Chief Investment Strategist
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We continue to believe the best long-term returns in equities will be in emerging markets
The Citi Private Bank Global Investment Committee left its asset allocation unchanged at its meeting on 28 August 2017. Global Equities remain 2.0% overweight. Fixed Income remains 3.0% underweight, with cash and gold small overweight positions. The equity overweight is held in non-US markets where relative valuations are appealing, and depressed currencies are rebounding. US equities remain at a neutral (full) weighting as we continue to expect risk-adjusted returns to exceed those of most fixed income segments over the coming year.
Within our overall underweight position to global fixed income, emerging markets and US credit are overweights. Other developed market (DM) bond segments are substantially underweight given persistent, historically-low yields. As expected, global market volatility has risen somewhat amid seasonally-depressed summer trading volumes. Amid negative news on several fronts, including domestic politics, international trade and security issues, markets have been notably resilient. Leading indicators suggest a broadening out of world growth, with the strongest growth readings since early in the present recovery period. Most importantly, we see corporate profits as likely to post a low double-digit gain globally in 2017 with momentum for further gains in 2018.
At the same time, the US Federal Reserve continues to very gradually tighten monetary policy while other DM central banks phase out bond purchases and other easing steps. In the coming year, we expect a decreased flow of central bank bond purchases to generate a headwind that will slow market appreciation. However, global growth provides a larger income flow which can’t be ignored.
Given the significant strengthening of DM credit markets from central bank easing in recent years, we would expect more modest credit and equity market returns and somewhat higher levels of volatility. This follows a very strong 16% global equity return posted over the past 12 months (in USD). Those gains were catalyzed by rebounding growth after several feared shocks failed to materialize. China’s growth and capital flows have proven resilient in 2017 and the oil price has rebounded from a destabilizing level for key petrol debtors.
Since the Fed began its policy tightening cycle in December 2015, a key metric of long-term corporate yields has fallen 120 basis points. The US dollar has also depreciated somewhat while equities have risen solidly. Inflation rates below central bank targets give them significant flexibility to tighten in a very gradual manner. However, monetary policy continues to show a potent impact on markets. The euro has risen more than 12% in the year-to-date versus the USD largely in a reaction to a likely tapering of bond purchases by the European Central Bank. Thus far, with growth in the region firm, this notably benefited euro equities measured in USD.
The GIC continues to believe the best long-term return opportunities in public markets will be seen in emerging markets. This is because of the 2011-2016 period in which performance lagged behind DMs in equities, fixed income, and often currencies. Fundamentals were challenged by the USD rise, misplaced concerns over US rates, and commodity weakness.
The correlation between EM equities and US equities is lower than other DM equities, adding to diversification appeal. However, the correlation is still positive, and notably high compared to low risk fixed income. After a sharp rise in 2017, corrections in EM assets could materialize alongside or apart from DM. If this occurs, the GIC would likely further shift allocations in the direction of EM.