Mixed directions for global asset allocators
Globally we continue to see a supportive backdrop for equities, which we still prefer relative to bonds. US stocks lagged in early 2015, but cuts to earnings expectations leave a low hurdle for positive surprise.
Meanwhile, higher beta markets—Europe and Japan—continue to deliver on earnings as currency weakness boosts output. Central bank stimulus is likely to keep in place a bid for duration, even though disinflationary trends appear to be bottoming out and yields are starting to rise.
As inflation expectations grind higher and the US starts to raise rates, bond yields—especially at the short end—have scope to rise further.
The most important considerations entering our calculus in setting our active asset allocation include:
- Europe and Greece – The market reaction to the events in Greece demonstrate that the risks facing the Eurozone are more from political contagion than financial contagion; the European Central Bank (ECB) has significant firepower to suppress market turmoil, and the muted reaction of periphery bonds and funding spreads suggests that the Eurosystem is markedly more resilient than it was in 2012. Once the situation in Greece stabilises we would expect the tailwinds of weaker EUR, improving Eurozone confidence, and an upswing in the credit cycle to drive European risk assets higher
- China – An area of concern remains emerging markets (EM), and recent volatility in Chinese markets suggest that policy tools may not be fully effective in addressing structural concerns. We note that EM assets are under owned and relatively inexpensive, but until there is greater evidence of structural reform – or assets are and truly discounted levels – we would remain underweight
- Commodities – Excess inventory in energy markets, and supply overhangs in bulk commodities are once again fuelling a downdraft in world commodity prices. We don’t expect the same ferocity of declines that we saw in 2014, but the outlook remains challenged across energy, metals, and bulks. In turn this reinforces our belief that although inflation levels have bottomed, there is little chance of a surge in world inflation any time soon
- The US Federal Reserve – At the time of writing we remain, marginally, of the view that a September hike is still on the cards. However this call is quickly becoming 50:50 – strong 2Q15 GDP and continued momentum in U.S. jobs support a Sept move, but any spill over from recent market volatility into a stronger U.S. dollar could stay the Fed’s hand. Nevertheless, we believe that the Fed will start hiking this year, and as such see the front end of U.S. rates as overvalued. We would anticipate some volatility in equities over the hike itself, but history suggests this should be short-lived – particularly when, as will likely be the case, it is better growth prospects that are leading the Fed to tighten
The downside risks of overzealous policy tightening, inventory overhang in physical commodities and a currency crisis in emerging markets remain. Meanwhile, potential tailwinds include emergence of a more synchronised global recovery, further policy stimulus, or meaningful structural reform across emerging markets could give a powerful boost to risky assets and send bond yields higher. On balance though, we believe that the themes of divergent global policy, a gradual recovery in Europe and a rebound in US economic strength will dominate the middle part of the year. The growth scare from the first quarter should abate, and while we anticipate some volatility around the first Fed hike, we see a US economy in mid-cycle and a supportive backdrop for risk taking.
Broadly speaking, our best investment ideas continue to be a preference for exposure to US and European equities over bonds and a modest overweight to longer dated US Treasuries, as well as a modest overweight in credit. We remain overweight the US dollar and Japanese stocks but have trimmed these positions. By contrast, we prefer to be underweight short-end U.S. Treasuries, emerging market (EM) equity, commodities and cash; we remain underweight in euro (EUR) and pound sterling (GBP) but with smaller positions.
John Bilton is global head of Multi-Asset Strategy at JP Morgan Asset Management