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  Asset Allocation Update February 2018

Substantial correction in equities

The US job market report published last Friday triggered a substantial correction on equity markets around the globe. What was going on? The climate of the past few months had been a positive one for equities, with growth gathering pace, low inflation and central banks able to tighten their monetary reins gradually. Yet the data coming out of the US suddenly showed a sharper increase in hourly wage rates than expected. This placed question marks against the Goldilocks scenario of improving growth and low inflation. Furthermore, equity markets had been through a very positive period: the upward trend in equities had accelerated further since the start of the year. This overly positive sentiment has now dissipated.

Business is booming

Our outlook for the economic cycle remains unchanged. The US job market report demonstrates once more that the economy is growing robustly and that January saw an increase in confidence among companies in the services sector in the US, the Eurozone, Japan and China. This picture is confirmed by the corporate results published over the final quarter of 2017. Many companies are reporting both higher earnings and revenue than had been forecast by analysts. The outlook for the coming years has also been adjusted sharply upwards, supported by the tax cuts in the US.

 

“There is certainly a risk of inflation rising too quickly, especially in the US.”

Inflation is getting going

And what about inflation? Inflation forecasts around the world are rising slowly but surely. This gives the central banks capacity to slowly start scaling back their highly expansionary monetary policies. After September this year, the ECB will quickly reduce the amount it purchases in bonds. In the US, the Fed is expected to raise interest rates three to four times and also reduce the number of bonds it holds that have been bought over the past few years. All in all, this translates into a fairly typical normalisation of policy. Yet there is certainly a risk of inflation rising too quickly, especially in the US. This is less of a risk in Europe for the time being as the job market is not as tight, but also thanks to the recent increase in the value of the euro.

Market outlook

Positive growth and earnings expectations and low bond yields mean that we continue to be positive about equities for the time being. US equities profited from the approved tax plans and a weaker US dollar, but valuations are starting to reach very high levels. We prefer European equities due to the lower valuations and greater capacity for an improvement in margins. We expect bond yields to rise in the Eurozone, but are positive about emerging market debt in local currency. The return of volatility also signals the return of opportunities in the market. A prompt response is essential.

 

Disclaimer
Kempen Capital Management N.V. (KCM) is licensed as a manager of various investment funds and to provide investment services and is subject to supervision by the Netherlands Authority for the Financial Markets. This information may not be construed as an offer and provides insufficient basis for an investment decision.

The Asset Allocation  Desk

Marius Bakker
Ivo Kuiper
Joost van Leenders

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