As of January 31, 2019
TRADING DEVELOPED CYCLICALITY FOR EMERGING OPPORTUNITIES
- We continued to add to emerging market equities as relative valuations remain reasonably attractive. A slower pace of U.S. Federal Reserve (Fed) tightening and prospects for a softer U.S. dollar are supportive while a resolution in trade could provide an upside catalyst.
- Within developed markets outside the U.S., we further reduced our exposure to value stocks in favor of growth as moderating economic growth outlook could challenge cyclically oriented sectors.
- Within fixed income we added to hedged non-dollar bonds as they offer attractive hedged yields for U.S. dollar-based investors given the short-term interest rate differential favoring the U.S.
As of January 31, 2019
EMs—A FEW LESS THINGS TO WORRY ABOUT
So, why the sudden reversal of fortunes? To start, the Fed now appears to be on a slower more data-dependent path for rate hikes and consequently the U.S. dollar has taken a pause. Recent headlines out of Beijing have also helped with news of stimulus measures and overtures signaling a willingness to compromise on trade. More importantly, last year’s fears of systemic contagion have all but disappeared as Brazil’s new pro-reform president has taken power and the Turkish economy has clawed its way back from the brink of collapse. While moderating global growth could be a headwind this year, for now, things don’t seem as bad.
EUROPE—KEEPING AN EYE ON CHINA
Slowing demand from China is putting pressure on Europe’s manufacturers as the region continues to slow from the 2017 peak. While this has yet to materialize in corporate earnings data, it has started to manifest itself in economic data. Manufacturing and business confidence appears to be worsening as Germany’s manufacturing sector fell into contraction territory in January, a four-year low, signaling a deepening of economic woes in Europe’s largest economy. Meanwhile, activity in France and Italy has also been weak. With Brexit on the horizon, unrest in France, and economic risks on the rise, the ECB may ultimately have to rethink plans to tighten monetary policy later this year.
GLOBAL EQUITIES—OFF TO THE RACES?
After a December to remember fomented by fears of recession, global equities are off to their best start since 1987, posting five straight weeks of gains, erasing much of 2018’s losses. The abrupt change in tone from the U.S. Federal Reserve, emphasizing its willingness to be patient with further interest rate increases, combined with speculation for further easing in trade tensions spurred a notable turnaround for equity markets. But while the Fed should have more degrees of freedom with inflation remaining low, the outlook for equities remains uncertain as growth expectations are easing and uncertainty over trade tariffs continues.
As of January 31, 2019
- Economic growth is likely to moderate in 2019 as fiscal impulse fades
- Inflation and labor costs are rising only gradually despite tighter labor markets, keeping recession risks relatively low despite the aging cycle
- Valuations reasonable given underlying fundamentals and macro risks
- Earnings expectations declining, driven by trade and lower oil prices
- Margins could face headwinds from higher wages
- Short-term rates may be close to peaking as Fed shifts toward data dependent policy
- Longer rates well off recent peaks as growth moderates and inflation remains modest
- The USD has been stable, despite downward pressure from fundamentals
- Valuations remain rich, growth and interest rate exceptionalism appear to be peaking
- The steady economic weakening across the eurozone continued into Q4, with the full year’s growth coming in at 1.8%, down from 2.3% the year before
- Italy officially fell into recession, shrinking by 0.2% in the last quarter of 2018
- Valuations are modestly attractive relative to the U.S.
- Earnings results were disappointing in 2018, but forward growth expectations remain positive
- The ECB kept its policy rate unchanged in January, and reiterated that this was unlikely to change through the summer of 2019 “or longer if necessary”
- Slow economic growth and political uncertainty kept European rates range bound for much of the latter part of 2018
- Political headwinds in Italy and France have eased recently, but weakening economic indicators continue to hold the currency back
- Expectation of QE unwind, supportive valuations, and a potential Fed pause are likely to be tailwinds for the euro in 2019
- The economy softened after a strong summer, slowing even further during the last quarter of 2018
- With the end of March deadline approaching, rifts remain between the UK and the EU over aspects of the Withdrawal Agreement
- Valuations continue to trade at a discount to other developed markets
- UK equities remain under-owned by investors, despite attractive valuations
- Near term direction of rates likely to be driven by Brexit outcome
- The Bank of England has refused to confirm which way rates would go in a “no deal’ Brexit
Weak economic growth and an uncertain political outlook due to Brexit continue to weigh on the GBP
Developed Asia & Pacific
- Trade tensions remain a key issue within the region, with business confidence beginning to fade
- Economic slowdown in Japan expected to continue this year with declining consumer sentiment a concern given the planned VAT hike
- Economic data has been weak despite the healthy job market; weaker housing market could weigh on consumer confidence
- Valuations within the region remain attractive relative to other developed markets, but earnings are vulnerable to a slowdown in global trade
- Japanese earnings have been weak, and expectations have been revised lower reflecting trade tensions and upside risk in the yen
- Australian profit margins under pressure by rising input costs, but valuations remain undemanding
- Longer-term yields in the region impacted by falling yields in the rest of the world
- BoJ continues to re-affirm its accommodative policy with current levels of inflation and wage growth still low
- Despite slowdown in global trade, RBA is firmly on hold as wage growth remains at acceptable levels
- Despite limited change in economic growth or monetary policy, the yen has rallied due to risk aversion and growing USD uncertainty
- Trade and commodity prices will remain important drivers of the Australian dollar
- Economic slowdown in China continues with incoming data likely to remain weak in the short term given the uncertainties around trade and global growth
- Policy response thus far, including infrastructure spending, tax cuts, and increased credit to small businesses, has yet to take hold
- Sentiment has improved since the start of the year on hopes of trade talks and further policy responses to help stabilize growth
- Earnings growth remains reasonably healthy, but expectations are falling
- U.S. Fed policy remains a wildcard
- Many central banks have shifted toward a tightening bias, but this is partially offset by the PBOC easing
- Currency volatility has endured, despite stability in bellwethers of risk sentiment (Turkey, Argentina, and Brazil)
- Valuations are broadly attractive versus history, with a more balanced tone regarding U.S. monetary policy and U.S.—China trade tensions providing additional support
ASSET ALLOCATION COMMITTEE POSITIONING
As of January 31, 2019
As of January 31, 2019
1 U.S. small-cap includes both small- and mid-cap allocations.
Source: T. Rowe Price. Unless otherwise stated, all market data are sourced from FactSet. Copyright 2019 FactSet. All Rights Reserved.
Information presented herein is hypothetical in nature and is shown for illustrative, informational purposes only. It is not intended to be investment advice or a
recommendation to take any particular investment action. This material is not intended to forecast or predict future events and does not guarantee future results.
These are subject to change without further notice. Figures may not total due to rounding.
Neutral equity portfolio weights representative of a U.S.-biased portfolio with a 70% U.S. and 30% international allocation; includes allocation to real assets equities.
Core fixed income allocation representative of U.S.-biased portfolio with 55% allocation to U.S. investment grade.
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