Tilney CIO: Global equities set to pause in coming months

Equity markets are set for a pull back in the second half of this year as the driving force of loose monetary policy wanes following a shift in central bank rhetoric, Tilney’s CIO Chris Godding says.

Major market indices have recently reached new highs with equity markets returning 4-14 per cent in sterling terms in the first half of 2017, according to MSCI data from Tilney. However, Godding says the reigning in of credit growth in China – which has fuelled global growth – will also hamper equity market returns.

“On the surface, the underlying outlook for the global economy remains supportive for equities but there are a number of factors which lead us to expect a pause in markets over the coming months,” Godding says. “These centre on a fading credit impulse and fiscal stimulus in China and cooling global credit conditions.

“Data appears to suggest a typical lag effect of around eight months between Chinese credit growth and its impact on manufacturing output, so we expect the weakening Chinese credit growth to manifest itself in slower output in the second half of this year before starting to recover again in 2018.”

Godding says central banks are now likely to simultaneously raise rates modestly, having already made more hawkish comments despite subdued inflation, which have prompted a sell-off in sovereign bonds.

Bond markets “offer no margin for safety”, Godding says, but although he is more positive on equities, Godding is wary on the outlook for wage growth. While economic growth is dependent on rising wages, they would be detrimental to companies’ earnings growth, he says.

However Godding disputes that equities are looking expensive, particularly in emerging markets and among consumer staples – which saw a correction in June following the surge in bond yields – and interest rate sensitive stocks such as utilities, real estate and telecoms.

“While there are clear signs of euphoria in parts of the market, notably technology, which has been a key factor in driving US equity multiples to the upper end of historic trend, valuations do not look excessive for most regions compared to long-term trends and are actually quite compelling for Asian and emerging market equities,” Godding says.

He adds that weak emerging market currencies have been supportive of emerging market equities, with the JP Morgan EM currency index down over 40 per cent between 2011 and 2016 due to the commodity super cycle and tightening financial conditions in China.

“The index has rebounded just 5 per cent from the lows and as a result, the terms of trade for the broad emerging markets basket remain extremely beneficial,” Godding says. “Macro-prudential policies in China may impact global economic growth in the second half of the year, but below average valuations, attractive yields and significantly lower dependency on foreign financial flows suggest that emerging markets look attractive.

“We are constructive on equities and less concerned about current valuations than some other investors. But we do anticipate developed equity markets are unlikely to move materially higher in the near term until there is evidence of renewed earnings growth or bold fiscal initiatives. Within our overall neutral view of equities we continue to have a preference for Europe among developed markets and also favour Asia Pacific and Emerging Markets.”

Within Tilney’s portfolios, the overweight to Europe was doubled “when valuations were at extremes”, Godding says, having sold the US exposure, followed by some profit taking a couple of months ago. While they remain positive on Europe overall, Godding says they have less conviction in the strategy now the “market is catching up”.