So far so good, but markets underestimate risks
SUMMARY: US equities continued to outperform other markets such as EMU and EM equities. This partly reflects the divergence between the US economy -which is supported by fiscal expansion and a patient Federal Reserve- and relatively weaker growth in the eurozone and EM. But there is more to this divergence than faster US economic growth. The US equity rally has been led by the IT sector. This has accounted for 20%-50% of US equity returns since 2016. The rally is now looking stretched on various metrics. The other salient development in August was renewed stress in emerging markets (EM). A combination of economic stress in Turkey, weaker growth in China, Sino-US trade tensions and a stronger US dollar hurt EM assets. We believe there is value in EM assets, but the obvious circuit-breakers are still absent: a weaker USD, aggressive China stimulus and fresh Sino-US trade talks. EM assets prospects have soured and protectionism and tighter liquidity continue to cloud their longer-term prospects.
Foreseeing calmer markets over the next few months, we have identified several reversal themes
SUMMARY: Despite trade tensions, concerns about global growth and more volatile markets than in 2017, our base case scenario remains one of robust global growth and contained inflation. This underpins our bullish view on equities, with a preference for eurozone equities where we see positive earnings growth prospects and room for margin expansion
Three stocks hit markets: (i) an escalation of political risk, (ii) weakening growth (notably in Europe); and (iii) a stronger USD, which led to stress in emerging markets In Italy, market worries about fiscal excesses and the prospect of a clash between the new government and European authorities escalated. As a result, ‘peripheral’ eurozone debt sold off. Italian markets are likely to remain volatile in coming months as investors digest further news on political developments and economic data There are signs of a growth slowdown, notably in the eurozone, according to recent data. However, we find it difficult to call a turn in the economic cycle yet. While the data have weakened, activity is still expanding both in the developed world and emerging markets Emerging market stress was largely a consequence of higher US yields and USD strength. In our view, local debt offers value and currently lower US yields are reassuring, but we need to see the USD and global risk sentiment stabilise for EM debt to rally materially
Our outlook for US inflation and growth has brightened considerably since the start of 2018, so we have lifted our targets for both US Treasury yields and TIPS-based breakeven inflation rates. Here, we review the factors we see as contributing to the rise in US inflation and we look at the potential monetary policy response from the Federal Reserve (Fed).
Flash note on the sell-off and implications for equity allocations
Why is volatility so low?
Equities to benefit from growth, still-low interest rates
US and eurozone PMIs underscore growth prospects; UK odd one out
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