Our monthly market view

August 2018: Balancing act


  • Equities - neutral
  • Fixed Income - neutral

We keep equities at neutral
July proved to be quite a decent month for risky assets, and equities had a good run with a
return north of 2 percentage points. The more hesitant environment that prevailed during
June recovered as the perceived threats from foremost trade and politics did not “come
through”. Consequently, confidence returned and a solid month ensued. Within fixed income,
rising yields was a bit of a headwind for government bonds, with US/Euro long yields rising
in the range of 10-20 basis points. However, in the credit space, spreads compressed mildly,
providing some relief. Especially Emerging Market bonds recouped some of the losses
sustained during the last couple of months.

In the months ahead, mostly the same issues that has shaped the year so far will continue to
dominate. We will thus see focus on the trade issue, politics and the ever present central
banks. Overall, the picture is roughly balanced and we continue to recommend being fully
invested in equities, i.e., we keep the neutral recommendation.

Slightly better signals from global growth
The global economy has enjoyed a strong period since the beginning of 2016, and growth
will carry on also going forward. This spring however saw some weak links, Europe being
one region where momentum lessened. Lately, it seems like this development has at least
stabilised, and that the fall in momentum has been arrested. We are not seeing Europe
quickly bounce back to the +2% levels reached during last year, rather settling on a level
that is still above the potential for the region. In the US, the economy powers on, the latest
GDP figures being above a growth rate of 4%. While not the biggest economy, Japan has
seen some loss of momentum lately, which partly detracts from the above picture, but far
from making us worry. Taken together, this eases some of the concerns we were having a
month or two back. The main part of global economy is thus still decently synchronised in
terms of growth, and growth at a healthy level.

Emerging Markets, meanwhile, have come under some pressure, with a number of individual
countries experiencing turbulence. The dollar strengthening has exposed weaknesses and
some markets have reacted accordingly. Partly, the political situation has added to the woes
in, for instance, Brazil and Turkey. China is also experiencing some softness, which has led
to easing of both fiscal and monetary policies. We are not predicting an implosion in growth,
but rather highlighting the fact that momentum will not be as strong going forward.

Overall, the growth outlook still supports risky assets, and on the margin things seems to
have improved. But that is not saying that the conditions from last year will return in the short
run. We still see the global growth backdrop as positive, but is has become more balanced
during 2018. And as always, there is some risks to the outlook. The trade issue is not (yet)
eating into global growth, but the risks of an escalation should not be underestimated. What
started as minor tariffs is at the moment threatening to get worse if Trump gets his way with
significantly increasing trade barriers -- not only against China but Europe as well. This is an
area we will follow closely. The flip side is of course the fact that negotiations are most likely
taking place and should some kind of agreement be reached, some of the clouds could
disappear and a market melt-up is entirely possible.

Earnings are still a strong support for equities
Global corporate earnings, led by the US, are a bright spot and are likely to reach double digit
growth again this year after a stellar performance of over 17% growth in 2017. So far,
Q2 reporting is closing its end, and the results are indeed encouraging. US companies are
beating expectations like never before, both on earnings and on sales, which we see as
especially positive given the margin worries that has been prevalent the last couple of
quarters. Another positive angle on the US earnings season is the fact that many companies
cite the trade issue, but not in an overly negative way. So far, impact is close to nothing, and
judging by guidance, at current state it will not be a big issue going forward either. Should we
get an escalation, it could of course change quickly. Europe and Japan will post more
modest numbers but the comparison is somewhat unjustified as US companies are riding
the wave of the tax cuts implemented at the beginning of the year. Overall, the earnings
outlook is still one of the key positives for equities, providing solid support. Events have to
take a serious negative turn for earnings growth to slip below double-digit growth this year,
and at the moment, we do not see that happening.

We have passed the peak in terms of monetary support
The monetary policy outlook remains relatively benign for the time being, but this is an area
that needs close watching. Only a couple of months ago, inflation was the great scare as the
markets feared it would accelerate during the year, prompting more action than expected
from the central banks. While that prospect has diminished as inflation/wage prints have
stayed relatively muted, it is still on the table. The same goes for rates, which were on an
upward trail together with inflation fears earlier this year. During July, rates have indeed
climbed upwards, but remember that the opposite was the name of the game only a month
or two back. While we still think the direction is upwards, the process will be slow, especially
outside the US.

Central banks slowly tightening the monetary spigots is potentially damaging to the growth
outlook, but so far it seems like the economy is doing decently. It could mean less liquidity
while at the same time increasing the supply of bonds (primarily in the US), pushing up
yields. This is not yet the case in Europe, as the ECB will end its QE program at the end of
this year. However, the signal is there and overall monetary policy is tightening. In Emerging
Markets, some bias towards tightening is also present. It is partly because of the dollar
strengthening, as some countries have to defend their currencies, but overall, it adds to the
picture of a more restrictive monetary policy environment. While we do not see the current
environment as a hindrance to the equity market, it could possibly restrict the potential going

Valuations neither a tail- nor a headwind to equities
Equities are still attractive from a valuation perspective, and YTD they have become
“cheaper”. In absolute terms, then, we cannot consider equities expensive, although some
pockets of the global market possibly could earn the epithet “a bit stretched”. Thus, we still
assert that equities can rise at least in line with earnings growth going forward. Earnings
growth will have to do the heavy lifting but given our expectation of continued earnings and
margin expansion globally, valuation may well edge slightly higher. Given that most risky
bonds are yielding very little in excess of government securities in historical comparison, and
riskless rates still hover near record lows with risks tilted to the upside, equities remain very
attractive in terms of risk/return outlook. Bonds have become, at least in the US, more
attractive after the rise in yields YTD. In the Euro area, this view is more debatable as yields
are essentially flat on the year. We are not overly attracted to bonds, but given the slightly
changed outlook, a neutral recommendation is prudent in our view.

Sentiment showing some positive signs
Equity markets have made a strong comeback after the plunge earlier this year, July being a
testament to that as global equities now have returned a healthy 5%, up roughly 10% from
the bottom in March. Both sentiment and technical indicators have mirrored this
development during the run, but with far bigger swings than the market. At the moment, both
are leaning to the positive side and some of the reluctance seen throughout the spring/early
summer has disappeared. Currently, investors are mainly positive. Actual positioning paints
a somewhat different picture as overweights in equities has been scaled down the last
couple of months. Still, overweight risky assets is the main position, and there is cash on the
side lines to deploy. Overall, we see the sentiment as more positive than last month, and
with the right trigger, for instance a solution on the trade issue, the conditions for a positive
market is definitely there. Of course, the opposite applies if events turn the other way.

Trade tops the list of political risks
Around the world, political issues are shaping some of the market behaviour, and will
continue to do so, at least short term. However, fears from earlier this summer have died
down somewhat, but that is not to say that they have gone away. Starting with number one,
trade, the big risk is an escalation from the current moderate protectionism. Markets are
waking up to the fact that the US Administration is serious in pursuing a mercantilist trade
policy. What started as a minor spat has grown to something potentially more serious. There
is of course no way to predict the end game here, but it is safe to say that trade carries a
significant risk to the outlook, not only economically, but also market wise. Anticipating the
moves by the main participants is a bit risky, and betting on them even riskier. Needless to
say, we keep a close eye on this development.

What was a troublesome development in Europe a month ago has lessened somewhat. The
Italian fuss is probably not over, but so far the worst fears of the market has not been
realised. A possible breakdown of the German government was also handled. We still think
Europe will create headlines, and not only positive ones, going forward, keeping the markets

Summing it all up, we have a slightly more positive view overall, but it is not enough to
change our stance at the moment, thus we keep the neutral recommendation for both
equities and fixed income.