After an extended period of calm, volatility has reasserted itself in 2018. In stark contrast to 2017, investor sentiment has been extremely fragile, with financial markets swinging wildly on the back of a myriad of macroeconomic developments at hand. Notably, investors have had to contend with an environment of rising borrowing costs, persistent trade tensions between the world’s two largest economies, a politically-charged environment in Europe, and some tentative signs of slowing global growth. In the highly-volatile and illiquid trading environment, nervous investors have fled indiscriminately from risky assets. Most recently, extreme pessimism has set-in and the S&P 500 broke below its February lows, with the U.S. benchmark now officially in correction territory.
With volatility comes opportunity and we at Fiera Capital view this latest pullback as a short-term, sentiment-driven correction within a cyclical bull market.
As such, after keeping some cash on the sidelines for the entirety of 2018, we are taking advantage of these increasingly attractive levels and adding to our U.S. equity position, which would reinstate a modest overweight allocation to global equities in general. For institutional portflios, we’ve cut our cash position by 5 per cent, while increasing our U.S. equity position by 5 per cent.
From a valuation perspective, it would appear that the worst-case scenarios pertaining to the tumultuous trade and political landscape are largely priced-in after the latest bout of multiple compression – even as earnings expectations have remained elevated. Moreover, overly-optimistic and complacent investor behaviours back in 2017 have translated into heightened levels of investor pessimism this year, which, when combined with oversold market conditions, has left the S&P 500 ripe for a technical bounce from these depressed levels.
From a fundamentals perspective, the conditions for a pronounced global economic deceleration are all but elusive at this time and the outlook for global growth remains reasonably bright even in the wake of a hostile trading environment. Specifically, the global economy is expected to grow at an above-trend pace in 2019, with all major regions contributing to the advance. The U.S. is set to lead the global charge, thanks to widespread momentum across both the consumer and manufacturing space, while the double-dose of fiscal stimulus boosts an already-buoyant economy.
Here in Canada, the economy is moderating towards a more sustainable, albeit still above-trend pace. And looking abroad, we expect both European and Japanese economies to grow in-line with their long-term potential, while emerging market economies should thrive in the environment of solid global demand and rising commodity prices
Encouragingly, the fragile trading relationship between the U.S. and China may have finally crested following the G20 summit in Buenos Aires, while there are some tentative signs that fiscal stimulus from policymakers in both the U.S. and China will help to stabilize the global economy in 2019. These developments should help to extend the economic upturn into 2019 and provide a buffer as major central banks take cautious and coordinated steps towards monetary policy normalization – while “quantitative tightening” (balance sheet contraction) should ultimately replace an overly-aggressive rate hike trajectory.
Taken together, the fundamental underpinnings for stock markets remains firmly intact as we head into 2019, in our view. In contrast, we believe that the path of least resistance for global government bond yields remains higher (and prices lower) in the environment of robust and above-trend global growth, rebuilding inflationary pressures, and coordinated monetary policy normalization – which remains at the root of our underweight allocation to fixed income and our preference for equities over bonds in the coming year.
Candice Bangsund, CFA, is vice-president and portfolio manager, global asset allocation, at Fiera Capital.