CURRENT MARKET CONDITIONS - July 2017
While there has been a marked improvement in the global economy, we are cautious investors as the world remains as uncertain as ever.
Global growth is expected to accelerate from 3.1% in 2016 to 3.5% in 2017, and remain buoyant at 3.6% in 2018, according to IMF projections. Underpinning this improvement is an acceleration in infrastructure and real estate investment in China, rising commodity prices, an improvement in manufacturing, moderate inflation, strong financial market performance and ongoing monetary support.
As a result, global trade volumes have also improved. This is key for growth in emerging markets, and in line with the uptick in trade activity, prospects have improved for a number of key emerging markets, including Mexico, Russia and, to a lesser degree, Brazil.
Europe has surprised on the upside and projected growth has also been revised higher for the US, despite a weak start to 2017. The outlook for the UK is less positive amid uncertainty about its domestic political environment and the Brexit negotiations.
The improvement in global growth momentum at the start of the year, and concomitant rally in commodity prices, saw an acceleration in related inflation off a weak base. Outside of Japan, headline inflation accelerated in Europe, the UK and the US, but core inflation remains subdued, despite growth accelerating and increasingly tight labour markets. A great conundrum for developed economy monetary policy makers is the slow responsiveness of wage rates to tight labour markets and generally more buoyant growth conditions. In some instances – the US, Germany, France, Japan and the UK – unemployment has reached rates consistent with considerably higher wage inflation, but wage inflation has remained weak, despite ongoing employment growth.
This creates a difficult economic environment for central banks to navigate. Only the US Federal Reserve has embarked on a slow, steady normalisation path. The European Central Bank has a tolerance for higher inflation (for longer) than would have been the case before. Nonetheless, it has also signalled a less accommodative stance, and some intention to taper its active quantitative easing programme.
The outlook for emerging markets is generally linked to China. Its recent revival has contributed to higher commodity prices, providing a fillip for commodity exporters. Of late, the Chinese government has been tightening liquidity conditions, which should see growth momentum slow. This implies somewhat weaker industrial commodity prices, and is less favourable for emerging markets. That said, growth momentum in many key emerging markets comes off a notably weak base, and should improve this year.
While the global outlook has improved, significant structural impediments remain, particularly in developed economies. These include the impact of policy normalisation on the economic upturn, as well as low productivity, weak wage growth, political risks and persistent inequality.
CURRENT FUND POSITIONING
From an asset allocation point of view, we continue to favour equities within our international multi-asset class funds.
Global equity valuations are not cheap, but when assessing all the major asset classes, we remain of the view that global equities will deliver the best long-term risk-adjusted returns to investors. Given the recent acceleration in price declines of retail property portfolios, especially in the US, we have started adding to this asset class and are excited about the long-term potential returns off these very depressed bases. Listed property has continued to diverge from the physical property market and we are exploring opportunities to take advantage of this anomaly.
While we continue to find very well-managed businesses at reasonable valuations in the US, European equities have started reacting to good economic news, and have outperformed the rest of the developed markets over the last six months. We continue to prefer investing in US management teams, even at slightly higher valuation multiples, as we find them to be more shareholder-focused.
Despite the challenges faced by emerging markets, we continue to find exceptional businesses with good long-term prospects trading at undemanding ratings, in these countries. Emerging markets still trade close to 30% below their absolute peak and offer a large margin of safety in our view.
Our negative view on government bonds remains unchanged. Within the income portion of our international multi-asset class funds, we maintain exposure to selected corporate credit and cash. Given the very low level of yield spreads, we have not replaced credit instruments that have matured over the last twelve months, resulting in overall portfolio exposure to credit reducing somewhat.
>> FIGURE 5: FUND POSITIONING AS AT 30 JUNE 2017