Russell Investments strategists’ outlook: Uncertainties around China and prospect of Fed tightening create an inflection point, not turning point, for global market outlook

— Continue high conviction overweight to eurozone; modest underweight to U.S. equities
— China experiencing a meaningful deceleration but ultimately a soft landing

SEATTLE, October 1, 2015

Russell Investments’ global team of investment strategists today released the 2015 Global Market Outlook – Q4 Update, offering a summary of the economic insights and market forecasts that help to guide the firm’s multi-asset portfolios and services. The outlook is dominated by uncertainties around China and the prospect of U.S. Federal Reserve tightening, and the strategists describe the markets as ‘struggling to find direction” to underscore the importance of separating ‘market noise from signal’. Volatility reached its highest level in four years in August when the Volatility Index (VIX) spiked to 40 as markets around the world pulled back, including 10% in the U.S., and around 15% in the U.K., Europe, Australia and Japan. However, the U.S. economy is viewed as robust and the strategists do not believe China will derail the global economy.

“The key question for investors now is whether the market turbulence is simply a retreat from overbought conditions or the beginning of a new bear market. Our view is the former,” said Russell Investments’ Global Head of Investment Strategy, Andrew Pease. “U.S. domestic growth is back on track and we don’t expect a recession any time soon. That said, Europe is still our most preferred equity market, followed by Japan, and we remain cautious on the U.S., U.K. and emerging markets.”

U.S. Federal Reserve still poised to hike rates later this year

The strategists continue to expect the Fed will begin to hike interest rates in December and they believe the pace of future interest rate hikes will be more important than the initial timing. This expectation is based largely on the fact that the U.S. economy is big enough, domestically-oriented enough and strong enough to shrug off downside risks from abroad. U.S gross domestic product (GDP) growth is forecast to stay in the 2.0% to 2.5% range, while a 2.8% 10-year U.S. Treasury yield is expected over the next 12 months.

The team is, however, watching two key developments from a market perceptive: The extent to which stock volatility ripples through the real economy and the sustainability of U.S. corporate earnings.

“We expect economic momentum in the U.S. to fade over the next 12 months to a more modest pace in the face of upward pressure on wages amidst the tightening labor market and an erosion of profit margins,” said Paul Eitelman, Russell Investments’ investment strategist, North America. “We maintain our underweight preference to the U.S. equity market in global portfolios because despite the recent market selloff, U.S. equities remain quite expensive.”

Managed slowdown in China

According to the report, the Chinese economy is decelerating but not collapsing. Real GDP growth in China decelerated in the first half of 2015 to its slowest rate since the end of the 2008 financial crisis, which stirred investor fears that Chinese weakness may undermine global growth.

The strategists see three key scenarios that could play out with the most likely one being that the Chinese economy will continue to decelerate, but policy instruments will forestall major financial distress and prevent a threat to global growth.

“A formidable array of policy instruments is being activated in China and we believe the Chinese economy continues to be an engine for world growth, expanding at a rate in excess of 6% per annum,” said Pease.

Strategy Outlook

Russell Investments’ strategists employ the firm’s three-pronged “cycle, value, sentiment” investment strategy process to update their forecasts. Currently, their global market perspectives include:

  • Business Cycle:
    • Moderately positive on the U.S. cycle, although views have been downgraded in light of modest earnings per share (EPS) growth prospects and the anticipated Fed tightening.
    • Continue to be favorable on Japan where EPS growth is relatively strong and there is potential for Bank of Japan policy support.
    • Strongest cycle view is for Europe, with the tailwinds of euro depreciation, credit growth and less fiscal austerity, along with the European Central Bank’s quantitative easing (QE), all supporting EPS growth.
    • The cycle is still negative for emerging markets amid U.S. dollar strength, falling commodity process and the economic slowdown in China.
  • Valuation:
    • The U.S market remains the most expensive among major developed markets.
    • The strategists view both Japanese and European equities as moderately expensive.
    • Emerging market equities are still considered moderately cheap.
  • Sentiment:
    • Momentum is now neutral across most equity markets and negative for the UK and emerging markets.
    • Contrarian indicator suggests that most markets are oversold following the declines in August and early September.

Updated regional exposure forecasts

Based on market shifts since the team’s Q3 update report in June, the strategists have updated their forecasts across global regions and asset classes:

  • North America: Continued modest underweight for U.S. equities given relatively expensive valuations which offset a modestly favorable macro backdrop.
  • Asia-Pacific: Broadly neutral on equity markets in this region which is “tracing out a somewhat downbeat economic growth path’ according to the report. That said, the team is warming to Asia-Pacific regional equity markets as prices fall and then settle at lower levels, but are not yet overweight on the region as a whole.
  • Eurozone: The team has maintained an overweight position to eurozone equities and peripheral bonds, while going neutral on core government bonds.
  • Emerging Markets: The team is underweight riskier emerging markets given cyclical weakness in China and believes more time needs to pass before weaker emerging market currencies as well as widespread cuts to official interest rates gain traction and efficacy.
  • Currency: Outlook for the U.S. dollar and pound sterling remains favorable, but less so that at the beginning of 2015. But an increase in the QE programs in Japan and the eurozone will most likely be a catalyst for a renewed period of U.S. dollar strength.
  • Fixed Income: U.S. government bonds are considered expensive and the team is underweight, while across the Atlantic, core government eurozone bonds have gone back to neutral after a third-quarter 2015 rally, but the team is maintaining an overweight position to peripheral eurozone bonds.

In summary, Pease said, “The volatility created by uncertainty over the Fed and China is unlikely to subside anytime soon. Our medium-term outlook for the U.S. and global economy is still positive though and global equities should deliver moderate returns. Markets are going through an inflection point rather than a turning point, and market pullbacks can be an opportunity to add more risk exposure to globally diversified multi-asset portfolios.”

For more information, please see the “Strategists’ 2015 Global Outlook – Q4 Update”.

About Russell Investments

Russell Investments is a global asset manager and one of only a few firms that offers actively managed multi-asset portfolios and services that include advice, investments and implementation. Russell Investments stands with institutional investors, financial advisors and individuals working with their advisors—using the firm’s core capabilities that extend across capital market insights, manager research, asset allocation, portfolio implementation and factor exposures to help each achieve their desired investment outcomes.

Russell Investments has more than $265 billion in assets under management (as of 6/30/2015) and works with more than 2,500 institutional clients, independent distribution partners and individual investors globally. As a consultant to some of the largest pools of capital in the world, Russell Investments has $2.4 trillion in assets under advisement (as of 12/31/2014). The firm has four decades of experience researching and selecting investment managers and meets annually with more than 2,200 managers around the world. Russell Investments also traded more than $1.7 trillion in 2014 through its implementation services business.

Headquartered in Seattle, Washington, Russell Investments operates globally, including through its offices in Seattle, New York, London, Paris, Amsterdam, Milan, Dubai, Sydney, Melbourne, Auckland, Singapore, Seoul, Tokyo, Beijing, Toronto, Chicago, Milwaukee and Edinburgh. For more information about how Russell Investments helps to improve financial security for people, visit russellinvestments.com or follow @Russell_Invest.

Contacts:
Steve Claiborne, 206.505.1858, or newsroom@russellinvestments.com
Davis MacMillan, 718-801-8862, or russell@neibartgroup.com

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