The tendency to set expectations for the future based on recent experience could partly explain why the bar for the U.S. economy is set so high. Investors have witnessed considerable (though sometimes uneven) improvement in U.S. economic and profit growth in the past two years, and they expect this to continue. Meanwhile, expectations for other major developed economies are quite downbeat: For example, Europe has been having a hard time regaining its economic footing. These expectations now serve as the deciding factor for market performance.
The United States Unable to Clear High Bar
While U.S. economic data continue to show decent growth, the pace is moderating. Although the labor market has surprised to the upside, most measures are coming in below expectations, delivering the most downside surprises to investors since last spring. Put simply, the United States is still doing well, just not as well as many had expected.
Europe, the Underdog
For Europe, on the other hand, data are surpassing very low expectations, helped in part by decreasing risks associated with Greece and Ukraine. The number of positive economic surprises has meaningfully increased, not just from the stronger economies, but also from the weaker periphery.
The Game Is Changing
To be sure, expectations are always shifting as economic conditions change, and more so now as the Federal Reserve (Fed) and European Central Bank (ECB) take increasingly divergent paths in monetary policy. While the ECB’s new bond purchases should boost investor enthusiasm and provide ample support to European stocks, the upcoming Fed rate hike could be problematic for U.S. stocks. Even though markets tend to recover, a tightening shift could bring about short-term declines and pronounced fluctuations.
Looking for Opportunities
This year so far, investors are moving out of U.S. stock markets and into international markets, which we still find attractively valued. In fixed income, although bond yields in some countries are negative, we expect long-term interest rates to rise this year and, therefore, prefer to look for higher yield in the market’s credit segments.