Visibility on the policy mix is globally increasing, as political risk is receding. Some major hurdles have been cleared in recent weeks.
The global expansion dynamics are well underway. Most recent data confirm that the outlook for the world economy appears solidly anchored above 3% growth for next year. In particular, the Eurozone and Japan are expanding above potential in spite of currency strengthening earlier this year. US economic indicators are again surprising on the upside, lengthening the horizon for the expansion underway. Earlier this year, emerging markets benefited from tailwinds such as increasing commodity prices, a weaker USD and accommodative central banks, but the temporary US dollar strength represents a headwind for EM assets. While inflationary pressures remain subdued, we don’t think inflation is dead.
Risks to the scenario. The main risk to our expectations would be an abrupt end to the goldilocks environment. Persistence in the rise of the oil price, leading to an inflation acceleration, could be a trigger. A sharp slowdown in growth would be another one, whether due either to no US tax reform at all, a monetary policy error or a significant slowdown in the Chinese economy.
GENERAL OVERVIEW: Equities vs. Bonds
Geopolitical risks remain the main tail-risk to our positive scenario for equities, while we continue to favour a low duration risk.
Positive on equities
We are positive on EMU equities. Data published early-November confirm the ongoing, more robust and geographically broadening economic expansion in the region. An accommodative central bank with a monetary policy horizon beyond 2018 and a decent corporate earnings momentum underpin the attractiveness of the region’s risk assets, which are no longer subject to a major political risk premium. The pause in the recent increase in the Euro is acting as a tailwind after a more challenging summer for EMU equities.
We have an positive stance on Japanese equities. The outcome of the general election has validated Shinzo Abe’s mandate and increased the visibility on an accommodative policy mix. As the Bank of Japan will not join other central banks in tightening its monetary policy anytime soon, a weaker JPY remains a strong conviction.
We are neutral onEmerging Market equities. EM equities performed well thanks to improving fundamentals and US Dollar weakness until early-September. Based on expected temporary USD strength and technical indicators, we have locked in some profits.
We are neutral on US equities. On the policy mix, we see progress on fiscal stimulus along with a tightening Fed. We note that economic surprises have rebounded strongly, but the Fed will take this opportunity to hike. The transition from the Yellen Fed to a Powell Fed should be smooth.
We are negative on Europe ex-EMU equities. The hawkish BoE monetary policy stance has put a barrier on GBP depreciation and challenging overseas profit growth. Domestic political wobbles are adding to the difficult Brexit negotiations and limited results in setting up new trade relations. We are looking forward to the Autumn Statement (22 November) for new signals.
Negative on government bonds
With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to continue their uptrend from September’s low. In addition to rising producer prices, we expect rising wages and potential stimulus to push inflation higher, although this is taking longer than expected to materialise.
The improvement in the European economy could also lead EMU yields higher, as political risks have receded and the ECB remains, overall, dovish in its QE recalibration.
We have a neutral view on Credit, as spreads have already tightened significantly and a potential interest-rate increase could hurt performance.
On emerging-market debt, the ongoing monetary easing is highly supportive of this asset class.