Written b: John Bilton, Head of Global Multi-Asset Strategy, Multi-Asset Solutions
In terms of the breadth of global growth, the first half of 2017 is shaping up to be the best start to a year since 2011. A surge in economic momentum in Europe and Japan, and solid corporate earnings globally, amply offset some wobbles in the hard data and a below-expectations print for U.S. first quarter growth. Equities, unsurprisingly, posted handsome gains as a result; but even so, investor sentiment appeared more cautious than price action might imply. The decline in bond yields, however, might paint a different picture. Although bond yields and equity prices have diverged previously in this expansion, the deviation is now raising questions about the reflation trade and, in turn, Federal Reserve (Fed) policy. Whether the level of bond yields is a warning of slowing economic momentum, or merely the result of a savage short squeeze and the third year running of negative net G4 sovereign supply1, remains a critical consideration in positioning for the remainder of 2017.
We expect the global economy to deliver trend-like growth in the second half of the year. The dip in U.S. inflation looks to be bottoming, and both financial conditions and inventory data suggest any slowing of manufacturing momentum will be modest and transient. The expansions in Europe and Japan are robust, with all key segments of the economies participating in the upswing, and emerging market (EM) economies too are showing improvement despite the slight slowing in China’s pace of growth. By contrast, the optimism over U.S. fiscal stimulus has largely dissipated, notwithstanding some lingering hopes of tax cuts this autumn.
With the U.S. at full employment and the economy moving into late cycle, overzealous policy tightening is the biggest threat to our constructive view. But the mood music from the Fed, indicating a gradual upward path of rates and the prospect of balance sheet reduction later in the year, remains reassuringly consistent despite some recent outliers in economic data. In our view, a roughly quarterly pace of hikes remains in sync with prevailing economic momentum and should not hamper our positive view of asset markets.
In our asset allocation, we remain overweight (OW) equities and underweight (UW) duration globally. As the U.S. economy moves toward later cycle, our one change at an asset class level is to trim credit from OW to neutral, reflecting that while credit will likely continue to outperform government bonds, it is unlikely to outpace stocks. Elsewhere, we maintain a neutral view on both real estate and commodities.
Within equities, the low level of inter-regional equity index correlation, together with the broad-based global upswing in growth, points to a diversified equity exposure across regions. Nevertheless, our quant signals and our fundamental analysis lead us to a marginal preference, in approximate order, for Japanese, European and EM equities over U.S. and UK stocks; thus we maintain an OW to Japan, Europe and emerging markets and an UW to UK stocks. We acknowledge the full valuations of U.S. stocks, but prefer to keep a small OW exposure, as all-in yields remain compelling, and should we see tax cuts back on the agenda it would likely give a boost to U.S. earnings.
For bonds, we believe that current yields will prove to be the low end of the 2017 range as recent softness in inflation clears and global economic momentum persists. With 2018 set to be the first year of positive net G4 bond supply since 2014, we see scope for global yields to slowly rise in the second half of 2017. We expect German Bunds to lead other markets to higher yields as better growth, fading political risks and the prospect of tapering of the European Central Bank’s bond purchases weigh on core eurozone bond prices. The path of bond yields is also likely to prevent any renewed U.S. dollar strength, and while we see some modest upside against the Japanese yen, we expect other major dollar crosses to settle into a range.
Our portfolio reflects a core view of persistent, trend-like global growth that will translate into modestly higher levels for both yields and earnings. The muted sentiment among investors and corporates alike may well delay the type of exuberance that can precede the end of an economic cycle. But later-cycle economies are, by definition, already quite mature, so our moderately pro-risk tone is accompanied by careful diversification and ongoing scrutiny of any dip in data.
ACTIVE ALLOCATION VIEWS
These asset class views apply to a 12- to 18- month horizon. Up/down arrows indicate a positive (^) or negative (˅) change in view since the prior quarterly Strategy Summit. These views should not be construed as a recommended portfolio. This summary of our individual asset class views indicates strength of conviction and relative preferences across a broad-based range of assets, but is independent of portfolio construction considerations.
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1 Net sovereign bond issuance removes central bank purchases and redemptions from gross sovereign issuance.
DISCLOSURE: The views contained herein are not to be taken as an advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield may not be a reliable guide to future performance.
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