Our core view is that the global economic recovery has further to run even though monetary policy is slowly normalizing and some economies are close to full capacity. Accordingly, we are overweight equities (expecting earnings to continue to be healthy) and underweight government bonds (expecting yields to continue to rise) and underweight credit (which we see as expensive and a diversifying position to equities). We see the pro-risk environment continuing albeit with some headwinds that will limit returns.
Within equities, we have a clear preference towards U.S. equities, expecting recent strong earnings and the success of leading firms to continue. In the international landscape we have a neutral view with a favorable disposition towards Japanese equities due to the continued easing of Japanese monetary policy and growth in employment and wages with low inflation.
The outlook for European equities is less positive due to the continued disappointing economic growth profile and geopolitical risks overhanging the Eurozone. We also underweight the UK based on Brexit and general political uncertainty; our expectation of a strong GBP will also weigh on UK stocks.
Emerging markets ex-China are a mixed bag in the short term but still represent a long-term structural opportunity for investment, fueled by a few bright spots such as India. The view towards Chinese equities is neutral on the basis of the negative impact of the ongoing entanglement with the current U.S. administration on trade and other issues.
For Canadian equities, we remain cautious with a neutral view. While a positive resolution of NAFTA is good for sentiment, Canada faces competitive challenges in addition to a significant household-debt overhang. The absence of a fiscal response to recent US corporate tax cuts makes Canadian equities less attractive when compared with the U.S.
Across market sectors we prefer financials which will receive a boost in profitability with rising interest rates. Technology shares will also continue to benefit from the solidifying of their market positions in an era of unprecedented disruption.
We are underweight government bonds across the board with the exception of Italy. While we expect the European project will face further challenges, we believe this will ultimately result in structural reform, and therefore see Italian bonds (that have priced in some euro break-up risk and concerns around the budget deficit) as attractive. It will, however be a bumpy ride and exposure to Italian bonds should be limited and adjusted on a tactical basis.
We think credit spreads are too tight and are underweight in both developed and emerging markets. In our view, corporate risk is best taken in equities while credit is inferior to government bonds as a hedge against recession risk.
Within currencies, we prefer the USD on rising yields and better growth, and GBP which we see as priced for a reasonably hard Brexit outcome, suggesting room for strong performance in a more moderate scenario as the Bank of England raises interest rates. While the yen is cheap on very long-term metrics such as purchasing power parity (PPP) we see no reason why JPY should perform well when policy is not expected to materially tighten. Japanese investors continue to look abroad for investment opportunities and interest rates in other developed economies are headed higher.
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