Amid background noise such as ongoing trade skirmishes involving
the US, the evolving Chinese economy and geo-political tensions, we
have spent time analysing recent market movements and the
implications for risk assets. Our belief that markets will continue
to provide low but positive returns has been reinforced, and our
views on asset allocation positioning ultimately remain unchanged.
However, we have recently upgraded US equities from dislike to
neutral.
Since the end of 2016, the US equity market has been the
worstperforming major market in common currency terms, and this has
been consistent with our outlook of steady global growth and
reflation, where we would expect emerging markets, Europe and Japan
to outperform.
However, the recent earnings season has been surprisingly strong
in the US, and importantly the strength has not been completely tax
reform-driven, as evidenced by upward revisions to forward EBIT
(earnings before interest and taxes) growth. Using this same
metric, prospective emerging market and European earnings growth
are being held back by currency movements, while Japanese data has
broadly met expectations, making the US performance surprisingly
encouraging.
This year, US equities have performed in line with global
equities, lagging Japanese and European markets, with the absence
of outperformance suggesting the US administration's tax cuts had
been previously discounted by markets. However, factoring in these
recent EBIT upgrades that signal improving fundamentals beyond the
improved tax environment, we believe the US equity market looks to
have cheapened year-to-date. This, coupled with the fact that the
US market continues to play host to dominant global players that
are attracting investment, warrants our upgrade to neutral from
dislike.
Sticking with the US, we have also spent some time analysing the
twin deficits - the outcome of which is to reinforce our view of a
structurally weaker US dollar medium-term, subject to sporadic
bursts of strengthening.
Macro-economic backdrop
Although growth at a global level remains strong, data has begun
to soften in a number of developed markets. Tightening financial
conditions, the absence of which had given a boost to growth in
2017, are being felt, although in the US the mistimed expansionary
fiscal package should boost GDP this year and next. Perhaps more
'noisy' is the emergence of trade wars, and while the current
immediate impacts are small, the direction of travel from here
bears close monitoring. We would not want to see it escalate to
more countries or to a broader range of goods and services against
a backdrop of imminent US rate hikes, stretched equity valuations
and late-cycle activity.
Equity bull markets have historically tended to end with a
recession or financial crisis, which we do not see on the horizon.
The volume of M&A deals continues to tick higher, and not in a
manner that appears creditor-friendly - but leverage does not yet
appear alarming. And so, in fixed income markets, our base case for
investment grade credit spreads is stability, rather than
widening.
While the outlook may be less constructive vis-à-vis a year ago,
it is difficult to pinpoint a turning point. For instance, although
the yield curve is flatter and credit spreads are wider,
unemployment is still falling and both momentum and style drivers
are positive. In past market peaks, trouble has tended to spring
from the largest sector at the time - today that would be
technology, which accounts for a quarter of the S&P 500. But
here, too, there is little to suggest a looming bear market.
Recession risk is sparse and inflation well behaved.
Asset allocation snapshot
Source: Columbia Threadneedle
Investments, as at 21 May 2018.
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