Upbeat on growth assets

After October’s turmoil, outlook improves for equities, even in China. By Michael Strobaek

Volatility in equity markets has come off its October highs but remains elevated. With the US midterm elections over, the focus is back on December meeting of the US Federal Reserve, the G20 summit and the fate of the Brexit deal as sources of market fluctuations.

Solid growth and steadily rising inflation in the US and euro zone should further encourage central banks to tighten policy. The possibility of an imminent recession in the US that would end the expansionary cycle remains low: labour market conditions are strong and corporate balance sheets remain healthy overall.

In the US-China trade dispute, a shortterm deal to freeze tariffs could be reached. We therefore recommend staying the course, sticking to a small equity overweight position in portfolios and a neutral overall fixed-income view.

China opportunities: Undemanding valuations in emerging market (EM) equities, particularly Chinese equities, in our view offer opportunities for investors whose exposure to Asia is low. Relative to earnings, Chinese stocks have de-rated to the same extent as Turkish equities.

Whereas the Turkish economy is in the grip of a recession as a result of the currency and financial turmoil earlier this year, China’s economic policy is being loosened and the economy is growing steadily.

US infrastructure supertrend: A split US Congress may limit legislative successes, but infrastructure investment plans are likely to be one of the few areas to enjoy bipartisan support. According to the G20, the global infrastructure gap is estimated to reach US$15 trillion by 2040.

In our view, key beneficiaries are engineering and construction companies, utilities with a growing share of renewable energy, companies that help improve housing affordability and companies that provide 5G network equipment and data-centre capacity.

Reducing exposure to investment grade credits: Investment grade (IG) credit spreads have remained tight, insufficiently compensating investors for deteriorating fundamentals, rising downgrade risks and unfavourable supply and demand.

While IG-rated corporate issuers have increased debt in order to finance capital expenditure, M&A activity and buybacks, IG bond-buying has been weakening. High currency hedging costs are deterring foreign buyers of US investment-grade credits, while central banks will no longer provide the same support as in the past as they wind down their asset purchase programmes.

Dollar well supported, sterling undervalued: The US dollar remains supported by solid economic data and comparatively high yields. Our view on the euro versus the dollar and the Swiss franc stays neutral.

We remain positive on the undervalued pound versus the dollar, as the UK economy is now expected to get a fiscal boost next year. This has led the Bank of England to provide a more hawkish outlook in the event of the Brexit deal passing.

We also remain positive on EM foreign exchange as the currency basket remains fundamentally undervalued and the macro picture remains solid. Increasingly hawkish central banks should support carry trade opportunities further.

Investment grade credit spreads have remained tight, insufficiently compensating investors for deteriorating fundamentals.