The key factor discussed in our recent annual global strategic asset allocation meeting was the trajectory of inflation in developed markets (DM). Within days of that meeting, the U.S. Equity indices had reacted to improved wage bill numbers, and the fear of inflation and a subsequent spike in U.S. bond yields started a correction in U.S. and global equity prices. There was a collective sigh of relief – is the world about to become normal again? The S&P500 had gone 310 days without a 3% draw-down and 402 days without a 5% drawdown – both records!
The U.S. equity market correction was followed by a global equity market correction across all regions. But, what had actually changed over the last few days? The short answer (no pun intended) is that a number of investors were short–sided with Short VIX positions, which created margin calls and a need to sell ‘other’ assets. This and the ‘machines’ started a flash crash and contagion across global equity markets. But, global economic growth and activity did not change in the last few days, we are still in a world of broad-based global economic expansion, activity and GDP growth. (See Fig 1: BCA Picture on Global Economic Expansion).
BCA Research’s (BCA) recently reported that the Citigroup Economic Surprise Index for major advanced economies has risen to near record-high levels. Goldman’s Global Current Activity Indicator stands close to a cycle high of 5%, up from 2.2% at the start of 2016. The BCA Global Leading Indicator has decelerated somewhat but is still pointing to above-trend growth this year. Growth in the Euro arena remains strong. The economy grew by 2.5% in 2017, the fastest pace since 2007. U.S. growth is gathering steam. Real private final demand increased by 4.6% in Q4. The Atlanta Fed’s GDP Now model is signalling growth of 5.4% in the first quarter, while the New York Fed Staff Nowcast is pointing to a more plausible growth rate of 3.1%. Corporate profits are racing higher, reflecting a healthy economy.
45% of S&P 500 companies have already reported their 2017-Q4 results. 80% have beaten consensus EPS projections, above the long-term average of 69%. 82% have surpassed revenue projections, which also exceeds the long-term average of 56%. (See Fig 2: Analysts scramble to upgrade earnings)
Our annual strategic asset allocation meeting also highlighted our big picture thinking on the global landscape and concluded that in the short term we can expect the following:
- Global growth to be firing on all engines.
- Gently rising bond yields can cause equity market volatility.
- Commodities may benefit from global economic activity and a moderately inflationary environment.
- We continue to prefer DM equities to DM bonds.
- We remain optimistic on Emerging Market equities and bonds.
- Value Equity is preferred to Growth Equity, across all markets.
- U.S. expensive relative to other regions, while Emerging Markets, Europe and Japan is our preferred equity market regions.
- AI and Chinese Technology continue to be the future drivers of consumer behaviour and can continue to support technology stock prices.
- The return of inflation – moderate, not runaway inflation.
- Global yields to remain low relative to historical standards as high debt levels will force central banks to use monetary tools to ‘manage’ any potential financial contagion while taking the ‘punch bowl’ of QE and liquidity away slowly.
- It is reasonable to expect lower (single digit) real returns from developed equity markets while emerging market equities and value orientated stocks may be the investment opportunity to rotate to for higher real return expectations. (See Fig 3: Yields are still low by historical standards)