The perils of patterns
The distinction may not matter in the short term: if markets want to see a pattern then they will act on it. It does matter, however, when it comes to sustainability. Here we try to distinguish between what looks good now and what is likely to keep looking good in future.
Macroeconomics: still stuck with cyclical healing
Governments have been largely unable so far to deliver structural change, with recovery continuing to rely on a gradual process of cyclical healing.
President Trump’s reform plans have run into trouble but we continue to expect an uptick in US growth next year to 2.3%. Eurozone growth is also likely to remain above potential (at 1.8% in 2017 and 1.6% in 2018). Japanese growth has been encouraging in recent quarters but we don't expect GDP growth to go much above 1% in the next two years.
China’s economy might appear to have steadied but private consumption growth could now moderate slightly. Economic data from emerging markets, meanwhile, shows that most appear to be in a good state to cope with a slight slowdown in Chinese growth.
Eurozone GDP growth forecasts:
1.8% – 2017
1.6% – 2018
Chinese GDP growth forecasts:
6.5% – 2017
6.3% – 2018
US GDP growth forecast:
2.1% – 2017
2.3% – 2018
Multi asset: enjoy it while it lasts
We have a generally constructive view of the 12 months ahead as investors continue to be spoiled by a “Goldilocks” scenario.
At present economic growth is neither too fast nor too slow, inflation is low, and central banks are still very capital market-friendly. But political surprises provide one reason to remain cautious. Self-reinforcing market dynamics could be another.
Credit opportunities in emerging markets
While possibilities remain in high-yield and investment-grade bonds, spread compression means that there may be more interesting opportunities in EM bonds. On commodities, however, we remain cautious, forecasting an oil price (WTI) of US$50 per barrel at end-June 2018 and no sustained gain in gold prices.
Changing currency dynamics
Further bouts of dollar weakness are possible later this year, with the euro a likely beneficiary, although we do not foresee a further sharp and sustained fall in the greenback into next year. So any multi-asset strategy also needs to pay attention to rather different currency dynamics.
Equities: high-altitude flying
Given the expected increase in corporate earnings, we have raised our 12-month forecasts for most stock indices.
However, such expectations seem already largely discounted. This is reflected by high valuation levels, particularly in the US, and low volatility. Any temporary setbacks could provide buying opportunities.
European equities on the up
We are now rather more positive about Europe, due to further signs of economic improvement, strong earnings growth and positive flows.
These generally appear to be in good shape. Inflation should remain relatively low and keep the Bank of Japan in easing mode for some time, but the value of the Japanese yen will remain key.
Emerging markets’ appeal
We are seeing positive earnings revisions and recovering return on equity. EM equities’ valuations still appear attractive relative to global valuations and, despite increasing interest, international investors still appear underinvested in this area.
Fixed Income: the US marches ahead on rate rises
With three interest rate rises now under its belt, the Fed is now some way along the road to policy normalization.
Following years of quantitative easing, the Fed is likely to start slowing the pace of reinvestment of maturing bonds, possibly from later this year.
With the European Central Bank (ECB), official interest rates are likely to remain negative. More likely is a cautious reduction in the rate of monthly asset purchases over time.
The Bank of Japan’s (BoJ) approach to yield curve control appears to have been relatively successful, which could allow for some unofficial tapering. However, don’t assume that the current policy will continue indefinitely.
The Bank of England (BoE) must cope with the difficult combination of a weaker pound pushing up inflation and a potential economic slowdown. We think that growth concerns will win out, holding rates at current levels.
Investment grade and high yield
Credit markets may adapt to these diverging central bank policies in different ways. In general, we remain positive on global investment grade credit markets, believing that fundamentals are still acceptable. Technical factors will likely support European investment grade, but US technicals are less consistent, with the markets more risk-sensitive. We remain cautiously constructive on the US and European high-yield markets. European high-yield bonds have seen significant issuance so far this year, but the size of the market is declining, allowing spread tightening.
Emerging markets prove resilient
Many investment grade emerging markets issuers are benefiting from an improving domestic economic outlook and sound debt indicators, and some high-yield issuers have benefited from stable commodity prices. Much-discussed “risk factors” (e.g. US rate rises and Chinese growth slowdown) have yet to impact, although geopolitical events still pose a risk.
Yen as a safe haven currency
Further bouts of US dollar weakness are possible later this year. But we think that US economic growth and monetary policy divergence will give the greenback renewed momentum in 2018. We expect yen to weaken slightly against the dollar on a 12-month horizon, but temporary gains are possible as the currency is used as a hedge against market volatility.
Past performance is not indicative of future returns. Forecasts are not a reliable indicator of future performance.
Edited from CIO Insights Q3, produced in July 2017.