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Q2 2018 – Global Market Outlook

Posted on April 30, 2018 in:

Cycle tailwinds from synchronized global growth, strong earnings and fiscal easing currently outweigh the growing headwinds from monetary tightening and inflation pressures, but we wouldn’t throw caution to the wind as 2018 progresses.

Volatility is back, the U.S. Federal Reserve (Fed) is picking up the pace of hiking and trade-war threats are increasing. But global growth is still strong and the U.S. economy is getting a jolt of fiscal stimulus. The tailwinds still outweigh the headwinds for now; however, this balance could shift as the year progresses.

Shifting Winds

January’s burst of equity-market euphoria has given way to fear of a trade war, a more hawkish Fed and the return of volatility. The challenge of late-cycle investing is that equity valuations
are stretched, there are worries about the economy overheating and the Fed is taking away the punchbowl. But at the same time, economic growth and earnings are strong, and surveys of U.S. investors still suggest plenty of optimism, even after the late January equity-market correction.

The added complications are that the U.S. federal government has enacted substantial fiscal stimulus at a time when the economy is at full employment, and President Trump is imposing trade sanctions that could escalate into a major trade war.

Our cycle, value and sentiment investment decision-making process has us broadly neutral global equities. We’re underweight U.S. equities because of expensive valuation, and because we believe much of the good news is priced in. Positive cycle views and relatively better valuation give us small overweights to Europe, Japan and emerging markets within global equities.

Paul Eitelman sees the U.S. fiscal stimulus as cycle supportive but argues there will be a price to pay in terms of inflation and the pace of Fed tightening. He worries that a trade war could be bad for growth and inflation – inviting stagflation – but thinks the U.S. is embarking on a negotiating strategy rather than an all-out trade war.

Wouter Sturkenboom remains positive on the cycle outlook for Europe. The strength in the euro has been a significant headwind for the local currency performance of European equities. He believes this drag should start to wane in coming months, allowing the positive cycle fundamentals to be rewarded.
Graham Harman and Alex Cousley remain broadly positive on the Asia-Pacific region. Policy settings are still broadly accommodative across the region and corporate earnings growth is healthy. They see the main risk as U.S. trade protectionism, targeted against China.

The Japanese yen has taken over from the euro as Van Luu’s preferred currency. The yen is relatively cheap against the backdrop of an improving economy and a current account surplus. Van expects the U.S. dollar to remain under pressure from the twin forces of large fiscal and current account deficits.
The U.S. Business Cycle Index model estimated by Kara Ng and Abe Robison points to relatively low recession risk over the next 12 months, though their model for U.S. equities versus fixed income has moved to neutral following a lengthy period of favouring equities.

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