brexit, a possible reduction in the average creditworthiness of debtors and pressure on the real estate market could significantly raise the capital requirements. At the beginning of 2019, therefore, attention should be paid to the debt position of British insurers. A further increase in bond yields is particularly important for life insurers. Life insurers with bond portfolios with relatively short average remaining maturities and companies with large investment portfolios are the main beneficiaries.

The effect of higher interest rates is not the same for every bank Higher policy interest rates are not reflected in the figures for each bank at the same time as the terms and conditions of loans often differ between countries. In the Netherlands, for example, we have many mortgages with a fixed long-term interest rate, while Spain has many mortgages with variable interest rates. This means that Spanish banks, on average, will be more likely to see the result of higher interest rates in the cash flows from existing loans. In the case of new loans, banks can adjust the rate more quickly, but here too there are considerable differences per country. Over the past 15 years, for example, the changes in policy rates in Italy were implemented more quickly in the interest rate for new loans than they were in Germany. The impact of the rise in interest rates is therefore not visible at

41

Henry van Heijster investment manager

Real estate sector

Dividends are attractive, but rising interest rates are a risk Real estate is a stable source of dividend income for many investors. A few percent of real estate, around 5% to 10%, in an investment portfolio also improves its diversification as real estate regularly moves differently from the stock market. European real estate market picks up The real estate market in Europe has recently been producing attractive returns. Germany in particular has been performing above average for many years, and will probably continue to do so in 2019. There is a constant, strong interest in retail property, offices and homes – especially in the seven largest cities. But real estate in the slightly smaller German cities is also gaining in popularity. The French real estate market has improved considerably in recent years and interest is still growing. With their office portfolios in France and Germany, many real estate funds now have an occupancy rate of well above 95%. Opportunities: e-commerce real estate and offices The e-commerce sub-sector is a relative newcomer to in the logistics real estate field in Europe. This market is growing rapidly. Centres that focus on local distribution have the best future prospects. These are large centres in sparsely populated areas in Western and Central Europe, and smaller distribution centres on the outskirts of larger cities. The growth of e-commerce does however have negative consequences for the returns on retail real estate because retail rents are often based on a percentage

of the turnover realised. The conditions for offices are improving, however. This market can benefit from the improving economic conditions, especially when it comes to ‘sustainable’ real estate, which for example is CO2-neutral in use. Real estate market in Asia different from the West The Asia/Pacific region comprises the world’s fastest growing economies and offers plenty of opportunities for real estate investments. The region is dominated by China, where major economic changes, such as urbanisation, have led to rapid growth of the middle classes. Investors can benefit from this by focusing on shopping facilities in the larger Chinese cities. The average consumer in Europe or the United States is not attracted to super luxury branded stores. But the new middle classes in the Asia/Pacific region, like the ultra-rich consumers, are keen to buy their products in this type of high-end stores. Here, the demand for retail property remains high. Bond yield important factor in North America... As the world’s largest real estate market, the US plays a decisive role in the North American region. The country therefore enjoys considerable interest

42

from both domestic and foreign real estate investors. The current investment climate is favourable, with continuing economic growth. But there are risks, resulting from the US-Chinese trade conflict and rising bond yields. Both factors can slow down demand for real estate investments and thus the development of property values. For example, the US ten-year yield was only 2.5% at the beginning of 2018, but had already risen to 3.2% at the beginning of November this year. And the end of the rise in interest rates is not yet in sight. ... where innovation can create opportunities in the retail market Investors in North America are paying a lot of attention to the office market. But the logistics centres for e-commerce activities also offer interesting investment opportunities. The same applies to the retail market, although there is an element of oversupply in this sector. Modern, popular retail formulas with higher than average returns are occupied by innovative management companies, such as the large US real estate fund Simon Property, in restored buildings for the most part. The rental housing market is an investment market that is growing in popularity, partly due to the increasing demand for such housing. Conclusion: no high expectations for 2019 As an investment category, real estate performed relatively well in 2018. Global bond yields are likely to continue to rise in the coming year and we therefore do not expect 2019 to be a particularly good year for listed real estate. However, the high dividend yield remains attractive. Moreover, real estate can contribute to the diversification within an investment portfolio.

43

Eric de Graaf investment analyst

Industrials

Is growth finished? The industrials sector is not only sensitive to the economy, but also to political factors. Sea freight, for example, is very dependent on the growth of world trade. Import duties represent an additional source of uncertainty. Although the economic developments of recent years have had a positive effect on the sales of many companies, the risks are increasing in this late phase of the economic cycle. Global demand, which is picking up thanks to growth, has led to greater production. But not all business sectors have sufficient capacity for (strong) expansion of production. New investments would be required for this. For the industrials sector, of course, this is good news. The increasing demand also leads to higher prices of raw materials. The profitability of industrial companies is therefore linked to the possibility of incorporating the price increases of raw materials into the prices. This is an uncertain factor. Besides economic developments, political developments also have a strong influence. Recently, this influence has mainly been negative. Airline companies: no straight ascending line Competition remains fierce in the airlines subsector. Over the years, this segment has acquired a bad reputation with investors, partly due to the many strikes and bankruptcies. In previous years we expressed our preference within this sub-sector for US ultra-low-cost carriers: extremely low-cost airlines that are able to offer tickets at low prices. The business model of this sub-segment and the growth of the consumer market have had a positive impact on the results of these companies. But in the recent period a reversal has occurred in the results and profit

expectations. Increased competition from regular airlines – so-called premium carriers – rising fuel costs and increasing overcapacity are important causes of this. Most US low-cost airlines only fly on domestic routes. They were able to maintain their growth for years by offering more routes and flights at ever lower fares. However, this business model seems to be rather worn out, now that there is greater market saturation. Air transport capacity is growing more strongly than ticket demand, which is pushing down profit margins, and thus the bottom line. Adapting to the new market situation takes time. Not all parties seem to have found the right answer, so that large differences in returns have arisen. We expect this development to continue. Transport: helped by the economy, hampered by rising costs Transport is a very diverse and highly specialised sub-sector. Broadly speaking, transport companies can be divided into two groups. On the one hand, the railway companies and ship carriers, which focus on the transport of bulk goods. On the other, the postal companies and package carriers, which take care of the smaller consignments. The US railway companies keep the industrial sector in the US running by transporting raw materials and finished products. This automatically makes them an important indicator for the – still smoothly running – US economy. The volumes are healthy, although some bulk goods, such

44

as coal, have fallen out of favour. Besides volume, efficiency and reliability are important aspects for profitability. For the time being, this sub-sector is still enjoying average revenue growth of 3-4%, leaving room for double-digit profit growth rates. Driven by this profit growth, there has been strong price performance in recent months. As a result, valuations, such as the price/earnings ratio, have now exceeded the subsector’s long-term average. Parcel carriers probably do not meet expectations Sea transport is highly dependent on international trade and although most economies are running smoothly, global trade is growing at a lower rate. This is due to political factors, such as Chinese-US trade tensions. We expect the maritime transport sector to remain difficult for the time being. Another aspect that makes us less positive about this sub-sector is the overcapacity among shipowners. On the other hand, e-commerce turnover (webshops) continues to develop favourably in line with our outlook and that means: high parcel volumes We previously wrote that parcel carriers, and postal companies to a lesser extent, can benefit from these higher volumes. A condition for this, however, is that these companies invest heavily in capacity, in order to be able to cope with the volumes, even at peak times. It looked good for the sub-sector, but recent market developments have tempered our expectations somewhat. For example, online sales giant Amazon – which accounts for a significant proportion of all parcels sent in the United States – has indicated that it wants to do the delivery itself, which is a disappointment for parcel carriers. Labour costs within the sector are also rising due to a lack of personnel.

Amazon wants to deliver parcels in the US itself Conglomerates such as GE and Siemens: end of an era? For decades, the Siemens industrial conglomerate has been regarded as an important indicator of the state of the German economy. The same was true for General Electric (GE) in the US. But the attractiveness of conglomerates – their spread across different sectors – has declined in recent years. Investors are increasingly able to attend to diversity in their

investment portfolios themselves. Furthermore, conglomerates are unable to take sufficient advantage of their range of activities. Because they do not maintain sufficient oversight and focus, certain activities perform less well. GE and Siemens are now increasingly focusing on their strengths. For GE in particular, this is a difficult and far-reaching process, characterised by extra writedowns on its book value and major reorganisations. During the past two years, the company lost more than half of its going-concern value. Neither Siemens nor GE appears to be particularly highly valued. Time after time, new problems arise, so that the profit falls. Both companies have a large division for the construction of power plants. These divisions are suffering from poor results due to limited investment in new power stations. Investors and governments are increasingly interested in reducing greenhouse gas emissions and many utilities are consequently shifting their focus to renewable energy. GE and Siemens are also active in this field, but on a small scale for the time being. This makes it less profitable. How profitable will wind energy become? The current share of wind energy in global electricity generation is about 7%. But it is generally expected that wind turbines will have an ever increasing share in the coming years. The estimates for this vary, but we consider a doubling of the amount of electricity generated from wind power by 2040 to be realistic. However, there are many players in the market and there is increasing pressure on prices. The fact that governments have switched to public tenders plays an important role in this. Temporary employment agency sector: heading for contraction? At the rising start of the economic cycle, we see strong growth in the temporary secondment of personnel. Companies may then see opportunities for growth, but hardly dare to hire permanent staff. At the moment we are much further in the cycle, i.e. in the final growth phase. It is then more realistic to assume a period of at most limited growth and even contraction in this part of the industry sector. Valuations are now relatively low and dividend yields high, but we see a structural risk. More and more companies are using apps to make direct working arrangements with standby workers and selfemployed persons. Temporary employment agencies no longer play much of a role in this process, as a result of which their market is shrinking.

45

Friso Rengers investment manager

Energy sector

Not yet done with oil The large-scale purchase and consumption of oil and natural gas has many negative effects - not to mention the environmental drawbacks. Thus for example, some of the regimes in the major oilexporting countries finance dubious practices with their oil and gas revenues. How do politicians respond to the disadvantages of this global billion-dollar industry? The US is increasingly becoming self-reliant and producing more and more of its oil and gas itself. The country possesses enormous amounts of shale oil and gas deposits. With a few exceptions, the countries in Europe and Asia have no such possibilities, or far fewer. They are therefore making greater efforts to diversify their energy sources. Apart from traditional fossil energy sources, these include nuclear energy, geothermal energy, solar energy, wind energy, hydro power, natural gas and imports from ‘new oil countries’ such as the US. Demand for oil and gas remains high While energy sources on the production side are becoming increasingly diverse, energy consumption is undergoing considerable innovation. Where will we obtain the energy for heating and electricity in homes and offices in the future? A lot of electricity is also needed for production facilities, means of transport, such as electric cars, and drones. In the long term, we foresee exciting changes. We may, for example, no longer sit in traffic jams, but will take the drone to work, if we still travel to work at all. Nevertheless, this does not mean that the large-scale demand for oil and gas will soon come to an end.

OPEC and reserve capacity There is hardly any spare capacity left in oilproducing countries. This means: one shock absorber less in the supply-demand relationship for ‘black gold’. The oil price can consequently respond even more quickly and more strongly to variations in supply and demand on the world market. $100 per barrel of oil or not? The phenomenal growth of the North American oil industry and the somewhat less strong economic growth in the emerging markets are factors that have prevented the oil price from rising above $100 per barrel of Brent oil in 2018. But will the North Americans sustain this rate of growth? Can Russia and Saudi Arabia increase their oil production further? And what is the situation, in terms of oil production, in medium-sized countries like Libya and Venezuela? So much for the supply side; in comparison, the demand side is much more stable. World oil consumption is still growing at around 1.5% per year. It is expected that, as long as a severe economic recession does not occur, oil consumption will continue to grow at this rate. Emerging markets are a much more important factor for the increase in world oil consumption than the developed economies, where not only economic growth is slower, but also the transition to electric vehicles is taking place. Nevertheless, our assessment is that the oil price does not have to exceed $100, provided that sufficient investments are made in (future) oil production. We will of course follow this closely. For the sake of clarity: in addition to the market forces mentioned above, the oil price in 2019 will also be influenced by possible agreements between the oil-

46

exporting countries to limit production. The sentiment surrounding oil stocks is certainly not bad at the moment, but this type of equity has a less solid position in the equity portfolios than previously. On the one hand because Amazon, Apple and Google have assumed the self-evident position of oil stocks, on the other hand the oil sector is under public pressure for obvious reasons, such as the environmental damage caused by the combustion products of fossil energy sources. We see that western oil companies have responded differently to this. The French company Total has more or less continued as before, and the market price is benefiting from this. The British company BP has finally recovered, following years of headline-gripping disasters – first in Russia and then the oil spill in the Gulf of Mexico. BP recently reinvested again in the long term by acquiring the shale activities of mining company BHP. The US company Exxon bought up a large number of its own shares, invested in itself, as it were, and thus for a long period assumed a wait and see attitude. Exxon had previously acquired shale gas production company XTO Energy and recently invested heavily in deep-sea offshore exploration and production. Two years ago, Royal Dutch Shell (Koninklijke Olie) focused even more on natural gas

Chart of Brent Oil Price

by acquiring British Gas. The US company Chevron, like Total, continued to grow without changing its strategy. It is also striking that the European oil giants (BP, Shell and Total) are real dividend stocks. This applies to a lesser extent to the US super majors Exxon and Chevron. For all five oil giants, approximately 80% of the total investment result of the equities over the past five years consisted of dividends. Oil remains a relatively solid investment, but also no more than that For the time being, the world will continue to consume huge volumes of oil – even if that is with some reluctance. Investing in oil companies seems relatively defensive to us, since income will continue to flow for many years to come. And if investments remain low relative to cash flows, dividends seem assured. On the other hand, doubts about the long term will not disappear, so that substantial, long-term price gains appear to be out of the question. Doubts about long-term perspective These doubts are being fed by technological developments in the transport sector. Not only electric cars, but also drones and innovation in cargo transport are playing a role. This is relevant for future

Source: Thomson Reuters Datastream, November 2018

47

oil demand, as oil is an essential raw material for transport services. Western oil companies are not the only key players anymore in the sector. Big sovereign oil companies in Asia and the Middle East are playing an increasingly bigger role. The Western companies are often still leading in the field of technology. Oil and gas service providers, offshore drilling platforms and technical suppliers This technical field also includes oil service providers, drilling companies and suppliers. Fugro and SBM are listed in the Netherlands. Many of the companies in this group have experienced hard times due to shrinkage and thin margins, especially following the fall of the oil price in 2014. In the period before that, too much capacity had been created, so that less was invested in exploration. Moreover, the oil companies have become much tougher in the price negotiations with the service providers, as a result of which these companies benefit less from higher oil and gas prices. As time goes by, investments in oil service providers appear to be gradually becoming more attractive, but for the time being their price recovery is disappointing investors.

Indices for oil producers and service providers

Source: Thomson Reuters Datastream, November 2018

48

Jenny Overman investment analyst

Healthcare

Quality and innovation as an answer After a weak start to the year, investor interest in the sector picked up again in the second half of 2018. This was due to the relatively low valuation, such as the price/earnings ratio. The fact that equities from this sector are regarded as defensive also plays a role. We have had a year of uncertainty. Due to the high prices of medicines, the government threatened to intervene in the sector. However, the negative influence of this is not as bad as expected for the time being. Moreover, most pharmaceutical companies were able to show good results from their product development. Investors had previously feared that there would be a shortage of successors to successful medicines whose patents would expire. This fear has now diminished. The Trump administration’s tax cuts also contributed to a strong price development, as a result of which the valuation in relation to the world index has increased. Income in the sector is less dependent on economic growth and industrial activity and this makes it relatively more attractive towards the end of the economic cycle. The development of new medicines presents opportunities Following a period of high expectations, disappointing product development and expiring patents, the medicine developers now again have a well-filled product development pipeline. Thanks to an improved focus on internal processes, varied product portfolios have recently emerged. These portfolios are resistant to expiring patents, setbacks in product development and political risks. A growing part of the revenues and the product development in the healthcare sector is realised outside the US where regulators have more

opportunities to take the benefit, the so-called added value, of a medicine into account when setting prices. This stimulates the development of innovative and unique medicines. In the coming years, medicine developers with strong product development will have the most opportunities. Boring is sometimes an advantage In recent years, many pharmaceutical companies have disposed of their related activities in areas such as vaccines, foodstuffs, veterinary medicine, personal care and agricultural chemicals. These often have lower growth and margins. They mainly focus on financing their product development. Such activities are less sensitive to political risks and, if run efficiently, can contribute to stable revenue streams. Companies in the pharmaceutical sector that have retained and optimised related activities can benefit from this if political pressure on healthcare costs increases further. Political risk remains present The discussion about healthcare costs in the US will continue for the time being. For both prominent Democratic and Republican politicians, this is an important point in the run-up to the 2020 presidential elections. But the introduction of stricter rules that actually have a major impact on the sector has proved difficult in practice. These attempts mainly lead to political discussions and to temporary pressure on valuations. Pharmaceutical concerns will, however, become more reticent with price increases. This may put pressure on future profitability, because price increases are an important component in the

49

Price/earnings ratio world index and healthcare index

MSCI All Country World Index and MSCI All Country Health Care Index. Source: Thomson Reuters Datastream, November 2018

Healthcare

overall profitability of a medicine. Health insurers are often responsible for the implementation of national healthcare plans and aim to have as many participants as possible, but in various countries politicians have made proposals to restrict national care plans. We believe that the ultimate effect will be better than expected for both pharmaceutical companies and health insurers. However, we do expect strongly fluctuating prices again this year. Remote care and medical technology Manufacturers of medical equipment and medical service providers are usually not affected by political discussions. Their products and services form a relatively small – albeit indispensable – part of a medical treatment and their share in the total costs is also limited. However, these companies do benefit from increasing digitisation, individualisation and remote care. It is a challenge for them to develop the necessary equipment, to optimise the quality of care and to guarantee the digital safety of these products. The healthcare sector does not have a good record in this field and will have to invest heavily here in the coming years in order to maintain the confidence of patients. There is also a risk that other personal equipment developers, such as IT companies, will enter the

healthcare sector. Established medical appliance manufacturers can benefit from their experience in the sector and they can use their ties with healthcare providers to hedge this risk. New, complex medicines under development For most biotechnology stocks, 2018 was not a very inspiring year. Prices were lower than the rest of the sector, there was little news about product development and the takeover market remained fairly quiet, even though low interest rates meant that capital was to a large extent available to finance acquisitions. However, the biotech companies did manage to improve their cash position last year. Thanks to the low capital market interest rates, the development of new products was easier to finance. This contributes to more promising medicines moving from the development to the test phase. When medicines enter the test phase, the larger pharmaceutical companies often consider taking over the company in question. We therefore expect more acquisitions by pharmaceutical companies in 2019 and the laboratories of biotechnology companies will also develop new, complex medicines.

50

Opportunities in China The Chinese healthcare market is rapidly modernising. This presents opportunities for Western healthcare companies in the areas of sales, production and development and they will receive a boost from the continuing growth in prosperity. Caution is called for, however: there are major differences in the field of patents and quality control. Chinese doctors and patients have different preferences than in the West and the

Chinese government maintains tighter supervision. Healthcare companies are expected to focus more on the Chinese growth market with actual success being dependent upon a strong focus and substantial investments.

51

Eric de Graaf investment analyst

Information technology

Market leaders are operationally strong, but cracks are appearing Within the information technology sector there are large differences in growth. The US market leaders generally perform well in their business operations. And in 2018 they were clearly helped financially by the Trump administration’s tax cuts. In a number of areas, some slowdown in growth is visible, however. The markets for smartphones and PCs will only grow to a limited extent in the coming years. The semiconductor sector is also currently experiencing a cyclical slowdown. At the moment, the strong growth is mainly in the providers of cloud services and data processing. Operational growth translates into stronger price development Equities from the IT sector have in 2018 up until now, as in previous years, on average been performing well on the stock markets. However, investment performance is not evenly distributed across all subsectors. For example, software producers performed slightly better than the sector as a whole, as did manufacturers of communication equipment and electronics. The semiconductor industry, where a period of strong cyclical growth seems to have come to an end, is lagging behind. There are also clear differences in price performance within the sub-sectors, with the market leaders often doing better than average.

Following an adjustment in the sector classification, IT has a more hardware character On 1 October 2018, the leading financial institution Morgan Stanley Capital International (MSCI), wellknown for its indices, made significant changes to the sector distribution. We also use the MSCI indices for our sector distribution. Social media companies such as Facebook and Alphabet (Google’s parent company) and game software developers such as Nintendo and Activision are now classified in a different sector index. As a result of this shift, semiconductor manufacturers and IT service companies have become much more important within the sector. You could say that the IT sector has become much more hardware-based. Limited growth for PCs and smartphones, consolidation Many initiatives were presented during the past years that could in the long term constitute a significant part of the turnovers in the hardware segment and thus produce growth. Examples include (self-driving) electric cars, all kinds of robotics applications and

52

virtual and augmented reality. Although the outlook for the long term still remains good, a number of these markets appear to be under pressure in the short term. This is due to the US-Chinese trade war and a slightly overoptimistic inventory accumulation. The hardware sub-sector also needs new growth markets, since the more traditional PC and smartphone markets are expected to grow at best to a limited extent in the coming years. Consolidation is taking place throughout the chain, although global regulators regularly veto this. The most striking example of this in the semiconductor sector is the fact that the acquisition of NXP Semiconductors by Qualcomm ultimately did not receive the approval of the Chinese regulator. The Chinese veto has certainly slowed down the pace of consolidation. Semiconductors also offer opportunities during a cyclical slowdown Semiconductors are particularly sensitive to fluctuations in demand due to their production process with high start-up costs and round-the-clock production. The production has to be sold, so prices are very volatile. There have especially been positive effects in the memory chip market in recent years due to the strong demand and insufficient supply. Extremely high margins, sometimes exceeding 50% net margin, pushed up prices, although valuations only partly reflected this. An increasing supply combined with weakening growth in demand leads to a fall in prices: a signal that can no longer be missed. For the time being, it does not appear that there is anything more than a normal cyclical slowdown, which also creates opportunities. However, an escalating trade war can lead to bigger problems. After all, China and the United States are important links in the production chains. Impressive growth in cloud services, but not all companies reap the benefits Many technology companies have invested in a presence in the cloud in recent years. The impressive growth figures of major players in this field, such as Microsoft, Amazon, Alphabet and IBM, therefore did not come as a surprise. The growth rate will slow down slightly, but will remain strong, as will the necessary investments. Here too, we expect smaller players to realise that profitability on an autonomous basis is ultimately unrealistic.

Cooperation or consolidation seems to them to be the only way to continue playing a role alongside the big players with a much larger budget. For the moment, the construction of large data centres is an important source of income for companies such as Intel and Nvidia, but also for all kinds of other suppliers.

Escalating trade war can hit the IT sector hard

IT service providers: data processors very successful The largest companies in the IT services sub-sector are data processors, such as Mastercard and Visa. Thanks to the growing flow of payments, these companies have performed extremely well in the past quarters. The fear that Apple Pay and Google Pay would have a negative effect on these companies has largely faded away. More cooperation than displacement is taking place. It certainly does not appear that turnover growth is exhausted, even though the market value (such as the price-earnings ratio) has become high. In a structural sense, things are slightly more difficult for the pure consultancy firms. But they are benefiting from the economic recovery thanks to previous selective acquisitions and cost optimisation. Due to the ongoing economic recovery in large parts of the world, we also anticipate turnover growth in 2019 and the first years thereafter. But a significantly higher average profit margin is not automatic and in the longer term, we only see relatively limited growth. IT specialists are often hired by external IT service providers. As a result of the structural transfer of activities to external cloud services, customers of IT service providers ultimately require fewer IT specialists, who are then often hired by external IT service providers. We therefore do not expect profit margins, and thus stock market valuations, to return to historically high levels again.

53

Eric de Graaf investment analyst

Communication services

New sector offers a lot of choice; differences are large The change in the global sector classification has drastically changed the profile of the communication services sector. Telecommunication companies only account for 40% of the market value. The rest consists of ordinary and social media companies. The most important themes in the new sector are advertising growth and the constant craving for content. For the telecom companies, it is important that the regulators grant approval for mergers and acquisitions. The financing of 5G networks is also a prerequisite for growth. Launch of new communication services sector The fact that telecom, media and IT companies are increasingly seeking one another out has not escaped the notice of MSCI, an index compiler. That is why, since the start of the fourth quarter of 2018, this leading institution has included the telecommunication sector in the newly formed communication services equity sector. In addition to all companies in the former telecom sector, this also includes digital service providers such as Facebook, Alphabet and Tencent. Media companies such as Disney, Netflix, WPP and Electronic Arts are also included in the communication services sector. Weighted by total market capitalisation, telecom companies only account for 40% of the market value of the communication services sector. Digital service providers: stronger growth, greater risks The shift from traditional newspaper, radio and TV advertisements to online advertising, which was started some time ago, is continuing with full force.

Facebook and Alphabet are benefiting enormously from this. Together, they have a market share of approximately 50% of global online advertising. Amazon is nibbling away at this a bit; growth is also slowing down. Discussions about market abuse, tax evasion and the distribution of ‘fake news’ will lead to extra costs and possibly increased supervision. It is still unclear what measures will be taken to limit the dominance of the internet giants. But this is a source of concern. In the second half of 2018, this combination of negative factors put considerable pressure on equity prices within this sector. Because there is still aboveaverage profit growth while prices did not rise, valuations have generally fallen sharply. In many cases, valuations have even reached levels that were not so low in years. At these levels, we believe they offer the prospect of above-average returns. Media and entertainment: great opportunities, major threats With the inclusion of media and entertainment companies in the communication sector, two groups have been added with completely different growth patterns and valuations. After all, they do not have the same background and function as the rest of the sector. For media companies, it is mainly the

54

case that the money has to be earned through advertisements and commercials. This is certainly not an easy task, because the non-online part of those markets is under pressure. The shift to online advertisements has resulted in the loss of a lot of turnover because in many cases they require less involvement from intermediaries and can be booked directly. Most entertainment companies create their own content, ranging from films, series and music to computer games, and also remain owners of them. This can be seen in the above-average growth and valuation. The acquisition of these companies, popular because of their attractive content, leads to discussion. It goes too far to say that all companies in this sub-sector will eventually become part of a larger whole.

Content is king in the seduction of media consumers But given the considerable costs involved in developing new films and games, it is logical to expect that acquisitions will follow in this segment. Companies such as Alphabet and Tencent are also looking for content to make their offering more attractive to consumers. Telecom companies seek growth in mergers In recent years, many takeover initiatives have been started in the telecom sector. Some of these have also been completed. The reason for this is clear: the years of declining revenues and the increase in digital solutions, which are replacing traditional telephony services. Relatively new is that both in the US and in Europe proposals have been made for horizontal integration. In recent years, such acquisitions have almost always been rejected by the relevant regulator in order to maintain market relations and thus also competition. It is still unclear how the regulators now look at this, but they seem to be rather more inclined to grant approval because the smaller providers have great difficulty continuing to compete and invest. Following the amalgamation of AT&T and Time Warner and the acquisition of Sky by Viacom, mergers between different media companies are still planned in the US. In Europe, too, regulators

have to assess a number of major acquisition plans. Given the difficulties with mergers in the past, a consolidation bonus in the prices is currently hardly anywhere to be found. No extra high prices, therefore, due to speculation about a takeover bid. Huge investments increase expenditure All these acquisitions cost money, and that while the necessary investments will increase in the coming years. The start-up of 5G, expansion of fast internet and other investments are expected to lead to higher expenditures in the coming years. The auctioning of the frequency spectrum for 5G networks in Europe alone is expected to cost the sector 10 billion euros. The sector’s debt position is on average lower than a few years ago, but the expected revenues have also decreased. A period of rising investment costs and declining cash flows is on the horizon. This increases the sector’s sensitivity to higher interest rates, which would increase funding costs and reduce the relative attractiveness of equities over bonds. In addition to the planned synergies, which should result from the many telecom mergers, cost savings should make a significant contribution to cash flows. Fortunately, there are still opportunities here, such as switching off outdated networks. With a fully operational 4G network and the stable 3G as a backstop, older technologies are no longer needed. Another possibility is to switch to unlimited subscriptions, which will make the administration of separate telephony, text and data bundles superfluous. The digitisation of maintenance, services and network management can also save a lot of money. 5G must fulfil future dreams The promise of 5G is not new. But with the actual start of commercial roll-out in the US and Asia at the end of 2018, the application of this new technology is finally coming closer. With 4G, telecom companies mainly supplied the infrastructure and other parties provided the innovation. With 5G, however, they hope to return to the forefront of digital innovation again. 5G offers internet speeds that are many times higher than 4G. More importantly, there is less delay in sending a digital command from A to B, which should facilitate the large-scale use of drones, self-driving cars and other technological pipe dreams. But in many cases these are still just dreams.

55

Consumers will still have to wait a while for a 5G telephone. Moreover, it is already quite easy to watch an episode of your favourite series. Converting the investments in 5G into actual income is the big challenge for telecom companies in the coming years. Companies that take the lead in this can quickly build up an advantage over competitors. This is perfectly possible in cooperation with a company that needs large amounts of data. A company with self-driving cars such as Waymo – a subsidiary of Alphabet – could, for example, be a forerunner in this field.

56

Want to know more? Do you want personal contact or have questions about your investment portfolio? Your Private Banker or Private Wealth Manager will be happy to assist you. If you do not have a contact at ING, call +316 3400 4800 to make an appointment.

Disclaimer This investment recommendation was prepared and issued (in Dutch) by ING Investment Office, part of ING Bank N.V., for the first time on 27 November 2018, 16.00 p.m. For the preparation of this investment recommendation, use was made of the following substantive sources of information: S&P Capital IQ, Bloomberg, CreditSights, Oddo Securities, Standard & Poor’s, Thomson Reuters Datastream, Moody’s, Fitch, UBS Neo, Reuters Metastock and/ or Sustainalytics. This investment recommendation was based on the following accounting principles, methods and assumptions: price/earnings ratio, price/book value ratio and/or net asset value (NAV). No protected models were used for this investment recommendation. A description of the ING policy regarding information barriers and conflicts of interest can be found here. Unless otherwise stated, ING Bank N.V. will not update the investment recommendation. Developments that have occurred after the preparation of this investment recommendation may affect the accuracy of the assumptions on which this investment recommendation is based. Investment recommendations are generally revised two to four times a year. This investment recommendation does not constitute individual investment advice, but only a general recommendation on which investors can also base their investment decisions and does not constitute an invitation to enter into any contract or commitment whatsoever. This investment recommendation is based on assumptions and does not represent any guarantee for a particular development or result. No rights can be derived from this investment recommendation. Decisions based on this investment recommendation are for your own account and risk. Neither ING Bank N.V., nor ING Groep N.V. nor any other legal entity belonging to the ING Group, accepts liability for any damage to any extent whatsoever, arising from the use of the above investment recommendation or the information contained therein. Investing entails risks. You could lose all or part of your initial investment. The value of your investment may fluctuate. Past performance is no guarantee of future results. ING Bank N.V. is not registered as a broker dealer and investment advisor as referred to in the US Securities Exchange Act of 1934, respectively, the US Investment Advisers Act of 1940, as amended from time to time, nor within the meaning of other applicable legislation and regulations of the individual states of the United States of America (hereinafter jointly referred to as: ‘US investment law’). This investment recommendation is not addressed to and not intended for US Persons within the meaning of US investment law. Copies of this may not be sent or brought to the United States of America or provided to US Persons.

ING Bank N.V. has its registered office in Amsterdam, Commercial Register no. 33031431, and is supervised by the Netherlands Authority for the Financial Markets (Stichting Autoriteit Financiële Markten) (“AFM”). ING Bank N.V. is part of ING Groep N.V. All rights reserved. This investment recommendation may not be reproduced, copied, published, stored, modified or used in any form, online or offline, without the prior written consent of ING Bank N.V. ©2018 ING Bank N.V., Amsterdam.

57