Russell Investments strategists' Outlook: Fed rate hike and Greek bailout dominate mid-year 2015 update
- Shift to neutral for global equities vs. fixed income [for multi-asset portfolios]
- Underweight US given expensive equities and low bond yields
SYDNEY, 30 June, 2015 – Russell Investments' global team of investment strategists today released the 2015 Global Market Outlook – Q3 Update, offering a summary of economic insights and market forecasts that help to guide the firm's multi-asset portfolios and services. The perspectives focus in a large part on anticipation around two key looming events: timing of the initial interest rate increase by the US Federal Reserve (the Fed) and negotiations around the Greek bailout. The strategists expect the first rate hike in September-a long-held view- and for Greece to stay in the Eurozone, but acknowledge that uncertainty around these events could lead to market volatility, which they see as an opportunity to add selected risk exposure to portfolios.
To analyse the anticipated Fed rate hike, the strategists compare market conditions before the two previous hikes in February 1994 and June 2004 to current conditions. The standout feature, according to the report, is that equities, bonds and the US dollar (USD) are all relatively expensive now compared to the last two tightening phases, and the corporate profit cycle is far more advanced. However, since the upcoming rate hike, in their view, is one of the best communicated policy shifts on record, they believe the shift is already priced into the markets. After looking at these factors collectively, the team maintains their favoured US market scenario of moderate inflation, moderate jobs growth, and single-digit profit gains.
"It makes sense to expect volatility around the Fed policy shift, but a key question is whether any resulting market setback would represent a turning point or an inflection point," said Russell Investments's Global Head of Investment Strategy, Andrew Pease. "We believe an inflection point seems more likely, and for equity markets to remain supported over the medium term if the US economy continues to post moderate growth."
Regarding Australia and New Zealand specifically, Russell Investments' strategists see the 3% real GDP growth rates of recent years will be giving way to growth of around 2%.
"Our central case for Australia and New Zealand in 2015 has been that these economies are slowing, but not collapsing," said Graham Harman, Russell Investments' senior Asia-Pacific investment strategist.
Mr Harman added that at mid-year the risks are increasing to the downside for both economies. He points to inventory swings in China, which can jeopardise demand for imported raw materials and make Australian bulk commodity export volumes vulnerable, such as coal exports which already have stalled. His team identifies residential housing as a second important swing factor in Australia. While viewing it as strong for now, he expects to see a shift from 'up-cycle' to 'down-cycle' over the coming 12 months.
"We sound a slight note of caution for Asia-Pacific equity markets in coming quarters, but still like Japan as a recovery play and Australia for yield," Harman summarised.
Global outlook forecasts take contrarian signals into account
Russell Investments' strategists employ the firm's three-pronged "cycle, value, sentiment" investment strategy process to update their outlook forecasts. Currently, their global market perspectives include:
- Business Cycle: Optimism for developed markets
The cycle appears very positive for Europe and favourable for US and Japan. The economic indicators in Europe, for example, are improving, with potential growth of corporate profit margins. Regarding the US market, corporate profits maintain moderate growth, supported by robust—albeit spotty—economic growth. In Japan, economic indicators are lackluster, but corporate profits are picking up and there is a strong chance of additional stimulus from the Bank of Japan (BoJ). The cycle score for generally riskier emerging markets remains negative due to the strengthening of the US dollar, falling commodity prices and a slowdown in China.
- Valuation: US equities remain the most
The strategists view equities in Europe and Japan are moderately expensive, while they see emerging markets equities as moderately cheap. The US currently is still the most expensive major equity market, with a Shiller PE ratio at 27 times and price-to-book value at 2.9 times (according to the US large-cap Russell 1000® Index as at 24 June 2015).
- Sentiment: Momentum is a positive driven in most
Since markets have been relatively stable, the team points out that many of the overbought contrarian signals have moved to neutral territory. Except for Japan, where the market is solidly in overbought territory, momentum is a positive driver for equity markets.
Updated regional exposure forecasts favour Eurozone asset classes
Based on market shifts since the team’s Q2 update report in late March, the strategists have updated their forecasts across global regions and asset classes:
- North America: The team sees rationale for a modest underweight for US equities since valuations offset a favourable business cycle.
- Asia-Pacific: Evidence is starting to build around a reacceleration in Japan, but the strategists are neutral on Japanese equities, considering them a recovery play. They are cautious on regional equity markets, noting the anticipated economic drop in China, Australia and New Zealand.
- Eurozone: The team has an overweight position for Eurozone assets, including equities and bonds. Further Greece-related unrest is seen as a buying opportunity.
- Emerging Markets: The strategists are neutral on emerging market equities since the negative cycle score offsets the good valuation and positive sentiment.
- Currency: The USD is overvalued against major currencies and the near-term outlook is mixed. Further appreciation may be caused by further easing by the BoJ, heightened concerns with Greece, or a stall in European growth, but the USD declined the last two times the Fed started a rate hike sequence.
- Fixed Income: The strategists have a neutral stance on US government bonds and believe that 10-year US Treasury yields will rise to 3.1% in the next 12 months. They are slightly long Eurozone government bonds and underweight UK government bonds.
In summary, Pease said, "Most of the quantitative models have moved towards neutral over the past quarter, which aligns with our qualitative assessment. We don't expect the Fed decision will contain any nasty surprises. Thus, our strong conviction in moving to a neutral asset allocation stance for global equities versus fixed income."
For more information, please see the "Strategists’ 2015 Global Outlook – Q3 Update".
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