Economic data and leading indicators continue to suggest a synchronised global upswing lasting at least through much of 2017. Surveys point to an improvement in the sentiment of companies, consumers and investors. Although the ‘hard’ data is less positive, this typically lags survey data and our base case is that the data will eventually catch up. Importantly, economic data continue to exceed expectations, indicating support for Growth assets.
Figure 1: Labour market points to eventual wage response
A third interest rate hike, in March 2017, has confirmed that the US is in a tightening cycle. The Federal Reserve attempted to assure markets of its dovish tendencies but looks set to increase rates until the employment, wages and inflation data starts to turn. The European Central Bank (ECB) is going to find it increasingly difficult to defend its aggressive monetary stimulus in our view. We highlighted this as a potential surprise relative to consensus last quarter as cyclical growth and inflationary pressures are likely to force a change in message from the ECB.
The more synchronised global growth should continue to underpin a recovery in earnings expectations and broadly support Growth assets. Leading indicators are still quite upbeat. The Federal Open Market Committee (FOMC) is likely to view as transitory recent weakness in Q1 US GDP. Although we are beginning to see initial signs that the business cycle is maturing, the risk of a recession in the next year still remains low and the global economy appears to have decent momentum. Monetary policy remains fairly easy even with the FOMC gradually raising interest rates, and there remains scope for accommodative fiscal policy in the US to support growth into 2018.
We retain our strategic bias towards Growth assets while this positive momentum persists. Tactically, we prefer equites and are more likely to reduce our allocation to high yield debt going forward based on valuation concerns. More generally, we acknowledge that, on a valuations basis, Growth assets are not as attractive as they once were and we continue to evolve our allocation to Defensive assets to counteract any reduction in the opportunity set. Overall, we continue to emphasise a selective bottom-up approach across asset classes, combined with relative value positions, as the best way to capture opportunities in a world where potential asset class returns are lower.
Given starting valuations, this improvement in earnings needs to continue in order for developed market equities to make further gains.
Figure 2: Nascent turn in earnings expectations
Major event risks appear concentrated in the political sphere, starting with whether the Trump administration can fulfil its promises on tax cuts and on easing regulations. Likewise, political risk dominates European headlines but has so far only affected bond markets, while the election of Emmanuel Macron in France has helped settle the political backdrop. We continue to focus on the Italian general election, due before May 2018. In China the government has once again clamped down on property ownership, and has more generally tilted towards monetary tightening, which could affect market sentiment.
Figure 3: Potential political risks
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