Voya Multi-Asset Perspectives - October 2017
After a rough August, global equity markets came roaring back in September. The biggest gainers were in the United States, where small cap stocks rose 7.7%. The S&P 500 gained 2.1% and developed international equities powered ahead, gaining 2.5%. Emerging market equities fell 0.4%.
It was the first in many months that the U.S. seemed to be on its front foot. From an economic standpoint, some modest improvement in the inflation data illustrated that the relationship between a tightening labor market and inflation has varied lead and lag times. There was some movement from a policy perspective as well. In an effort to show bipartisan support, President Trump reached across the aisle to Democratic Congressional leaders to lift the debt ceiling until early December. Recognition of such a bold move was at the center of the strong rally in equities.
The trade-weighted U.S. dollar had a countertrend rally, gaining 0.86%. It was a big move for the currency, which has been on a steady decline for most of the year. We expect the dollar to continue its strength for a while longer; as the Republican-led initiative to cut taxes, with a focus on the U.S. corporate tax rate, will generate demand for the greenback.
We continue to view the credit markets as fully priced. U.S. high yield spreads are near their lowest levels in nearly a decade. With U.S. bond yields likely to push at least modestly higher, current high yield spread levels leave little compensation for investors. Leveraged loans have more flexibility due to their floating-rate coupons. Most of the recent issuance has come from refinancing activity, which puts the loan market in a classic low-supply, high-demand environment.
For the rest of the year we expect equities handily to outperform fixed income. We remain constructive and positioned accordingly.
We have had a positive view on risk assets for all of 2017 and still think that equities can grind higher into the end of the year. Profits and policy are at the center of our view. Let’s take each in turn. Regarding profits, our lead indicator for U.S. earnings is projecting high, single-digit growth for the next 12 months. We think an important factor is very low unit labor costs. Wages remain contained, giving companies flexibility and opportunities to deploy cash toward growth initiatives; and result in less pressure on margins. In our view, this is a powerful driver that is likely to extend this cycle and has not been incorporated fully into asset prices. Despite earnings growth in Q2, companies that beat expectations were not rewarded with near-term lifts in share price. We suspect it was because of other worries and defensive positioning among institutional investors, but it’s worth monitoring during the upcoming earnings season. Current projections for 3Q U.S. earnings are 5.4%, quite achievable in our opinion.
From a policy perspective there is a lot on the table. Tax policy is a focus point for us: we have kept our expectations low, knowing that reducing taxes may require a Herculean effort in Washington. The administration’s recent pivoting, however, to reach across the aisle to Democrats, gives tax legislation at least a marginally higher chance of success. We also are focused on monetary policy. We have long believed the Federal Reserve at least would be true to its projections for this year and raise interest rates three times. Financial markets have moved slowly to align with our view, which was central to our maintaining an underweight duration posture for 2017. While it was an early call, it is starting to materialize as rates are moving higher. How high rates will go may depend on two factors: whether there is an increase in the deficit to finance tax cuts and the outlook on wage growth and inflation. We think the equity market can digest a rise to about 2.6%, but may struggle beyond that level. We would need to see more meaningful upside to growth expectations to be able to withstand rates at 3% in the near term.
Our strategy is to focus on asset classes and parts of the global equity market that are cyclically geared to growth, namely the emerging markets, U.S. small caps and equities generally. Emerging markets have been strong performers all year and we expect them to continue to move higher. After having underperformed the developed world for the better part of 2011–2015, they are catching up. While the rest of the world is focused on tightening monetary policy, the big EM countries have enough slack to ease or at least maintain their current, loose policy stances. Our view of U.S. small caps is that they should benefit from continued U.S. economic expansion. Many of those companies are at the highest effective tax rate and would benefit from any reduction in corporate taxes. During the month we also rotated our international equity position toward Japan. It is the only major equity market to have had falling price/earnings multiples this year. We also think the yen has probably concluded its strengthening in 2017 and will now be a tailwind for profitability. The snap election may be the turning point for Japanese stocks this year.
Multi-Asset Strategies and Solutions Team
Voya Investment Management’s Multi-Asset Strategies and Solutions (MASS) team manages the firm’s suite of multi-asset solutions designed to help investors achieve their long term objectives. The team consists of 25 investment professionals who have deep expertise in asset allocation, manager selection and research, quantitative research, portfolio implementation and actuarial sciences. Within MASS, the Asset Allocation team, led by Barbara Reinhard, is responsible for constructing strategic asset allocations based on its long-term views. The team also employs a tactical asset allocation approach, driven by market fundamentals, valuation and sentiment, which is designed to capture market anomalies and reduce portfolio risk.
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