Mark Burgess

Global equity markets were largely unchanged in April, although this masked a fairly wide dispersion in returns at the sector level.

Earlier in the month, for example, technology stocks came under pressure and triggered a general slide in equities due to fears that valuations were overstretched. Tensions between Russia and the West also undermined investor sentiment. However, equity markets subsequently rallied strongly on the back of encouraging US data and some easing of geopolitical tensions before some disappointing earnings releases in the US, a deterioration in the Ukraine crisis, and fresh concerns over the economic outlook in China weighed on risk assets in the final days of the month.

Treasury yields fell with the 10-year benchmark yield ending April at 2.66%, compared with the 2.72% level seen at the end of March. At the end of the month, and as expected, the Federal Reserve continued to reduce its monthly bond buying by US$10bn to US$45bn. The central bank said that growth in economic activity had picked up recently, having slowed sharply during the winter. The Federal Reserve also repeated its ambition of keeping interest rates at very low levels, saying it would maintain interest rates “below levels the committee views as normal in the longer run” even after the US economy has improved enough to hit target levels of unemployment and inflation.

In the eurozone, Portugal returned to the bond market for the first time in three years, holding a successful auction of €750m. The auction was three times oversubscribed and 10-year government debt yields fell sharply to an eight-year low of 3.58%. Greece also returned to the bond market for the first time since 2010. It sold €3bn of five-year bonds at a yield of 4.95% and said the issue was eight times oversubscribed. At the end of the month, the yield on the Portuguese 10-year bond had fallen to 3.64%, while that of the Greek equivalent was down to 6.64%. Eurozone bonds in general gained over the month on speculation that concerns over deflation could cause the ECB to adopt new stimulus measures.

The J.P.Morgan EMBI+ Index (on a total-return basis) delivered a positive return as emerging market bonds continued to recover. Russia proved an exception, however, with tensions between the West and Moscow over the Ukrainian crisis hurting investor confidence in the country’s bonds. Moreover, the credit rating agency Standard & Poor’s cut Russia to BBB- with a negative outlook, placing it on the brink of junk status. Meanwhile, the MSCI Emerging Markets Equity Index (total return, local currency) was largely unchanged over the month.

We made no changes to our investment strategy over the month. We remain overweight equities as valuations are largely reasonable, although less compelling than was once the case. We also remain underweight Asian equities on concerns over China, while we are overweight Japan as valuations are attractive versus developed world peers. Although we remain overweight equities, it would be fair to say we are less optimistic than we have been. Having said that, the recent pick-up in M&A activity in areas such as pharmaceuticals should prove supportive.

Within fixed income, core yields are going to grind higher, and there is much less value in credit given how far spreads have tightened. Only emerging market debt appears to offer any real value, but given the risks in terms of China, geopolitics and the macroeconomy, we are wary of increasing our weighting at present. The good news is that the current environment is likely to continue to provide opportunities for stock pickers, which we aim to exploit.

by Mark Burgess, CIO at Threadneedle Investments

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Latest Global Outlook report released by Standard Life Investments

Standard Life Investments, the global investment manager, believes that global equity markets can move higher if corporate earnings come through and companies invest their war chests of cash.

Speaking about the latest edition of Global Outlook, Keith Skeoch, Chief Executive, Standard Life Investments said: “Risk based assets such as equities and real estate can make further progress given the positive economic momentum. However a key issue that will determine the pace of recovery and return will be the extent to which companies step up to the plate and put their cash balances to work in generating growth.”

He added: “A recovery in US business investment during 2014 will signify that the upturn is self-sustaining and raise confidence about asset returns. This could also be the year of the merger if a number of larger firms deploy their cash to buy up attractive smaller companies.”

The Global Outlook also states that financial markets are being tugged in opposing directions, on the one hand by an improving global economy, on the other by worries about policy decisions, structural reforms and politics. However, Standard Life Investments’ House View remains confident about the ability of companies to generate positive cash flows into 2014. Global equity markets range from fair value to moderately expensive which is justified by the currently supportive policy environment and expectations of better profits growth.

Standard Life Investments remains Heavy in equities and real estate, Neutral in credit, emerging market debt and cash and Light in government bonds. Favoured equity markets include the UK, US and Japan, reflecting our forecasts for better corporate earnings growth and domestic demand into 2014.

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Growth in US equities predicted.

Despite the strong upward trend in global equity markets, equities should be favoured over bonds and cash, although equities are expected to outperform bonds by a smaller margin than in the first half of 2013, according to Russell Investments.

This sentiment is contained in Russell Investments’ 3rd Quarter Strategists’ Outlook and Barometer, a quarterly assessment of global capital markets. It features in-depth analysis of key economic and market indicators by Russell’s global team of investment strategists, who help guide Russell’s multi-asset portfolios and services.

In the report, steady growth is projected for the U.S. market over the next 24 months, forecasting the U.S. economy has sufficient spare capacity to grow without generating inflation pressures. Within global equities, Russell strategists prefer Europe and Japan due to slight improvements in the Eurozone, the success of ‘Abe-nomics’ in Japan, and the overall attractiveness of Japanese and European equity valuations relative to U.S. valuations.

Russell Investments senior investment strategist, Asia-Pacific, Mr Graham Harman, said Asia-Pacific offers opportunities in Japan, China and Australia.

“Japan is experiencing strong GDP growth for 2013, and the Chinese government is prioritising reform over short-term growth,” Mr Harman said.

Locally, while there are encouraging signs in Australia’s housing sector, the economy faces a slowdown.

“The overwhelming challenge domestically is to absorb the impact of a precipitous decline in resource sector-related capital spending, and to take up the slack in export growth, in housing, and in domestically oriented industries,” he said.

Russell Investments global head of investment strategy, Mr Andrew Pease, said economic growth in the months ahead will remain modest but robust, with Europe emerging from recession and Japan set to accelerate.

“The gains in global equity markets and rises in bond yields mean that we head into the second half of the year with equity markets offering reasonable, but not outstanding value, and with bond markets less dangerously overvalued,” he said.

Emerging markets may underperform in the near-term, but prospects are improving 

Conditions in emerging markets remain challenging for equities, given the strengthening of the U.S. dollar (USD), falling commodity prices and general geopolitical upheaval in countries from Brazil to Egypt. However, Russell’s strategists believe an export recovery and a settling of the current uncertainty around China could serve as catalysts for a rebound in the medium-term.

“Emerging markets offer good value and could rebound as exports recover amid stronger growth in developed economies and if EM central banks allow their currencies to depreciate against a stronger USD,” Mr Pease said.

Despite some challenges, U.S. economy likely to generate stable growth 

Russell’s strategists believe that U.S. employment gains will likely average 200,000 jobs per month for the next 24 months. The first increase in the federal funds rate likely won’t take place until the fourth quarter of 2015. However, the June revision to the annualised real consumption figure, which lowered the growth rate from 2.9% to 1.8%, implies less momentum going into the second half of the year.

Another challenge will be the U.S. Federal Reserve’s (the Fed) wind down of quantitative easing that is likely to begin in 2013, though it is the end date that is most significant. Russell believes the Fed is unlikely to hit their growth, inflation and Treasury yield targets this year.

Many investors fear that the current economy resembles 1994 where the Fed policy tightened dramatically, leading to a sudden rise in yield rates and choking equity growth. Russell Investments’ perspective is that the economic conditions today parallel 1984 more closely, when a bullish U.S. economy forged the way for stable global growth. Russell expects the U.S. economy to be characterised by moderate inflation, a low recession risk and stable growth.

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