The economies in the US and Japan have picked up, the Eurozone is finally escaping recession, and the emerging markets are well-equipped to avoid a repeat of a 1997 Asian Crisis. In this environment, we remain overweight equities and underweight in...
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Mikio Kumada, Global Strategist at LGT Capital Management
fixed income, with a short duration. At the same time, we fine-tune our allocation by shifting part of our equity position from the US and Japan to Europe, and by expanding our convertible bond exposure.
Continued cyclical recovery remains our main scenario
The world’s flirtation with recession was short-lived this year. The US purchasing manager surveys have comfortably jumped back above growth threshold as the labor markets continued to heal, and even the Eurozone has finally escaped its 18-month recession. In Japan, questions remain about the political will to start addressing the necessary fiscal consolidation, but “Abenomics” is nevertheless gaining traction. In the emerging world, meanwhile, economic growth has slowed, and credit issues remain a concern in some countries, but fears of a repetition of a 1997 Asian Crisis-type scenario are exaggerated in our view (see last LGT Beacon). Rising bonds yields in the major markets (US, UK, Germany etc.) have followed on the heels of a defused euro crisis, exacerbating the repatriation of capital to the West and taking their toll on many emerging markets. Still, the bottom line is that most emerging economies are fundamentally much more resilient to exogenous shocks today than they were 16 years ago. Thus, our main scenario for the coming months remains broadly unchanged, and we expect the cyclical recovery to continue, with few inflationary risks on the horizon. Our risk scenario – fallback into recession – cannot be entirely ruled out, but has become less likely.
Bull market remains intact despite coming “Fed taper”
From an event-risk perspective, we find ourselves hard-pressed to identify developments that might derail the bull market. The ones we can think of are either too unlikely (e.g. full-blown EM crisis) or would have only a marginal impact on long-term risk sentiment (e.g. a military strike on Syria). Meanwhile, the US Federal Reserve’s much-discussed gradual withdrawal of stimulus (“taper”) has been to large extend priced into markets already, with long-term bond yields rising, the yield curve steepening, and the US dollar trading on a firm note. Besides, in the context of a growing and/or improving economy, rising interest rates need certainly not be the game-changer that ends a boom in domestic equity investments.
Potential warnings signs from a behavioral finance perspective
At the same time, however, our behavioral finance experts see potential warning signs: market breadth has deteriorated somewhat (not only) in the US, housing and transportation stocks are weak, or appear to be loosing momentum, valuations are less supportive than in the past, while most asset allocators are now tactically overweight stocks, and low volatility and put-call-ratios suggest some degree of investor complacency. A set-back in stock prices in the near future would thus not surprise us. However, should markets indeed correct, we would still consider the medium-term outlook as constructive from today’s standpoint.
Equities: Europe raised from neutral to overweight in exchange for trimmed overweights in US and Japan
Against this background, we have decided to moderately trim our equity overweight by reducing our hitherto pronounced preference for Japanese and US stocks, and in exchange raising our European equity exposure from neutral to overweight. The Eurozone could surprise on the upside in coming months, while the region’s monetary policy outlook is set to remain supportive, even as the US moves toward a gradual withdrawal of stimulus. All three developed markets are now overweight by a similar order of magnitude. Lastly, we are keeping our underweight in emerging market equities. This segment is showing some tentative signs of bottoming in relative terms. However, given our relatively large strategic position, we continue to prefer not to reduce our tactical underweight at this stage.
Source: ETFWorld – LGT Capital Management
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