The recent political crisis in Italy has come and gone, but trade wars appear here to stay. U.S. growth leadership will fade in our view as Europe and Japan improve. China is resilient and the U.S. dollar rally is running out of steam.
The dual headwinds of Italian political volatility and escalating trade-war fears have not stopped equity markets from staging a choppy rebound from their March 2018 lows. The U.S. 10-year Treasury yield has found stiff resistance to moving above 3% and the strengthening U.S. dollar has put pressure on emerging markets asset classes.
Our cycle, value and sentiment decision-making process holds us at a broadly neutral weighting on global equities. We have a small preference for Europe, Japan and emerging markets over the U.S., and expect that the U.S. 10-year Treasury yield has limited upside. We see the U.S. dollar bounce as having run its course.
Paul Eitelman thinks the U.S. economy can continue with above-trend growth through mid-2019. However, U.S. Federal Reserve (Fed) policies appear on track to invert the yield curve by the end of 2018. Given the usual lags, we believe this means an elevated risk of recession by the end of 2019 and through 2020.
Wouter Sturkenboom acknowledges that economic growth in Europe has cooled, but thinks it is still above trend and that corporate earnings are growing at a healthy pace. Wouter rates the threats to global trade and Brexit as bigger dangers for Europe than Italian politics.
Graham Harman and Alex Cousley remain positive on the Asia-Pacific outlook. Fears of a significant China slowdown in their view are overdone, and the rest of developing Asia has shown good resilience to the rising U.S. dollar. Japan is more mixed, with weak consumer data offsetting strong corporate indicators. Rising real wages, however, should see the household sector recover.
Van Luu and Max Stainton see the bounce in the U.S. dollar since mid-April as mostly technical and not the start of a structural dollar bull market. They see signs at mid-year 2018 that the dollar rally is running out of steam.
The U.S. business cycle index model estimated by Kara Ng and Abe Robison points to relatively low recession risk over the next 12 months. Their model for U.S. equities versus fixed income has bounced back at mid-year to a small pro-equities bias after last quarter’s neutral reading.
Finally, we dedicate this edition of the quarterly outlook to our colleague, Steve Wood, who died June 5. Steve advised, guided and supported the investment strategist team. His energy and relentless optimism were inspirational. We will miss him.