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Emerging markets growth will drive equities’ returns

Steven Wieting

By Steven Wieting

Chief Investment Strategist

October 24, 2017Posted InInvestments, Equities and Investment Strategy

The Citi Private Bank Global Investment Committee left its asset allocation unchanged at its meeting on 19 October 2017. Global Equities remain 2.0% overweight. Global Fixed Income remains 3.0% underweight, with cash and gold small overweight positions.

Our overweight position in equities remains entirely concentrated in emerging markets (EM) and select developed markets (DM) such as the Eurozone. North Asia likely offers the strongest equity return opportunities regionally within EM.

We remain neutral (fully allocated) to US equities. This reflects rising corporate profits and our expectation of profit gains in both the US and international markets in 2018. It also reflects the near record valuation discount of non-US markets to the US.

Early in the present recovery, markets appeared to fear “global contagion” on any local risk. Today, most negatives fail to derail even assets in close proximity. As such, the ability to positively surprise financial markets will be more difficult in the coming year amid higher growth expectations. This suggests solid, but less dramatic asset market gains than seen in the past year.

Our asset allocation anticipates a “catch-up” performance for non-US equities over the next several years. In the nearer-term, US-centered assets may outperform as markets have raised expectations for US tax cuts and Federal Reserve rate hikes. This has predictably meant a partial rebound in the USD and a stronger performance for domestic-focused US equities. It has also meant that performance has tilted somewhat toward more highly-valued assets (when looked at regionally.)

Global markets face a near-term challenge as President Trump is expected to select a new Fed Chair this month. With stark choices between continuity and dramatic change on the table, foreign exchange markets may be posed to exaggerate the practical impact of the choice.

Two candidates reportedly in the running for Fed Chair would appear to support a break from recent Fed policy. Their appointment would likely accelerate the expected rate hike path and cause a brief spike in market volatility. Two others would suggest continuity with the current benign and predictable US monetary policy outlook.

Despite the risk of a short run over-reaction of markets to a changing of the guard at the Fed, in fixed income, EM and US credit remain far more competitively valued globally than European and Japanese bonds. We continue to overweight both US investment grade and US high yield debt within a global fixed income allocation that is underweight overall.

Investors may see greater benefits from hedges and alpha-seeking strategies after large gains in broad equity indices and a decline to historic lows in implied volatility. With many local risks - such as Brexit implementation in the UK, NAFTA negotiations, and looming elections in 2018 in some Latin American countries - we believe well diversified global portfolios will better serve investors than regionally concentrated portfolios.

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