Since Sandaire’s last market update in July 2016, we currently find that economic growth is no stronger, and liquidity (interest rates) and inflation are rising in the UK and US. Yet equity markets have been robust despite their already lofty valuations.
The fundamental drivers of equities suggest limited support for prices going forward. Economic growth of the developed economies has been slow and unsteady. Companies continue to keep a firm grip on capital spending, and consumers are shackled by a lack of income growth.
Investors have been attracted to improving economic and political management of some emerging economies, of which India is a prime example. Their economies are not large enough, though, to be the global growth locomotive.
In a world of low nominal interest rates equity is one of the only asset classes that offers much hope of a positive return after inflation. Investors have sought both income and to mitigate volatility in equities as an asset class by buying the ‘quality’ equity segment. As a result the price differential between quality and value stocks has been stretched to a multi-year high. Consequently, we see an opportunity to sell some of our quality equity exposure to switch into a value style of investment.
As part of a switch to cheaper equity we have decided to increase our emerging market exposure (especially Asian markets) by reducing European equities. The European markets have been underperformers this year and the economic and investment outlook no longer appears encouraging.
For all the Brexit angst in the UK, its equity markets seem to be in better shape than Europe. The FTSE100, with more than 70% of its exposure coming from overseas, is a convenient hedge to sterling’s depreciation.
Japanese equities also continue to offer something of a relative bright spot, with a market that is underpinned by the unprecedented actions of the Bank of Japan, reasonable valuations, and a corporate sector that finally seems to be improving its attitude to shareholder yield.
The latent rise in inflationary pressures in some economies, together with possibly increased debt issuance by governments, may result in higher yields and we continue to avoid government bonds except for index-linked securities, preferring corporate issuers and short duration.
Our asset allocation views have not sought to anticipate the outcome of the US election. Too many permutations seem plausible for the presidency, senate and house, and even knowing the result may not provide a clear guide to the behaviour of markets.
Our preferred currencies are the US dollar and Japanese yen: US dollar strength predicated on rising US interest rates; whilst the yen has resumed its traditional role as a safe haven currency.
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