Despite a very strong Q2 earnings season, equity markets halted their march higher in August, amid renewed geopolitical tensions.
Meanwhile, the economic cycle is sound and synchronized at a global level. In the US, there are no signs of imminent recession, even though we are probably reaching the late stage of the business cycle, while Europe is enjoying strong and widespread growth, which has surprised on the upside.
If the appreciation of the Euro remains limited, as we believe, it should not derail positive economic and earnings momentum. The subdued global inflation outlook, confirmed by July figures both in the US and Eurozone, is enabling Central Banks to hold back from any aggressive moves in terms of both interest rates and balance sheet normalisation.
Also in Emerging Markets (EM), the fundamental backdrop remains supportive. In this scenario, we believe investors should continue to maintain a moderate risk-on stance, with an increasingly selective approach as valuations become tight in some areas of the market. Risk allocation should therefore favour equity versus credit, with a focus on areas of the market which still retain a valuation gap.
However, we believe hedging strategies continue to be appropriate to try to manage risks. Over a longer investment horizon (12-24 months), we believe investors may face an asymmetric portfolio payoff. Upside (gains) could be limited (due to market performance and high valuations), while the probability of downside (losses) may increase in line with a natural deceleration of the US economy, the shifts in monetary policy and geopolitical risks.
Therefore, we believe investors will need to be ready to reduce risk should this shift in economic and market conditions start to materialise, while also continuing to focus on the still unrewarded market opportunities.
High Conviction Ideas
Multi-Asset: we are increasing the focus on hedging due to a resurgence of geopolitical risk and currency swings. The preference for equities is still our highest conviction asset allocation idea, reflecting the view of a gradual shift from an asset reflation phase (ultra-accommodative Central Banks) towards a late cycle phase in 2018 (more restrictive in terms of monetary policy and with increasing inflation). We maintain a neutral view on credit markets (still valuable from an income perspective) and a negative bias on government bonds.
Fixed Income: we still maintain a moderate short duration bias. We do not see the risk of a rapid acceleration of growth and inflation in the coming months, but we believe that the current level of government bond yields underestimate the shift in Central Bank policy in both the Eurozone and US. Inflation linkers are also attractive, as they discount inflation forecasts that are too conservative, as are floating rate notes. In fixed income, we continue to favour credit in developed markets, but with an increasing focus on credit quality and liquidity, as valuations have become stretched across the board.
Equities: the equity outlook is still constructive, driven by earnings growth and the positive economic backdrop. We do not see broad risk due to current valuations, but markets can be vulnerable to any disappointing news, in an absence of a strong positive catalysts. As the business cycle is aging, especially in the US, a selective approach, with more focus on value, is favoured.
Real Assets: we continue to see opportunities in the real asset space to play the gentle reflation scenario. Real estate and infrastructure will continue to be attractive for hedging purpose against inflation, in our view.
Pascal Blanqué – Group Chief Investment Officer – Amundi
Vincent Mortier – Deputy Group Chief Investment Officer – Amundi