Voya Multi-Asset Perspectives - July 2017
The global equity markets were led by the United States at +0.6% and emerging markets at +1.0% during the month of June. Small- and mid-cap equities outperformed large cap equities in the U.S., while value equities outperformed growth for the first time since December of last year, due to the technology sector sell-off. Developed markets excluding the U.S. were mixed, with Europe and the UK lower and Japan +1.0%. High yield credit outpaced U.S. Treasurys slightly, as credit spreads were virtually unchanged while 10-year Treasury yields rose for the month.
Domestic economic releases for June continued their goldilocks, not too hot not too cold, trend. Strong U.S. employment and payroll numbers imply a labor market that is tightening, but the transmission to faster wage growth has been elusive. Most measures of wage pressures are hovering around 2.2%. That is good for corporate profits as salaries are a big part of operating expenses, however, lack of wage pressures cannot persist indefinitely and will eventually bubble up.
The FOMC, as expected, raised interest rates 0.25% at the June meeting and reaffirmed its commitment to gradually hiking rates as the labor market strengthens, while also conveying that the balance sheet reduction process could commence by year-end. The minutes for the June FOMC meeting revealed that participants are still divided as to when to start the unwinding. Internationally, comments out of the Bank of England and European Central Bank pointed toward the possibility of removing various forms of monetary stimulus, and signal an important inflection point, with three of four major central banks on their way to removing accommodation. Sovereign yields jumped, with 10-year U.S. Treasury yields moving back toward 2.35% and German 10-year Bund yields trading over 0.50% for the first time in 18 months.
The big question that has been on market participants’ minds has been where is the U.S. in the business and economic cycle. It matters greatly for positioning, especially among asset allocators who have to make the equity to fixed income investment decision. In our mind, the U.S. is squarely late cycle with the Federal Reserve tightening monetary policy and unemployment rates falling to new lows. The rest of the world is further behind the U.S. with more slack still to be absorbed, but central banks are just starting to talk about adjusting monetary policy to match underlying economic strength. To be sure, late cycle is not necessarily bad for equities, especially when monetary policy is being renormalized from an extremely accommodative stance.
What gives us confidence that late cycle will not turn into a recession in short order? Data we look at closely to help make that determination are corporate earnings, financial conditions and benign inflation. All are at center of this investment view, let’s take each in turn.
It is now just a bit over a year, 1Q16 to be exact, since the earnings recession ended. We are expecting full year earnings growth of 9% and sales growth of 5%. Our Voya earnings lead indicator gives us mid-single digit earnings growth over the course of the next year. Financial conditions (Figure 1) are a weighted average of policy rate, long-term bond yields, credit spreads, equity price variable and trade-weighted exchange rates. Four out of five of these components are easier on a year-on-year basis in the U.S., which underpins our view that the Federal Reserve is indeed tightening into an economic growth scenario, not into a slowing scenario. Lastly, we focus on inflation. After three consecutive declining inflation readings from February through May, we have enough data to extrapolate that inflation is likely to be relatively benign for at least for the next three quarters, at least until some of these transitory price declines in wireless plans and other factors roll out of the calculation. We can see this in the breakeven inflation rates (Figure 2), which stopped falling in June. In our opinion, benign inflation coupled with relatively subdued wages helps corporate profit margins and works to elongate the cycle. We are watching these factors closely, as it may just be we are in the early innings of the late cycle.
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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