Global monetary policies remain very supportive of – and focused on – global growth, according to Percival Stanion (pictured), Head of Asset Allocation at Baring Asset Management (Barings), and in this scenario, equities should remain the major building blocks of portfolios…
Even the tentative signals being made for an eventual policy change in the US and UK, such as a rise in interest rates, are being framed in a language that is still hugely supportive and highly sensitive to any market overreaction, and Barings believes this bodes well for equity investors.
We remain overweight equities on a global view. We acknowledge though that market valuations have already seen a huge rise over the past eighteen months and while the outlook for corporate profits is for modest growth, it is difficult to justify another leap in valuations. So progress from here in equities could be quite slow, even if it is still ahead of other asset classes.
Within equities, Japan still has the capacity to surprise a very sceptical investor base so we remain overweight the asset class. The market is cheap compared to its peers and earnings growth expectations are well underpinned. We are also warming up to emerging markets where the exuberance of recent years has turned to pessimism. The secular story is still superior to the West and valuations are now reasonable.
In Japan, the central bank’s nerve was tested with the recent hike in the sales tax. So far the data has justified their stance, according to Barings. Retail sales did not fall as much after the tax rise and have recovered more quickly than markets expected. The improvement in the jobs market is also faster with the job offers to applicants’ ratio at a new record. As a result, the Bank of Japan is just continuing with its existing (albeit huge) bond buying programme, rather than launching any new initiative. It is testimony to the huge scepticism that greets any political initiative in Japan that markets have largely ignored all the very positive news flow from the real economy.
The three pronged economic agenda introduced by Shinzo Abe has so far focused on monetary and fiscal stimulus. Following a period where Japan has lagged other developed equity markets, we are in a really interesting point in time for the Japanese market. We have seen better expectations about corporate profits and interestingly the market has outperformed of late without the Yen having to weaken. Since the start of 2014 we have been adding to our position to take advantage of low market valuations and now hold 11.9% in Japanese equities.
In Europe, Mario Draghi is doing an excellent job in transforming the European Central Bank into a much more pragmatic central bank, believes Barings. The ECB is engaged in a continuous dialogue with the markets akin to the Anglo Saxon model, although deflationary forces are still powerful, especially in peripheral countries. And the Federal Reserve’s dual mandate, to promote both growth and full employment, obliges it to try and employ these unutilised resources: as a consequence, Barings believes that the Fed’s preference is for rates to remain on hold until well into 2015. However, events may force their hand. Sharply falling unemployment or a surge in inflation could make them act sooner, or risk a major loss of credibility.
Each central bank has a subtly different communication problem to overcome; they also need to be very sensitive not to weaken their own credibility with markets. In the UK Mr Carney has undermined his own forward guidance policy on interest rates by suggesting an earlier hike is possible. If the data remains strong due to continued jobs growth and rising wages then the Bank of England will have to act, or risk a major loss of confidence.
Barings believes that in the US, the harsh winter weather significantly amplified confusion as first quarter US GDP showed a fall of 2.9% for the period although Barings believes that the underlying trend in real final sales is still almost 3%. Catch up spending in Q2 could well boost the data temporarily and is then likely to ease back again in the second half of the year. Despite this, 2.5-3% GDP growth could be as good as it gets for any major economy in this cycle.
Although our central scenario is still for a continued recovery, we cannot avoid thinking about alternative outcomes. Central banks could get their market communications wrong and destroy their own credibility. This would certainly raise volatility and possibly destabilise currency markets. The risks from the Iraq situation causing a regional conflagration, or further Russian destabilisation also need to be considered and kept under constant surveillance. Even if we manage to avoid these more threatening scenarios, we should expect a rise in volatility among financial assets as monetary policy slowly changes from the current extremely easy conditions.