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A perfect storm: binary outcomes

A perfect storm: binary outcomes

23-07-2018 | Insight

It is amazing how so much can change when not much has really changed. While fundamentals are still pretty much the same, increasing market risks have sent global equity markets into risk-off mode.

  • Fabiana Fedeli
    Fabiana
    Fedeli
    Portfolio Manager

The main risk is the threat of escalation of the US-China trade tensions. In addition, a further rise in US inflationary pressure may cause the Fed to accelerate its tightening path. The ECB is also moving towards normalization of global liquidity and will end Quantitative Easing at the end of this year.

Credit spreads are likely to widen, driven by a combination of tighter monetary policy, record-high valuations and high leverage. In developed equity markets, unless we get positive news on the trade disputes, volatility is likely to stay elevated as the market is discounting the increasing risks and declining Central Bank support.

As for emerging markets, steady growth in emerging and developed markets remains a positive factor, while inflation in the emerging world is at historical lows. However, sentiment towards emerging markets has been dented as well, by weak currency performance in several emerging countries, rising risk of a trade war and political events in emerging countries. Global emerging markets equity funds are starting to see outflows, emerging bond spreads are widening and emerging markets have lagged developed markets year-to-date. Valuation remains a clear positive, with a discount of around 25% on trailing and forward earnings against developed markets.

What we need most of all is a resolution of the trade tensions for global markets to get off their risk-off stance. For the US-China relations, one can never tell what the future holds, but eventually markets will have to get used to the two most powerful countries in the world being at odds from time to time.

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