Investment strategy 2nd quarter 2018

Solid and even growth across the globe

Volatility has returned to the financial markets this year. But that’s nothing exceptional. What was exceptional was the smooth stock-market rally that lasted throughout 2017. At this late stage in the macro cycle, it’s normal to see more uneven performances as investors adjust their monetary policy forecasts.

At the moment, investors are most worried about inflation. Although prices have been surprisingly slow to rise around the world, investors are on the lookout for the first signs of an upturn in wages. For the time being, wage growth is being held back by structural changes linked mainly to such factors as the digitisation of the economy. But a rebound nevertheless seems inevitable in countries that are close to full employment, like the USA. Geopolitical factors have also had an impact on the financial markets recently, with tensions escalating again in the Middle East and northern Asia. And, given the USA’s ever-expanding trade deficit relative to China, among other factors, President Trump has revived the aggressive tone he adopted during his election campaign and is threatening to impose tariffs on US imports of certain goods and services. These moves may have more to do with negotiating tactics than with a real intention to spark a trade war that no country would win. Beyond inflation, the major central banks will be keeping an eye on the economic risks of this tough talk and may even slow down or put off the much-awaited normalisation of their monetary policies as a result. Luckily, these tensions have resurfaced at a time when global economic growth is back on a firm and even track.

Barring the worst-case scenario of a large-scale trade war, the climate is still ripe for equities to outperform, especially against bonds, which offer low returns and are exposed to upward pressure on interest rates. This pressure is most likely to be felt in Europe, where the policy of zero and even negative rates will probably come to an end soon. We are therefore reducing our exposure to European bonds in our portfolios and increase cash and cash equivalents. After their recent dip, share prices are back at more reasonable levels, at a time when corporate earnings are rising sharply. Valuations remain more attractive outside the USA; they are particularly appealing on European markets, which are still a long way from their record highs. Japan also has some catching up to do, even though the Tokyo Stock Exchange may face a yen that starts to rally. Using forward exchange contracts to partially hedge against the yen is therefore no longer the right strategy.