Asset Allocation Quarterly
Central banks induce regime shifts
• Central bank tightening fuels volatility – As financial markets begin to slowly grasp that central banks are no longer
underpinning asset prices, sharper and sudden market moves look set to become the new norm. In such a world more
emphasis will have to be on fundamentals again, and price action will be determined more by incoming macroeconomic data
and corporate fundamentals.
• Bonds no longer good hedges – As quantitative easing ends, we expect to see core bond yields moving structurally higher
(especially as real yields and term premia reverse from their QE-depressed levels). This makes bonds less useful for portfolio
hedging and we are diversifying using other assets.
• What’s in the price? – We believe some bad news is already in equity prices. Previously elevated valuations have corrected
sharply and our macroeconomic scenario framework shows that stocks have started pricing in the more bearish scenarios, but
they could have further to run compared to our most bearish scenario.
Asset Allocation Quarterly - january 2019
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