Key Asset Class Views
From a bottom-up perspective, equities are balancing a good macro environment with waning price momentum, mixed earnings sentiment and stretched valuations. This view is moderated by the significant policy response providing an additional tailwind. As such, we maintained a slight underweight to equities, but there is material dispersion at the regional level. The US is the top-ranked region supported by strong long-term momentum indicators and positive earnings and sales estimates, which offset weak valuations. The potential bottoming of PMIs, better risk appetite and a weakening US dollar bolster emerging markets. The forecast for Pacific equities ranks poorly, driven mainly by negative momentum and sentiment indicators for Japan. REITs rank poorly across all factors in our model. Higher financial leverage, greater volatility and weak long-term price momentum weigh on the outlook.
The negative outlook for government bonds is driven by our models, which continue to forecast an increase in interest rates and a steepening of the yield curve. We don’t anticipate that this move will happen significantly in the near term. There has been some positive near-term data, but the overall depressed level of activity suggests that short-term rates are likely anchored for some time. However, we do see pressure that could arise at the intermediate and longer ends of the curve, driven by a still positive spread between nominal GDP and the yield on 30-year treasuries and the pickup in economic activity evidenced by improving PMI readings. Further, longer-term rates could start to pick up as investors look past the abyss that will be reported for second quarter GDP and start thinking more seriously about inflation Lastly, the potential for yield-curve control and central bank bond buying may limit the extent of the threat posed by higher interest rates, keeping expected returns for government bonds subdued.
Gold continues to look attractive across most technical and fundamental factors we monitor, and we continue to hold an overweight position. Negative real yields, rising debt levels, creeping inflation expectations as well as firm technicals all support an allocation to the precious metal.
Credit valuations remain attractive as our models anticipate meaningful spread tightening for both investment grade and high yield. This is partially driven by a lower cost of capital given historically low interest rates and the prospect for a steepening yield curve as the economic backdrop improves. While momentum for equities weakened slightly, it remains supportive and, combined with relatively lower volatility, suggests a beneficial environment for high yield bonds going forward. Despite the potential for an increase in defaults, the Fed’s commitment to limiting downside risks in credit markets along with the recovery in the energy backdrop, support further spread tightening.