Global Reflation Provides Boost for Equities says Queen's Bank

Coutts Bank explains risk assets have benefited from higher levels of inflation, but warns that good value opportunities are getting harder to find

Coutts 18 July, 2017 | 2:16PM

Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Coutts Bank shares its views on global growth and equity expectations.

The normalising global economic environment, with growth picking up and interest rates rising, has been positive for risk assets and has pushed equity and credit valuations up. We believe this benign environment will continue for a while but are watching closely for signs of slowdown.

Reflation implies that growth and inflation should normalise from their low mid-2016 levels, followed by central bank normalisation. This environment is typically positive for risky assets such as equities, in particular information technology and financials, and high yield bonds. We expect this trend, which started in the US, to persist in the medium term and become more prominent in Europe.

However, valuations across equity markets have become even more extended and some economic and credit indicators indicate we are nearing the end of the business cycle. Hence, we remain cautious by having a small equity overweight only and prefer relative value opportunities. We also like alternative investments as they typically provide good diversification, downside protection and attractive risk-adjusted returns.

Equities Outlook

Despite expensive valuations, the economic environment remains supportive for equities. We remain slightly overweight on the back of the positive macroeconomic backdrop and receding political risks. We are cautious however, and favour relative value within the asset class.

For example, we continue to prefer European and emerging market equities over the US, as markets are cheap and the cyclical backdrop looks more favourable. After six years of disappointing economic growth and underperformance of developed markets, emerging markets equities now look much cheaper. They should re-rate if relative GDP growth and earnings per share improve, as predicted by analysts.

European equity is cheap relative to the US and the fundamental outlook is positive. Economic growth and earnings growth have picked up in Europe over the last year. With political risks easing, international investors who abandoned Europe in 2016 are now purchasing European assets again.

Healthcare and Technology Outperform

The pharmaceuticals and healthcare sector has performed well since the US election. It combines attractive valuations with a positive fundamental outlook. After the uncertainty prior to last year’s US presidential election the sector has stabilised, but investors remain under-invested.

Earnings and sales are improving steadily. Valuations remain cheap by long-term standards – traditionally this sector trades at a premium to the S&P 500.

Technology is one of the best performing sectors so far in 2017 boosted by healthy earnings. Latest earnings results confirm the strong underlying growth trend as many technology companies continue to surpass earnings forecasts. The “disruption” of economic activities via new technology remains a long-term investment theme.

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