Executive summary

U.S. equities continue to post record highs as the economy disappoints and bond yields decline. We’re cautious about the rally, and we maintain our "buy the dips and sell the rallies" mindset.

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Venus & Mars

Bond investors are from Mars and equity investors are from Venus, or at least that’s what their current behavior suggests. The unbridled optimism of record highs in the U.S. equity markets is in stark contrast to the somber mood depicted by low and declining Treasury yields.

The two will eventually reconcile, but it’s possible that these contradictory views will persist for a while longer. Our cycle, value and sentiment investment process has us skeptical about U.S. equity market optimism, but it also acknowledges that momentum can push markets beyond fundamentals for an uncomfortably long time.

We’re still seeing a resilient but mediocre U.S. economy and better growth prospects in the rest of the world, most notably Europe.

Paul Eitelman warned last quarter that U.S. growth was likely to disappoint, and the data flow has supported his judgment. He expects inflation to stay low and prevent the U.S. Federal Reserve from raising the Fed funds rate again this year. Expensive valuation and a lackluster economy underpin Paul’s recommendation for remaining underweight U.S. equities.

By contrast, Wouter Sturkenboom thinks the good news in Europe can continue. Europe is in a sweet spot of robust growth, low inflation and strong corporate earnings. Political risk is also easing, following the election of Emmanuel Macron in France. Next year’s Italian election is the main cloud on the horizon. A win by the centrist Matteo Renzi would cement Europe’s political renaissance.

Graham Harman and Alex Cousley see a mixed, but mainly positive, outlook across the Asia-Pacific region. Japan is benefiting from strong exports, and there are the first signs of an inflation uptick. China’s economy remains robust ahead of the five-yearly meeting of the National Congress later this year. Australia and New Zealand remain lackluster.

The lifting of political risk has made Van Luu more constructive on the outlook for the euro. Van thinks the U.S. dollar has peaked in this cycle and that there is some upside for the undervalued Japanese yen. Brexit uncertainty and the political instability caused by the minority government in the UK should keep the British pound in a 1.20-1.30 range.

The models estimated by Kara Ng and Abe Robison are largely unchanged from the previous quarter. The U.S. business cycle index model continues to show low recession probabilities. Their models for U.S. equities versus fixed income remain firmly in the neutral zone.

We’re more inclined to side with the bond market than the equity market at this late stage of the cycle. As we look ahead to the second half of 2017, like Paul McCartney’s lyrics, we’re sitting in the stand waiting for the show to begin when Venus and Mars align again.

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