by Toby Lewis, Chief Investment Officer, Centrepoint Alliance
The global economy continues to grow and company earnings are in a global uptrend. Over the medium to long term, this is likely to be reflected in higher equity prices. However, over the shorter term, we may see some periodic dips in asset prices as the outlook for interest rates changes. The world’s major central banks are gradually withdrawing liquidity support and this is very likely to affect investment markets.
Our analysis used a simple and commonly used valuation model to illustrate that, while not necessarily expensive, equity markets may prove to be extremely sensitive to changes in interest rates.
The downside risk to equities from rising interest rate expectations and yields may even go far beyond the downside risk to bonds, the asset class most often associated with interest rate risk. Further, the availability of hedging instruments to bond portfolio managers means that they are more able to manage the downside risk than their equity counterparts.
The US economy is back to full employment and economic growth is recovering fast. President Trump has shown a clear desire to add fiscal stimulus to the economy, without yet outlining exactly what forms the stimulus might take .The Federal Reserve has a very difficult task in judging when to raise interest rates; too early and the risk of recession is not negligible, too late and the risk of inflation accelerating and global bond yields rising sharply is very real.
We argue that investors should worry more about periodic and significant set-backs in the equity market than potential small falls in bond prices stemming from rising interest rate expectations.
We do not recommend shifting to defensive, underweight positions in stocks. Instead we suggest a number of ways to benefit from long-term expected market returns, while improving the path of returns that investors may experience in the short term.
This is an extract from the CIO Market Outlook for April 2017, exclusive to the Centrepoint Alliance adviser community.
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