Synopsis

Trade wars, the U.S. Federal Reserve (the Fed), China stimulus and the direction of the U.S. dollar dominate our near-term outlook. At this juncture, U.S. recession risks appear low. We believe that European growth can improve over the next couple of quarters. We view emerging markets as oversold but see a bounce as dependent on the next move in the ongoing trade wars between the U.S. and other countries.

                                                           Video Length: 00:04:17

Key market themes

The S&P 500® Index has been the best performing regional equity market this year, but U.S. equities remain very expensive, with a Shiller cyclically adjusted price-to-earnings ratio of 33 times as of mid-September. While we see momentum as continuing to favor U.S. equities, some of our contrarian over-bought indicators are beginning to trigger. In addition, a December Fed funds rate hike looks likely, as do three or four more hikes in 2019, which would take the rate to 3.3%. A shift to a more aggressive outlook would put upward pressure on the U.S. dollar and Treasury yields. It also would add to the stresses in emerging markets.

We like the idea of leaning into eurozone equity exposure after its recent underperformance. In particular, Italian risk looks to be dissipating, corporate earnings are still robust and the industry consensus has become too pessimistic about the economic outlook. Trade-war risk, however, tempers our enthusiasm for this region as a whole.

UK equities continue to look slightly cheap on our scorecard. At 1.5%, 10-year gilts are still long-term expensive. However, given the near 20 basis-point rally in yields we’ve seen over the third quarter, we no longer classify government bonds as very expensive—just expensive.

One of the top stories in Asia Pacific has been Australian growth, which has been impressive so far in 2018. However, we believe that this economy may have seen a peak in growth for the next couple of years, as the headwind of falling housing prices continues to grow and uncertainty around the strength of the Australian consumer remains. Meanwhile, in New Zealand, our outlook for the country is deteriorating as uncertainties around government policy are likely to slow the economy and damage business confidence.