JULY 2017

Midyear Outlook
Implementation Guide


The global expansion is chugging along, with an improved eurozone outlook in particular; deflation fears and near-term political risks look to have faded; and financial market volatility is subdued. This may provide a fertile ground for further modest gains in risk assets
such as equities.

Market views

We prefer equities over fixed income, and credit over government bonds. In equities we generally prefer European, Japanese and emerging market (EM) stocks over their more expensive U.S. counterparts. We see room for the momentum style factor — including technology shares — to outperform further, albeit with potential for swift reversals. We also like selected value shares and financials. In fixed income, we like higher-quality credit and generally prefer inflation-linked bonds over nominal ones. We also see potential opportunities in selected EM debt and income assets.

Key themes

1 Sustained expansion: The current U.S. economic cycle has been unusually long, sparking market fears that it is ready to die of old age. We have a different take, and believe the U.S. expansion’s remaining lifespan can be measured in years, not quarters.
2 Rethinking risk: Financial market volatility has been low, but that does not necessarily mean markets are complacent. We see the probability of a volatility regime shift as low – as long as the economy remains stable and systemic financial vulnerabilities are kept in check. Result: Many investors may be under-risked.
3 Rethinking returns: Structurally lower growth and interest rates force a rethink of asset valuations. Historically low government bond yields could be here to stay, and although worrying about equity valuations -- particularly in the U.S. -- has become a favorite pastime, we believe equities may be cheaper than they look in a low-rate world.

Flows: A European tale

We believe analysis of exchange-traded product (ETP) flows can provide insights into how investors might be positioned for the quarter ahead. The central narrative of the first half of 2017 was focused on flows into European equity ETPs with more than $28 billion invested in European equity ETPs this year.*

European equity buying does not appear to have been funded by selling down U.S. equity positions, however. Globally, more than $86 billion has flowed into U.S. equity ETPs in 2017. At the same point last year, $11.6 billion had flowed into the same exposures globally. More likely is the European equity flows this year are evidence of the $34 billion 2016 European equity ETP global outflow returning – assets which may have been sitting in cash. Initially, it was European-based investors doing most of the buying, but as political risks rolled off – particularly the French election – many U.S. investors started buying the region and overtook Europeans in terms of percentage of inflows.

We believe there is room for further flows into European equity ETPs. A portion of the 2016 outflow has still yet to return and Q2 European earnings were strong (relative to the U.S.). Globally, European equity ETP assets under management (AUM) has increased by 26% since the end of June 2016. Total global ETP AUM has increased by 30% over the same period.

Significant equity flows this year ($97 billion versus $24 billion in the first half of 2016) do not appear to have come at the expense of fixed income. More than $87 billion has flowed into fixed income ETPs globally so far this year, with investors appearing to take a positive view on U.S. investment grade credit exposures – which account for a third of the total global fixed income inflow – in particular.

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