It feels like 2015 has been a long year already! Clearly markets have had much to contend with, but the dominant feature has been the continued collapse in core bond yields. Global economic activity remains muted, and the deflationary forces lowering inflation and impacting nominal growth are many and varied. Politics and geopolitics continue to grab headlines, and in the case of the Greek election, have the potential to affect markets significantly due to Greece’s conflicting ambitions of retaining the euro whilst also seeking forgiveness on its debt.
The oil price remains weak, and whilst its impact on inflation is clear, the follow-through in terms of consumer spending is less clear cut. On the policy front, the ECB recently announced full-blown sovereign bond quantitative easing (QE), with an intention to purchase €60bn a month in bonds until its target level of 2% inflation is reached.
Against this backdrop, yielding assets have had a strong start to the year. Credit, particularly investment-grade credit, has performed well, and similarly equities have enjoyed positive returns in a number of markets. Our equity strategy has been to favour the US, which has enjoyed a relatively stronger economy, the UK, which has valuation support, and Japan, where corporate profits are being boosted by ‘Abenomics’. Although the UK equity market has been held back by its exposure to energy and materials, both Japanese and US equities have performed well since we moved to favour them in our asset allocation model.
However, the US equity market’s valuation now looks relatively stretched given both its outperformance and, more worryingly, the impact of a stronger dollar on US corporate profits. Europe, on the other hand, benefits from a number of decent tailwinds: a weaker euro, lower oil prices, and a boost from the ECB’s QE programme. It is quite possible that we will see upward revisions to European GDP growth this year, a first for many years. European corporate profits will be supported by improved competitiveness as a result of the weaker currency, and valuations are relatively attractive. Interestingly, European earnings revisions have just turned positive (albeit in a very small way).
Elsewhere, in Asia Pacific excluding Japan, and also following a long period of underperformance, valuations look increasingly attractive. Whilst there a number of obvious losers in the region as a result of the oil price fall, there are many winners, and we are finding a wider range of interesting investment opportunities. Consequently we have moved overweight the region for the first time in a while. Similarly, we have moved overweight in European equities, funding both of these moves by downgrading US equities to neutral from overweight. We have also used these recent asset allocation changes as an opportunity to reduce the magnitude of our overweight in equities, but we continue to prefer equities over bonds.