We’re still bullish global equities expecting gains through year end of 5-10% for major markets. By quite a margin, our top reason is the massive global reflationary effort underway led by the ECB and BoJ and being followed by many other central banks. While corporate fundamentals in these important regions are improving rapidly, much of the improvement comes from beggar-thy-neighbour currency weakness. We are therefore increasingly uncomfortable with equity market momentum. Our trade ideas reflect this through careful implementation strategy and we seek uncorrelated and un-crowded risk-on exposure in preference to the more obvious monetary momentum strategies.
Equity valuations ‘fair’ but only in a low yield environment – With FX moves dominating all else, Japanese and European equities are now showing improving profitability through margin expansion. The market is yet to pay a full valuation for this in our view. US and emerging equities face profitability headwinds however. While we see US equities 7% higher by year-end, we also see them becoming more expensive in the process and, particularly so, if US yields rise with growth and inflation. Deflation concerns legitimate – Negative headline inflation data recently has sparked a wave of concern and led to confusing anomalies in rates markets in some regions. European yields caught-down to Japanese as the “Japanisation” baton is passed. US yields remain low considering Fed forecasts and persistent real growth.
A new wave of easing – ECB QE is far larger than other central bank efforts when measured against net supply. Combined with negative deposit rates, this reflationary effort against negative inflation data, sparked a wave of monetary easing globally. The scale of global policy interventions is trumping all fundamental factors for now. Increasingly uncomfortable – It’s a little too easy to be bullish equities in regions with weakening FX and very loose monetary policy. We are increasingly uncomfortable that returns can so easily be generated as a result of the decisions of a handful of individuals. We therefore look for strategies that are risk-on, but contrarian in nature. Shorting USO volatility (Oil ETF) is one opportunity we investigate. EU equity momentum – While we are uncomfortable, it does seem very likely that European equities perform strongly in the coming year. Our favoured strategies reflect this discomfort – buying weak FX, low-rates and cheap oil “free-riders” like the DAX (over FTSE), buying quality dividend payers while controlling volatility (BNP Max Income Index) and being long carry on value sectors sensitive to reflation (selling SX7E puts)
