Paul O’Connor, Head of Janus Henderson’s UK-based Multi-Asset Team, outlines his view on the events of 2018 thus far and gives his outlook for different asset classes.
QE peaks, volatility troughs
We see the recent upshift in financial market volatility as a return to more normal market conditions, following one of the most tranquil years in market history. In our view, the hefty US$2,000bn injected into financial markets by key central banks in 2017 was a major factor shaping the unusually benign, high-return, low-volatility market environment. From here, with the global economy continuing to heal, central banks will be slowly guiding monetary policy back towards more normal settings. It seems likely that 2017 could be a peak year for QE (quantitative easing) and a multi-year low for market volatility.
Looking to buy equity dips – sell bond rallies
Despite the choppy start to the year in global equities, we still favour the asset class strategically and see scope for positive returns in 2018, while our constructive outlook remains intact. Our core view here is that the global economic expansion has the potential to be unusually long by historical standards, underpinned by historically low interest rates. We believe the scale of monetary tightening that we anticipate from global central banks should not threaten this market-friendly scenario.
In fixed income, we still struggle to find value, given that both real government bond yields and credit spreads remain exceptionally low by historical standards. While our general stance in equities is to buy dips, as we did in recent months, we will keep leaning towards selling rallies in fixed income until valuations become more attractive.
The most credible overarching threat to our long-cycle scenario would be if inflation expectations lifted enough to compel central banks to normalise monetary policy more urgently. While recent data still support our view that the recovery in global inflation will be gradual, we continue to monitor developments on this front closely, as a sustained increase in inflation expectations could be a game-changer for financial markets.
Beyond these dynamics, the threat of a continued escalation in global trade tensions looms as the other big threat to economic and market stability. While it remains difficult to predict how these politically-charged negotiations will evolve, our core view, for now, is that economic logic and corporate lobbying will ultimately guide leaders away from outcomes that damage the global expansion.
Opportunity in volatility?
Our central scenario is that an unusually long period of economic growth can sustain unusually long bull markets. However, there are sizeable risks to this view and they are hard to calibrate, given the idiosyncratic nature of the current environment. Even if things work out well, we expect only modest returns from most asset classes this year. Market volatility should give us some opportunities to add value in both asset allocation and fund selection.
Bull market = a financial market in which the prices of securities are rising, especially over a long time. The opposite of a bear market.
Bond yield = the level of income on a security, typically expressed as a percentage rate. For a bond, this is calculated as the coupon payment divided by the current bond price. Bond yields move inversely to prices.
Credit spread = the difference in the yield of corporate bonds over equivalent government bonds.
Inflation = the rate at which the prices of goods and services are rising in an economy.
Monetary policy = the policies of a central bank, aimed at influencing the level of inflation and growth in an economy. It includes controlling interest rates and the supply of money.
Monetary stimulus = the act of a central bank increasing the supply of money and lowering borrowing costs.
Monetary tightening = central bank activity aimed at curbing inflation and slowing down growth in the economy by raising interest rates and reducing the supply of money.
Normal conditions; normal settings = by this the manager means markets that are more reflective of historical norms, particularly in regards to levels of fluctuations of asset prices. In recent years, markets have displayed an abnormally low level of fluctuations, in part because an extended period of central bank asset purchases and low interest rates (ie, unusually accommodative policy settings) have supported asset prices since 2009.
Quantitative easing = a measure whereby a central bank creates large sums of money to purchase government bonds or other securities, in order to stimulate the economy.
Volatility = the rate and extent at which the price of a portfolio, security, market, or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility.