Global Market Perspective - Q2 2019

Risk assets rebounded sharply in the first quarter with US equities recording one of their best first quarter gains on record. Strong performances were also registered by China A-shares, which was the best performer during the period, and from Europe where the Italian market stood out.

Part of this can be attributed to a rebound from the significant collapse at the end of last year which left equity markets oversold. However, the key driver was a pivot in monetary policy led by the US Federal Reserve which signalled an end to interest rate hikes and an earlier-than-expected stabilisation of its balance sheet.

This spurred a rally in sovereign bond markets with yields falling as investors priced in looser monetary policy. The fall in yields combined with the increase in risk appetite supported a strong rally in credit markets and underpinned the recovery in equity.

Our asset allocation strategy has focused on adding duration and risk through carry trades to benefit from the looser monetary environment at a time when growth expectations are still weak. This is primarily reflected in a significant shift from underweight to overweight in high yield and European investment grade credit.

We have trimmed equities to neutral, but remain overweight emerging markets where valuations are attractive and the region should benefit from a firming in commodity prices and an eventual softening in the dollar.

Investors are currently very focused on the inversion of the US Treasury curve which has been a reliable indicator of recession in the past. We wrote on this at the end of last year (see Global Market Perspective Q4 2018 here) where we showed that equities can continue to perform after a curve inversion as interest rate expectations ease.

However, ultimately recessions are not good for risk assets and we highlight what our economic forecasts and scenarios imply for profits over the next two years. In allocating risk, investors will need to balance policy easing against lower corporate earnings expectations.

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