Investment Outlook - Q3 2018
After almost a decade of a relentless equity bull market, global markets are struggling to make any gains so far during 2018. We have for some time highlighted that a transition from a central bank liquidity driven to an earnings driven market would be tricky and likely volatile and indeed this has been the case. Markets have been further restrained with additional uncertainty arising from trade tensions continuously emanating from the USA.
Our central scenario remains that we are in a synchronised growth phase for the global economy and that this will last for a few more years. We do not believe we are at the end of the current economic cycle but do acknowledge that any risks to this view are skewed more to the downside, in particular factoring in the risk of trade wars. Despite strong earnings growth and resilient prospects for further growth, investors have over recent months been more risk adverse with markets remaining in the doldrums.
We expect further upside for equity markets over the next 12-18 months but equally highlight that there are short term challenges and markets may find it difficult to make much progress over coming months:
- Geopolitics, especially trade wars. A full blown trade war, while not our central expectation would be a major negative with nobody a winner. Emerging markets would be in focus.
- The politics of Brexit and also some political instability in Germany and Italy. US mid-term elections will be a focus also.
- Any signs of further increases in inflation will raise concerns about further interest rate rises and higher bond yields.
- The fact that the abundant liquidity of recent years will continue to diminish with quantitative tightening ongoing by the FED and the end of quantitative easing forthcoming by the ECB.
In summary, a positive medium term outlook but reasons to expect little progress in coming months.
Asset class outlook: Equities
Our central scenario is as outlined. Absent a material trade war (as distinct to fears of same) we don’t expect an imminent material correction in equity markets nor a bear market.
The equity bull market has been strongly and increasingly driven by a narrow list of growth and momentum stocks and sectors. The relative valuation argument has not mattered during this phase with growth trouncing value. We have seen this before and not least during the technology bubble of the early 2000’s.We believe that as confidence is restored in a synchronized global economic cycle, that a rotation within the equity market and more towards more economically sensitive sectors and style stocks will occur. This should lead the next upward phase of the equity market. It is also critical that companies continue to delivering earnings and dividend growth for this to happen. EM should benefit in this scenario.
A theme of ours over recent quarters in portfolio construction has been and will continue to be one of avoiding what we believe to be excesses that may have lots of associated downside potential such as:
- Companies carrying excessive debt on their balance sheets
- Excesses of valuation e.g. certain technology stocks
- Companies funded by more expensive corporate credit
Asset class outlook: Bonds
Government bonds should be avoided as we believe they are fundamentally overvalued and remain vulnerable. An unexpected recession would certainly support government bonds
To conclude, the fundamentals remain supportive for further gains in global equity markets but expect progress to be slow. A switch from liquidity to stronger earnings growth is where we will focus our stock picking and we stick with our view of rotation within the market. The potential for a trade war is the biggest risk.
KBI Global Investors Ltd. is regulated by the Central Bank of Ireland and subject to limited regulation by the Financial Conduct Authority in the UK. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. KBI Global Investors (North America) Ltd is a registered investment adviser with the SEC and regulated by the Central Bank of Ireland The views expressed in this document are expressions of opinion only and should not be construed as investment advice.