Economic data in October revealed improvements in the US, UK and China but a surprisingly large downturn in Japan. Read more here.
Against this backdrop, investment strategist Andy Brunner outlines Morningstar OBSR's latest asset allocation views below.
Equities
The global economy appears to have subsided into a period of sub-par growth with little prospect of a return to above trend even over the medium term. Equity risks remain high and near term worries over the “fiscal cliff” will likely increase volatility. Even so, economic and financial trends are resulting in coordinated policy responses from governments and central banks that should gradually encourage investors to rebuild equity weights in portfolios and, therefore, we retain a slight long term overweight position. Tactically, we remain overweight the EU, UK and Emerging Markets. The suggested strategy for long-term investment in a low growth/low inflation world, where earnings growth will be at a premium, is to buy exposure to growth markets irrespective of sector, focusing on quality companies with healthy balance sheets and strong cash flow. Income will also be sought in a low interest rate world and higher yielding stocks with rising dividends also remain preferred.
Bonds
The magnitude of the decline in main market government bondyields was driven by fear and financial repression rather than normal fundamental valuation, with yield levels justifiable to those investors only caring about return of capital rather than return on capital. This has been the case for some time and, although yields look set to remain at low-ish levels, the trend is now upward. Investment grade corporates offer better value with spreads likely to continue to narrow. Even so, yields are at or close to all-time lows and, with the probability of rising government yields, some capital loss may well offset the pick-up in income. Investors should still consider riskier UK and US credits and Emerging Market debt in portfolios.
UK Commercial Property
The recent deceleration in the pace of decline in UK commercial property values is welcome news, albeit principally driven by another upturn in Central London office values. While the outlook for next year remains unclear, given that secondary property yields may continue to widen, growing investor interest should limit the downside and indeed a number of commentators now forecast capital value gains. Together with a near-7% yield and record yield gaps relative to bonds and cash, property could prove increasingly attractive to yield-starved investors.
Commodities
A global economic background of ongoing low growth and, in particular, the rebalancing of the Chinese economy (towards consumption with a consequent significantly lower trend growth rate) presents a more difficult medium term backdrop for many commodity producers. This represents a departure from the structural bull market witnessed during the last decade and will lower potential returns until capacity tightens again. Quantitative Easing has failed to weaken the dollar and failed to sustainably reinvigorate either industrial or precious metals, and most markets look set to tread water, indeed much as the commodity composite has done for the past two years, albeit in volatile fashion.
Currencies
Currencies remain extremely difficult to predict but, with EU “tail risk” having subsided, volatility has decreased somewhat. Of the major crosses, the yen still appears overvalued and sterling overbought while the euro and dollar are currently relatively stable. All this could change, however, on the outcome of the “fiscal cliff” negotiations and/or should EU sovereign debt issues resurface. It is interesting to note that most of the major crosses are now fairly close to estimates of long term “fair value”. With regard to the longer term, Asian/Emerging Market currencies are the preferred choice as most remain undervalued versus the dollar.
