The global economic expansion is rolling on. We are positive on equities but expect higher volatility and more muted returns ahead. Inflation has picked up, keeping the Federal Reserve on track to raise rates. Key risks include increasing trade tensions and a renewed spike in bond yields.
1. Room to run
The U.S. tax overhaul and spending plans have lit a fire under earnings growth, which was already gaining momentum on the back of economic strength. Dividend payouts and share buybacks are another support, particularly in the U.S. as companies look to deploy their tax windfalls.
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We remain constructive on equities, despite the fact that we are nine years into a bull market. ”
2. Inflation comeback
U.S. inflation is moving back toward the Fed’s target. Yet we think it will likely take some time for any economic overheating to challenge the gradual pace of interest rate hikes. Inflation remains muted in Europe and Japan, supporting ongoing monetary policy accommodation there.
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In the U.S., we expect that inflation will reach the 2% target of the Fed, and slightly above that. ”
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Long-term treasuries will likely still work as ballast when it matters most (global risk-off events), but we see short-term U.S. debt now offering compelling income, along with a healthy buffer against the risk of further interest rate rises. Rising rates also boost the appeal of floating rate assets, which are designed to hedge against monetary tightening.
3. Reduced reward for risk
Last year was nearly nirvana for diversified portfolios. Returns were strong — and volatility was exceptionally low. Yet a mix of more muted returns and “normal” volatility challenges this dynamic.
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A comeback of inflation and Fed normalization may create a challenge for investors looking for high risk-adjusted returns. ”
Our outlook for a steady, sustained expansion supports the momentum factor. It has historically outperformed the broader market over time. We also like the value factor, home to the cheapest companies across sectors in this cyclical upswing. It has the added benefit of a long history of negative correlation with momentum.
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