Markets face consolidation phase as ‘growth surprises’ falter, states Larry Hatheway, group chief economist and head of multi-asset portfolio solutions, at GAM. Risk assets have recovered sharply from their dramatic sell-off at the beginning of the year, he adds, a key supportive factor has been better-than-expected economic data, as shown by the rebound in growth ‘surprise indices’ (the extent to which indicators exceed or fall short of consensus estimates) since early February.
The key question he identifies is whether risk assets – and in particular global equities – can maintain their strong momentum. “We believe this is unlikely,” he says. “Growth surprises are nearing extremes and are therefore less likely to be supportive going forward. The Q1 earnings season is likely to deliver poor results, including outright declines in aggregate US corporate profits. Equity valuations (ex-energy) are also no longer attractive.”
The largest risks for global investors include the following:
US inflation: Quietly, US core measures of inflation have ticked higher, he observes. The consensus at the Fed appears to view rising core price pressures as transitory. If they are not, market expectations for rate hikes could shift sharply, undermining both stocks and bonds and boosting the dollar, leaving global investors with few forms of portfolio protection.
Political uncertainty: Uncertainties about the EU immigration crisis, Mideast tensions, potential political dislocations in Brazil and US elections could yet upend markets. Over the course of this year, at various points in time, politics will probably intrude on markets and leave their impact there as well.
Brexit (British exit from the European Union): Recent polls and spread betting suggest the ‘remain’ outcome is most likely, but volatility could well spike in the weeks leading up to the referendum. Sterling remains most vulnerable to an exit result.
Markets are now likely to enter a consolidation phase. ‘Sideways’ is a persistent theme for 2016, characterised by low single-digit returns across most asset classes, accompanied by recurring episodes of elevated volatility. With risk assets converging on their highs for the year and given an unchanged fundamental backdrop, we advocate a reduced exposure to global equities.
In this context, the challenge for investors remains identifying attractive risk/reward opportunities, he says. Most global fixed income markets remain expensive and, to date, many alternative strategies have not demonstrated an ability to deliver consistent positive and uncorrelated returns.
“Emerging markets offer some opportunity: earnings are depressed and valuations are as well, so the starting point from that perspective looks promising. But emerging markets have to deliver growth. We need stabilisation of the Chinese economy, we need better growth outside of the US, we need a recovery of commodity prices. Some of those things are falling into place, others are not. Therefore investments in emerging markets will have to be selective, particularly focused on economies where reform is taking place.”