(1/7)

Globally, economic growth is cur-rently strong, with GDP growing in practically all of the OECD coun-tries and even accelerating in many. The new investment year is supported by exceptionally broad-based and strong economic growth around the world. This has of course already been factored into the money markets and 2017 was the strongest upward year since 2009, with the MSCI World All Country index rising +19.8%. Inter-est rates remained relatively low due to moderate inflation and the resulting stimulating central bank monetary policy. We are coming into the new year in a neutral posi-tion in our allocation products in terms of equity weight (read more in our Allocation insight). On the fixed income markets, the year ended with a slight rise in in-terest rates. However, the interest rate level remained exceptionally low in Europe in the long term, compared to current economic growth. The non-existent inflation is the factor due to which central banks in Europe are only now, very slowly, dismantling their massive stimulus measures.

This holds a possible element of sur-prise for this year: even a moderate rise in inflation due to the impact of rising wages, raw material prices and other factors might shift the current factoring in of the ECB’s key interest rate (first key interest rate hike sched-uled for mid-2019) closer to the pre-sent. Short and long-term rates would rise as a result. The corporate bond markets featured the largest ever scramble onto the issue markets, with compa-nies buying up financing from the bond and bank loan markets. Credit risk premiums are at this cycle’s bot-tommost figures and the low level of the underlying interest rate is pushing companies’ interest expenses down-wards. For investors, this means se-lectivity when choosing bonds. In our view, many corporate bonds were ineligible for investment at the end of last year. Globally, equities reached the best figures since 2009, with the MSCI World All Country index rising +19.8% last year. In the US, the to-tal return on the S&P 500 index was +21.8% (in dollars), but due to the weakening of the currency, only

+6.9% (in euros) without hedging. Meanwhile in Europe, the Stoxx 600 index’s total return was +10.6%, which meant that, finally, Europe per-formed better than the US (in euros). Last year, the stock volatility was the second lowest in US history measured during the calendar year, as equities rose without any signifi-cant turbulence. Earnings growth ex-pectations have supported this: cur-rently, +11.5% earnings growth is slated for the S&P 500 index for 2018, accompanied by a significant decline in the corporate tax rate, and +9% earnings growth for the Europe-an Stoxx 600 index. Also the earnings forecasts of emerg-ing market (EM) stock markets have been raised, which means that global economic growth and the positive earnings forecast development will provide the equity markets with sup-port as we enter the new investment year.

5 January 2018 Market Outlook

Mandatum Life Insurance Company Limited • Postal address: P.O. Box 627, FI-00101 Helsinki, Finland • Registered office and address: Bulevardi 56, 00120 Helsinki, Finland • Business ID 0641130-2 • www.mandatumlife.fi

Source: Bloomberg. Past performance is no guarantee of future results.

Market returns 29 December 2017

A new investment year begins – strong global economic growth supports the markets

Juhani Lehtonen, Head of Fixed Income & Market Strategy Investment Solutions

Fixed Income Return 1 mth Return 2017 Return 1 yr Alternative Investments Return 1 mth Return 2017 Return 1 yr

JPM Money Mkt 0,0 % -0,3 % -0,3 % S&P Commodity TR 4,4 % 5,8 % 5,8 %

JPM EMU Govt -0,8 % 0,4 % 0,4 % Oil (spot) 5,2 % 6,2 % 6,2 %

Barcleys Infl.Linked -0,6 % 1,4 % 1,4 % Gold (spot) 2,6 % 12,0 % 12,0 %

JPM Credit Index -0,3 % 1,1 % 1,1 % HFRX Global HF 0,5 % 3,5 % 3,5 %

JPM High Yield 0,2 % 6,2 % 6,2 %

JPM GBI EM Divers. (LC) 1,3 % 1,2 % 1,2 %

JPM EMBI+ (HC) 0,6 % 8,3 % 8,3 %

Equity Markets Return 1 mth Return 2017 Return 1 yr Foreign exchange 29.12.2017 30.11.2017

(Local currency, Net Total Return)

OMXH Cap Helsinki 0,1 % 11,5 % 11,5 % EURUSD 1,20 1,19

Euro Stoxx 50 -1,7 % 9,2 % 9,2 % EURJPY 135,28 133,96

Stoxx 600 0,7 % 10,6 % 10,6 % USDJPY 112,69 112,54

S&P 500 1,1 % 21,8 % 21,8 % EURGBP 0,89 0,88

Dow Jones 1,9 % 28,1 % 28,1 % EURSEK 9,83 9,97

Nasdaq 0,5 % 29,6 % 29,6 % EURNOK 9,84 9,90

Nikkei (Japan) 0,3 % 21,3 % 21,3 % Interest rates

Hang Seng (China) 2,6 % 41,3 % 41,3 % Fed 1,50 1,25

India 2,7 % 29,6 % 29,6 % ECB 0,00 0,00

Russia (RTS) 2,6 % 5,0 % 5,0 % BoJ -0,10 -0,10

Brazil 6,2 % 26,9 % 26,9 % BoE 0,50 0,50

MSCI Europe 0,8 % 10,2 % 10,2 % Euribor 3m -0,33 -0,33

MSCI World All Country 1,3 % 19,8 % 19,8 % Euribor 12m -0,19 -0,19

MSCI Emerging Markets 2,6 % 30,6 % 30,6 % Germany10y 0,43 0,37

MSCI Latin America 6,1 % 22,1 % 22,1 % iTraxx Europe 5y (IG) 44,78 48,41

MSCI Eastern Europe 1,9 % 6,9 % 6,9 % iTraxx Crossover 5y (HY) 232,38 229,92

(2/7)

The fixed income markets lacked major movements at the end of the year. Interest rates turned slightly upward in Europe but the interest rate level remains astonishingly low in relation to economic activity (Germany’s 10-year at +0.45%). This is largely the result of low inflation, which is why the ECB is main-taining its massive monetary stimulus policy. The ECB provided the markets with an update on its outlook in mid-December. It is now expecting euro zone growth to reach +2.4% for 2017 and +2.3% for 2018. The ECB expects core inflation, less energy and food, to wind up at +1.1% in 2018. It is not much and this is exactly where the fixed income markets’ hot topic lies. Thanks to the rapid improvement in the eco-nomic situation, the unemployment rate has fallen to 9% in the euro zone and to 5.5% in Germany, which has previously been an indication of bottlenecks in the labour markets in certain sectors. The wage ne-gotiations on Germany’s labour markets will provide a guideline for raising wages, which means, in our

view, that keeping abreast of wage inflation is im-portant when assessing the central bank’s monetary policy setup. In the US, long-term interest rates rose more evidently already at the end of 2016, from which level they have already stepped slightly downwards, but the 10-year government bond remains at the 2.45% level, which is 2 percentage points higher than Germany. Due to the Fed’s interest rate hikes, the interest rate on the 2-year government bond is already 1.92% and has thus risen more, in relative terms, than long-term interest rates, which means that the yield curve (difference between short and long interest rates) has levelled out in the US. The transatlantic interest rate differential at the short end is the price that euro investors have to annually pay for dollar hedging. The government bond index re-turned +0.4% and the corporate bond index +1.1% in the euro zone last year.

Past situation

Fed tightens, ECB continues to stimulate

Fixed income

The future

Bonds and money market instruments equipped globally with negative interest rates come to more than USD 10,000 billion, which means that the pos-sible rise in interest rates is not a trivial matter for asset prices. According to our calculations, a brisk 2% surge in interest rates along different maturities, in euros, would lead to a similar crash on the global markets, as the one the financial crisis inflicted just on the equity markets. The implications of an interest rate surge will be extensive, as it is well known that the negative and low interest rate environment has changed in-vestors’ and speculators’ behaviour also in other and completely new instruments. However, as long as inflation is nowhere near the central banks’ targets, a rapid tightening of monetary policy is not on the cards. A lot will depend on inflation as the economic cycle develops, and any unused capacity will be

taken into production in various sectors. The future pricing of inflation on the markets appears low: the five-year period starting in five years is at around 1.73%, or, still clearly below the ECB’s 2% goal. At the same time, economies are growing well, even in southern Europe. Globally speaking, economic growth is cur-rently at its strongest and most broad-based this cycle and we are headed for 2018 in a Goldilocks scenario: inflation is low and growth is solid. As for companies, the latest confidence indices in Germa-ny were good in December: 63.3 (unchanged) and 60.6 in the euro zone (also unchanged from Novem-ber). The UK’s PMI fell to 56.3 (previously 57.9), with the impacts of Brexit slowly beginning to affect economic development.

Keeping an eye on interest rate risk

Current situation

The number of new corporate bond issues beat the previous record at the end of 2017. In Europe, more than EUR 65 billion in high yield corporate bonds were issued and on the Nordic markets the amount was more than EUR 13 billion in local currencies. Despite the enthusiastic issue rate, corporate bonds still represent just slightly over 4% of companies’ financial liabilities, while in the US, the correspond-ing figure is around 11%. There is thus plenty of room remaining for market growth. However, credit risk premiums are, in practice, at their lowest this cycle and have remained firmly entrenched there. At the same time, the loosening of loan terms, familiar from earlier cycles, has now resulted in the same situation. Thanks to high investor demand, companies no longer need to lock their loan terms too tightly, for instance in terms of covenants. The looseness of covenants has been commonplace in the US for some time, but the same can now be said about Europe and the Nordics as well. We have very se-

lectively participated in new issues of corporate bonds and equally carefully in the bank loan mar-kets. In many cases, we have estimated that the prevailing return level on a bond or loan is not in line with the risk. Thus, the volume of cash has accumu-lated slightly in our ML Fixed Income Portfolio, for instance, providing a good starting point for the new year’s scenarios. On the whole, patience is the word of the day in the current fixed income market envi-ronment, where tight credit risk premiums fail to pro-vide a sufficient buffer against any future company-specific challenges. The Nordics remain an interest-ing environment for fixed income investors; it is pos-sible to invest in the 5.5% return level of our ML Nor-dic High Yield investment basket, for example, with an amount of interest rate risk corresponding practi-cally to that of the money markets.

Companies rush to the loan markets

Mandatum Life Insurance Company Limited • Postal address: P.O. Box 627, FI-00101 Helsinki, Finland • Registered office and address: Bulevardi 56, 00120 Helsinki, Finland • Business ID 0641130-2 • www.mandatumlife.fi

(3/7)

Equities

Past situation

The past investment year was the strongest equity market growth year since the recovery from the fi-nancial crisis in 2009. The MSCI World AC index rose +19.8% and in the US S&P 500 +21.8% (in euros just +6.9%). Volatility was, correspondingly, the second lowest since 1964, which caused volatili-ty-adjusted (Sharpe ratio) equities to return extreme-ly well in the US last year. In addition, on the S&P 500 index, each individual month of 2017 was in the black, which has never before occurred in the long history of the index. In this sense, we can already speak of an unusual stock price surge in the US. Sector-wise, information technology companies (sector +39%) yielded the best returns in the US, followed by materials (+24%) and the consumer sec-tor (+23%). The weakest were telecommunication services and energy.

In Europe, the Stoxx 600 index returned +10.6% and the best performing sectors were basic industry and technology. Last year’s winners were, however, emerging market equities. The brisk up-grade of earnings forecasts, fuelled by economic growth, pushed China (Hang Seng +41%) and many Asian emerging market stock markets to rise sharp-ly. As a whole, the MSCI EM index rose +30.6% last year. Of the emerging market stock markets, Russia was relatively weak with the RTS rising just +5% last year despite the sharp surge in the oil price. The Helsinki stock market (OMXH Cap index), rising +11.5%, beat out the other European broad indices last year.

Strongest surge since 2009

Current situation

The raising of companies’ earnings forecasts sup-ports the surge in stock prices at the beginning of the new year. Right now, the markets forecast +11.5% earnings growth for US S&P 500 index companies, which could be achieved with a +5.6% growth rate in sales. The markets are currently raising their fore-casts, immediately following the major tax reform in the US, which will reduce the corporate tax rate. In Europe, the Stoxx 600 earnings growth forecast for this year is +9% and the growth forecast for net sales +3.9%. Forecasts were raised further at the end of 2017, aided by the positive economic devel-opment. The best upward momentum in earnings fore-casts in late 2017 was seen in Japan (2018 earnings growth expectation currently +8.7%), led by the weakened yen. The earnings forecasts of the emerg-ing markets index have been raised similarly and expectations are the strongest in this market in 2018 – earnings are expected to rise +13.2%. Globally speaking, earnings growth forecasts are at a good

level and what is key for the continuation of the short-term rise in the main equity markets is that they are currently being raised. The starting up of earnings reporting for the past year will prove interesting es-pecially when it comes to US companies: what do companies think of the tax reform and what will the reactions be on the markets. In Europe, economic growth has spread and global European companies are also benefiting from the slashing of the US cor-porate tax rate. In Germany, the DAX index’s earn-ings expectation for this year is +10% and in Italy, the MIB index expects as much as +15%, driven by the banks. The overly-rapid strengthening of the euro early on in the year may dampen the mood in European export companies in the short term, but otherwise, fundamentals for European companies are looking good.

Earnings forecasts continue to be raised

The future

The United States’ tax reform package, substantial even historically speaking, was approved by Con-gress and its implications are being feverishly fac-tored in on the equity markets. The corporate tax rate will decline from 35% to 21%, which is its lowest level in decades. It is very possible that the fall in corporate tax may mainly improve, in the long run, companies’ earnings accrual, so this alone will not have any wider-reaching impacts on the US national economy, or subsequently on the macro markets. Changes to households’ loan interest rate deduc-tions may affect the real estate markets, but these impacts are likely to be minor. President Trump’s policy to improve the oper-ating conditions of domestic companies notched its first win as a result of the tax reform. The shutting down of the government was avoided at the end of the year in the US and now, by the 19th of January, the debt ceiling must be raised. The USD 1,500 bil-lion budget deficit linked to the huge tax reform needs to be filled and there is not much time to get the budget in shape.

The Fed has not changed its policy despite the challenging fiscal situation; it will raise the key interest rate two or three times this year. At this rate, short-term interest rates will rise to more than 2% and the yield curve (difference between short and long-term interest rates) will level out more, indicat-ing challenges for the banking sector and further afield, by raising the likelihood of a downturn. In con-trast, the real economy is experiencing strong growth with almost full employment. Not until the real inter-est rate (interest rate level adjusted with inflation) begins to be clearly over 1% will the situation change more clearly in this economic cycle. The new invest-ment year is starting with the support of strong global growth. The valuation levels of equities rose slightly towards the end of the year, but the equity markets’ upward trend is strong globally and we have re-mained in neutral position in terms of equity weight in our allocation products (read more in our Allocation insight).

US tax reform approved

Mandatum Life Insurance Company Limited • Postal address: P.O. Box 627, FI-00101 Helsinki, Finland • Registered office and address: Bulevardi 56, 00120 Helsinki, Finland • Business ID 0641130-2 • www.mandatumlife.fi

(4/7)

Alternative investments

With regards to alternative investments, nothing new appears to be at hand. The low level of risk-free interest rates particu-larly in the euro zone is still driving invest-ments to asset classes with no daily re-demption opportunities. Thus, investors are looking for higher yields resulting part-ly from this weaker liquidity and the relat-ed liquidity premiums. This is well-suited to many investors’ portfolios. The investment capacity in Euro-pean private debt funds has still not grown significantly in light of statistics. New in-vestment opportunities are steadily flow-ing onto the private debt markets with, for instance, the tightening of banks’ regula-tion framework opening up new opportuni-ties for investors. The yield levels on new private debt bonds have not fluctuated very much globally since 2013. In our

view, the market situation is still relatively positive for the Mandatum Life Private Debt investment baskets, from the per-spective of long-term investors, particular-ly compared with traditional asset classes. The private equity markets’ valua-tion levels are nearing their all-time high-est levels. The performance of private equity funds last started up at these valu-ation levels between 2006 and 2007 re-mained low once the financial crisis hit the markets in 2008. At the moment, the vol-ume of investment capacity in private eq-uity funds is at an all-time record level. On the European real estate mar-kets, and especially for core properties (best offices in city centres), returns for investors have fallen to their all-time low-est level due to high demand and the low interest rate level. At the same time, the

valuation levels of underperforming real estate (e.g. half-empty office premises etc.) have not risen correspondingly. Due to the core market situation, our Manda-tum Life International Real Estate invest-ment basket is focusing on investments in so-called value add and loan-form proper-ties where we still see good return poten-tial.

Mandatum Life Insurance Company Limited • Postal address: P.O. Box 627, FI-00101 Helsinki, Finland • Registered office and address: Bulevardi 56, 00120 Helsinki, Finland • Business ID 0641130-2 • www.mandatumlife.fi

This Market Review is based on the views of Mandatum Life Insurance Company Limited (Mandatum Life) and on assessments based on data collected from public sources. Mandatum Life gives no guarantee as to the validity or completeness of the presented information, views or assessments, and Mandatum Life does not assume any responsibility for any direct or indirect damages, expenses or losses which may be caused by the use of the information contained in this Market Review. The assessments and views expressed in this Market Review are based on the data available at the time of its release into the public domain and Mandatum Life reserves itself the right to change its views or its assessments without any prior separate announcement. This Market Review and the information, assessments and views contained in it are all provided solely with the purpose of informing, and this Market Review should not be seen as a recommendation to subscribe to, to hold on to or to trade specific targets of investment or to implement any other actions affecting the value development of an insurance policy. The policyholder should examine with care the terms and conditions and brochures related to the insurance policy and investment targets before signing the insurance policy, before changes are implemented in the insurance policy, and before selecting or making changes in the selection of investment targets.

PMI development Equity indexes (2.1.2009 = 100)

Fed funds rate and 2y government bond yield US consumer price index and underlying inflation

Source: Bloomberg. Past performance is no guarantee of future results.

30

35

40

45

50

55

60

65

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

ISM Index Non-manufacturing ISM Index

Euro PMI Index China PMI Index

-4

-2

0

2

4

6

8

10

12

14

16

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

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2009

2011

2013

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%

US CPI Index US Core-CPI Index

50

100

150

200

250

300

350

400

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

S&P 500 Index OMXH Index

STOXX Europe 600 Index Nikkei 225 Index

0

2

4

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16

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%

Fed Funds Rate 2y US Govt rate

(5/7)

Allocation insight

5 January 2018

i) Accelerating inflation in the US would affect the return levels across all

investments

Elements driving inflation. According to economists, inflation results from two main

reasons: 1) a change in the demand/supply balance, 2) a change in the amount of money

circulating in the economy. Demand and supply bottlenecks, essentially workforce short-

ages, have been considered to be the causes behind demand or cost inflation. It has

been thought that, when demand for workforce increases faster than supply, the general

pay level rises, the funds available increase

and the general price level rises. Similarly,

an oversupply of workforce would lead to a

decline in the general pay level, reduce con-

sumer spending and cause negative inflation,

i.e. deflation. Deflation has generally been

considered undesirable from the perspective

of economic development.

An abundant supply of workforce has been the main argument for maintaining

monetary stimulus in the US. It also impacts the timing of the winding down of the stim-

ulus programme, now that the unemployment rate in the US has fallen well below five per

cent. The twofold mandate given to the Fed – maintaining an inflation rate of around two

per cent and trying to achieve maximum employment – has largely been based on the

idea of labour-market-based demand and cost inflation. Despite strong monetary stimulus

and the current tightness of the labour market, the general inflation level, although having

risen slightly, has not reached the target level set for itself by the Fed. So far, this has

allowed for the monetary policy to be tightened at a very moderate pace, in spite of the

fact that the economic growth in itself would justify higher interest rates.

Changes in the general inflation level are, however, also impacted by another

source of inflation: a change in the amount of money circulating in the economy. It

has two main drivers: a change in the amount of money put in circulation and the turnover

of money circulating in the economy (Figure 1). Following the monetary stimulus pro-

grammes, the amount of money has increased heavily, by about +7% per year, but as the

figure shows, money turnover has clearly declined over the past few decades, neutralis-

ing the inflationary effect of the amount of money. A number of reasons have been ad-

vanced to explain the declining turnover, but the tightening of bank sector regulation

during the past few decades is particularly relevant. Reining in bank regulation is high on

the US Republican administration’s agenda this year. This, together with the declining

consumer savings rate over the past few years, raises the inflation risk asymmetrically.

The passing of the tax reform in the US put a positive seal on the 2017 investment year. However, the investment environment in 2018 will most

likely be more challenging than last year. The valuation levels of the various asset classes are elevated, and with the impact of central bank stimulus

declining in the Western countries, market rates will go even more clearly up. We will look into the three elements most likely to influence our alloca-

tion decisions to identify possible changes in the investment environment this year.

Mandatum Life Insurance Company Limited • Postal address: P.O. Box 627, FI-00101 Helsinki, Finland • Registered office and address: Bulevardi 56, 00120 Helsinki, Finland • Business ID 0641130-2 • www.mandatumlife.fi

Market themes for the next 12 months

Economic growth in

itself would justify

higher interest rates

Allocation Insight

Slig

ht o

verweig

ht

Overw

eigh

t

Un

derw

eigh

t

Slig

ht u

nd

erweig

ht

Neu

tral

Finland

Scandinavia

Europe

USA

Emerging markets

Money market investments

Government bonds

Investment gradecorporate bonds

High yield corporate bonds

Senior loans

Emerging market debt

Private debt investments

Real estate

Private equity

Equities

Fixed income

Alternative

investments

(6/7)

The impact of an exceptionally extensive monetary

stimulus programme has been seen mainly in the

capital markets in the form of rising investment valu-

ation levels. At the current stage of winding down stimu-

lus measures, it is likely that deflationary pressure is

building up on the capital markets in the form of declining

valuation levels. This will have a negative impact on the

investment portfolio’s total expected return. From the

perspective of equity investors, the situation is not partic-

ularly problematic, as long as inflation accelerates at a

slow and controlled speed and the monetary policy tight-

ening measures are known and follow this trend.

Impacts on investors’ portfolios. In equities, an infla-

tion rate exceeding current expectations would probably

lead to sector rotation from defensive to cyclical sectors

(e.g. banking and insurance), which offer better protec-

tion against inflation. For fixed income investors, the situation would be more challenging, be-

cause fixed income investments fail to offer solid protection against accelerating inflation. In

alternative investments, the liquidity premium compensates for the lower return expectation re-

sulting from declining valuation levels.

ii) Technology sector growth and earnings development plays a key role in equity

allocation

One of the phenomena making its mark on the 2017 stock market year was the upsurge of

the technology sector, driven particularly by giants that have built their business models around

the internet and mobile communications. In the US, more than 35% and in the emerging markets around 25% of the equity market’s total return

comes from increased stock prices in the IT sector (Figure 2). Europe did not experience a similar phenomenon, partly because the technology

sector makes up a clearly smaller proportion of the European equity market and partly because the new-age internet companies mainly come from

the US and emerging markets. Examples of these companies whose share prices rose by more than +50% last year are Amazon, Facebook and

Netflix from the US and Alibaba and Tencent from China.

Many technology companies have seen their stock price rise at a pace faster than their

earnings growth rate, which has raised the companies’ valuation levels. Following the

stock price rise, their weight in regional main indices has increased – in the US and on the

emerging markets, information technology is currently the largest sector. The development of

the technology sector is thus likely to preserve its key role also in terms of geographical allo-

cation. Should technology companies continue to go from triumph to triumph, the US and

partly also the emerging markets would benefit, as last year. However, if a correction closer to

the long-term average were to occur in the valuation of technology companies, Europe would

be a likely relative winner. In our allocation solutions, we have positioned ourselves with cau-

tion in the strongly risen IT equities, while maintaining the broader technology sector slightly

overweight.

Mandatum Life Insurance Company Limited • Postal address: P.O. Box 627, FI-00101 Helsinki, Finland • Registered office and address: Bulevardi 56, 00120 Helsinki, Finland • Business ID 0641130-2 • www.mandatumlife.fi

From equity investors’

perspective, the situation

is not particularly prob-

lematic, as long as infla-

tion accelerates at a slow

and controlled speed

Figure 1. Velocity of M2 money stock in the USA. Source: Bloomberg.

1,2

1,4

1,6

1,8

2

2,2

1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

In the US, more than 35% and

on the emerging markets

around 25% of the equity

market’s total return comes

from a surge in IT sector

stock prices

Figure 2. Total return breakdown by sector in 2017. US return in dollars, Europe’s and emerging markets’ return in euros. Source: Bloomberg.

-5%

0%

5%

10%

15%

20%

25%

US Europe Emerging markets

Information Technology Financials Health CareConsumer goods and services Industrials Consumer StaplesMaterials Utilities Real EstateTelecommunication Services Energy Others

(7/7)

The impact of an exceptionally extensive monetary

stimulus programme has been seen mainly in the

capital markets in the form of rising investment valu-

ation levels. At the current stage of winding down stimu-

lus measures, it is likely that deflationary pressure is

building up on the capital markets in the form of declining

valuation levels. This will have a negative impact on the

investment portfolio’s total expected return. From the

perspective of equity investors, the situation is not partic-

ularly problematic, as long as inflation accelerates at a

slow and controlled speed and the monetary policy tight-

ening measures are known and follow this trend.

Impacts on investors’ portfolios. In equities, an infla-

tion rate exceeding current expectations would probably

lead to sector rotation from defensive to cyclical sectors

(e.g. banking and insurance), which offer better protec-

tion against inflation. For fixed income investors, the situation would be more challenging, be-

cause fixed income investments fail to offer solid protection against accelerating inflation. In

alternative investments, the liquidity premium compensates for the lower return expectation re-

sulting from declining valuation levels.

ii) Technology sector growth and earnings development plays a key role in equity

allocation

One of the phenomena making its mark on the 2017 stock market year was the upsurge of

the technology sector, driven particularly by giants that have built their business models around

the internet and mobile communications. In the US, more than 35% and in the emerging markets around 25% of the equity market’s total return

comes from increased stock prices in the IT sector (Figure 2). Europe did not experience a similar phenomenon, partly because the technology

sector makes up a clearly smaller proportion of the European equity market and partly because the new-age internet companies mainly come from

the US and emerging markets. Examples of these companies whose share prices rose by more than +50% last year are Amazon, Facebook and

Netflix from the US and Alibaba and Tencent from China.

Many technology companies have seen their stock price rise at a pace faster than their

earnings growth rate, which has raised the companies’ valuation levels. Following the

stock price rise, their weight in regional main indices has increased – in the US and on the

emerging markets, information technology is currently the largest sector. The development of

the technology sector is thus likely to preserve its key role also in terms of geographical allo-

cation. Should technology companies continue to go from triumph to triumph, the US and

partly also the emerging markets would benefit, as last year. However, if a correction closer to

the long-term average were to occur in the valuation of technology companies, Europe would

be a likely relative winner. In our allocation solutions, we have positioned ourselves with cau-

tion in the strongly risen IT equities, while maintaining the broader technology sector slightly

overweight.

Mandatum Life Insurance Company Limited • Postal address: P.O. Box 627, FI-00101 Helsinki, Finland • Registered office and address: Bulevardi 56, 00120 Helsinki, Finland • Business ID 0641130-2 • www.mandatumlife.fi

From equity investors’

perspective, the situation

is not particularly prob-

lematic, as long as infla-

tion accelerates at a slow

and controlled speed

Figure 1. Velocity of M2 money stock in the USA. Source: Bloomberg.

1,2

1,4

1,6

1,8

2

2,2

1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

In the US, more than 35% and

on the emerging markets

around 25% of the equity

market’s total return comes

from a surge in IT sector

stock prices

Figure 2. Total return breakdown by sector in 2017. US return in dollars, Europe’s and emerging markets’ return in euros. Source: Bloomberg.

-5%

0%

5%

10%

15%

20%

25%

US Europe Emerging markets

Information Technology Financials Health CareConsumer goods and services Industrials Consumer StaplesMaterials Utilities Real EstateTelecommunication Services Energy Others