Page 33 - DIY Investor Magazine | Issue 38
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     I believe that a benign US soft landing scenario is increasingly priced into financial market expectations. By Alastair George, Chief Investment Strategist.
Aug 2023
DIY Investor Magazine ·
Inflation fears are starting to ebb as producer price indices remain subdued, yet growth prospects in the US at least are for now on an improving trend even as European survey data disappoints.
However, our estimates of the equity risk premium and price/ book multiples suggest a US soft landing is fully discounted. US equity valuations are once again abnormally high and with expected returns lower than average.
Therefore the ‘Goldilocks’ scenario for the US economy, with unemployment remaining strong even as inflation falls, appears to be firmly embedded in the pricing of US equities. European markets are trading close to fair value, reflecting weaker growth prospects and the near absence of global technology leaders, missing the current investor enthusiasm for artificial intelligence.
We maintain a neutral outlook on global equities and believe US long-term government bonds remain attractive. With factory gate inflation having slowed sharply, we now expect government bonds to outperform as growth decelerates towards the end of the year. However, global equity valuations slightly above their long-term averages offer little directional guidance at a time of cyclically low earnings growth.
We have been surprised by the resilience of global equity markets over the past three months. Only four months ago, markets were focused on a potentially nascent banking crisis.
Since then, US cyclical and technology sectors have powered ahead despite a concurrent rise in US short-term interest rate expectations. Contrary to bearish commentary, the volatility within the US banking system has not had any observable impact on the strength of the US economy to date.
In fact, rising economic surprise indices highlight a run of improving incoming US data
We maintain a neutral outlook on equities. For equities, more than 50% of global market capitalisation is currently represented by US equities, which are trading at the upper end of traditional valuation ranges. We believe the US soft landing scenario, where inflation is brought under control without a major recession in either the US or elsewhere, may now be the base case but is already discounted.
We note that valuations in Europe are more attractive than for US equities but investors will need to navigate weaker economic trends and the near absence of global technology leaders. Inflation remains high but on a declining trend in both the US and Europe. Given easing producer price inflation, consumer inflation is likely to continue to converge towards central
bank targets in the second half of 2023. In the context of a disinflationary environment, 10-year US government bond yields at 3.9% appear to be at much more attractive levels than just 18 months ago.
US government bonds appear to have resumed their traditional role as diversifiers within a portfolio, offering a return 1.5–2% above medium-term inflation expectations with yield compression potential in the event of an economic slowdown. In the context of declining inflation expectations, we would suggest a modest overweight in this asset class at this time.
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