The theme of central bank policy being a core driver of asset price moves and investor sentiment has been a key feature of the post-financial crisis world.
This remains the case this month as investors digest an interest rate cut and an extension in the use of quantitative easing by the European Central Bank (ECB), not to mention today’s potential interest rate rise in the United States.
The package announced by the ECB may have underwhelmed investors but does mean continued bond buying for another 15 months at least, and negative interest rates for some time yet. This contrasts with the US, which looks set to raise rates this week. Europe has lagged the US in the aftermath of the financial crisis in several areas: its banks have not cleared up their balance sheets, its politicians have failed to engage in meaningful economic reforms, and its central bank was very late to the party.
The economic outlook for Europe now looks reasonably positive but its recovery still has a long way to go. Europe also trails the US in bringing unemployment down and raising inflation. Meanwhile, the US has seen unemployment fall to a level that is finally feeding through to higher wages and while its economic data remains unexciting, it is strong enough for the Federal Reserve to justify raising rates.
The contrast between a tightening Fed and loosening ECB will certainly provide an interesting backdrop for markets and assets going into the new year. Our views remain broadly optimistic on the outlook for economic growth globally.
However, given the relative performance of US equities in recent years, we think returns elsewhere will be stronger on a relative basis and as such we are underweight. We remain underweight the UK too, where we think growth looks reasonable, but again there are more attractive opportunities elsewhere, such as in continental Europe, which has both improving earnings and a more dovish central bank supporting risk assets.
We continue to be overweight Japan given its improving corporate and consumer backdrop, despite its economy falling back into recession. We are also overweight Asia, where we feel the stabilisation in Chinese economic data will have a positive impact on a region where valuations remain relatively good value. We are neutral on emerging markets where there is clearly a lot of value on offer, though stock and country selection remains important.
Fixed income remains an underweight, as we feel the risk-reward payoff is not favourable given valuations, not least in an environment where interest rates and inflation are likely to move higher over the next 12 months.
Geopolitical risks and tensions will remain elevated and this is potentially not a great backdrop for risk assets. This comes on top of more troubling signs in bond markets as spreads widen and defaults attract more attention.
Overall, we still think we can make some progress but markets will likely see further volatility, given ongoing fragility in investor sentiment. We are positive but cognisant that in a world where growth remains muted, investors should not be too expectant over the absolute levels of market returns.
Rob Burdett is co-head of F&C Multi-Manager
