Columbia Threadneedle has recently increased its equity rating to favour from neutral on the back of lower political risk and positive earnings developments.
Since last summer we have had a neutral stance towards equities, though within that we have favoured Japan, Asia and Europe, and since March this year have been negative towards the US. Against the background of a two-year earnings recession, and substantial policy uncertainties in Europe and the US – as well as a variety of other investment opportunities across other asset classes – valuations have appeared fair but uncompelling.
However, re-examining these factors, a number of changes have taken place.
In Europe, earnings have been sluggish for a decade and we saw meaningful short-term policy risks in the form of the Dutch, French, German and Italian elections this year. Clearly, the risk from the Dutch and French elections has now diminished – with both Geert Wilders in Holland and Marine Le Pen in France failing to gain enough support to extend the Trump/Brexit nationalist theme. The CDU in Germany appears to be consolidating its position – but the Italian election that is likely over the next year remains a risk.
With electoral risks diminished, the sea-change in corporate fundamentals now has the scope to be appreciated. Earnings’ reports this past quarter have been their strongest in 10 years, and the operational leverage attached to European firms looks likely to turn from a drag to an advantage for investors in the environment of gentle reflation that we expect. There also appears to be a lot of pent-up demand for European equities following years of outflows, particularly from Asian and US investors who have disliked the region since the Greek crisis.
This brings us to China. The Chinese economy is perennially one to watch, and fears over a substantial currency depreciation or sharp economic slowdown have dominated our thoughts. But our most recent review of the region indicates that a number of positive indicators are in place. Firstly, Chinese economic surprises are rising despite better expectations, while domestic consumption continued to contribute the lion’s share of GDP growth in Q1 2017 (representing two thirds of the 6.9% growth rate). Meanwhile, the property market is looking less troubling, and pressure on the currency has abated once again. Finally, the current account has become less of a concern, as both headline exports and imports are rising strongly and in April they meaningfully beat expectations in both yuan and US dollar terms.
In the US, President Trump’s inability to implement his policies is in some ways positive, and in others negative, for equities. On the positive side, the meaningful disruption from the pursuit of a heavily protectionist agenda has diminished, but on the negative side so too is the scope for delivery on a major corporate tax cut that the market has in many cases incorporated into valuations.The Federal Reserve has begun its tightening cycle but we believe it is unlikely that Fed hikes will cause equity markets to sell-off.
All of the above contribute to a more constructive investment environment in which favouring equities should contribute positively to portfolios.
Within currencies, we have downgraded the US dollar to neutral, marked up the euro to favour from dislike, and raised the yen to neutral, while we continue to dislike the Australian dollar and sterling. The shift to strategic US dollar neutrality is supported both by valuation and fundamental factors. After a period of strong appreciation the US dollar appears fairly fully valued, as does the Australian dollar.
Toby Nangle - Global Co-Head of Asset Allocation, Head of Multi-Asset, EMEA - Columbia Threadneedle
Maya Bhandari - Portfolio Manager, Multi-Asset - Columbia Threadneedle