Fourth successive month sees global equities continuing to rally
Global equity markets continued to rally in July for the fourth successive month as equities benefited from an asset allocation shift as bonds sold off. The stock market was also supported by earnings reports that were generally in line or modestly higher than expectations and modestly firmer economic data.
Bonds had a vicious sell off in July. The global bond index was down 3% on the month, with the US and UK bond markets down over 4.5%. Treasury yields backed up over 100 bps in one month! Several factors combined to hit the bond market. First, there was a modest improvement in economic data, but improvement in economic fundamentals was very incremental and did not justify the magnitude of the rise in bond yields. Other factors were at play - some increase in supply, disappointment on hopes for the aggressive Fed purchase of Treasuries, and the so-called 'convexity-related selling' of Treasuries by the mortgage market players.
Economic data has shown a modest improvement. Both the US and Japan posted stronger-than-expected growth in Q2. The US is on track to grow above 3.5% in Q3. Business confidence posted improved readings both in the US and in Europe. Given the big bond sell-off, some pull back in bond yields appears likely, easing the interest rate headwinds to equity markets. Further, the earnings and valuation backdrop continues to support equities. Therefore, we look for equities to continue to outperform bonds.
Equities vs bonds - We have an overweight position in equities versus bonds. Our proprietary valuation, earnings, interest rate, technical and quantitative models continue to make a case for an overweight in equities. Further, economic data, in general, has a firmer tone, except for labour market data, and preliminary evidence points to stronger growth numbers in the second half in response to monetary and fiscal stimuli. Deflation fears are fading into the background - at least temporarily. Hence, the equity overweight.
Bond Market Strategy - Among global bond markets, we have an overweight position in European bonds as we look for them to continue to outperform, given the weak economic data and the likelihood of another rate cut by the European Central Bank by the year end. We have a neutral position in US Treasuries as the unprecedented rise in US yields between mid June and early August indicates the possibility of some consolidation. We are underweight Japanese bonds and UK Gilts. Japanese bonds are likely to remain around 1%. UK bonds are likely to continue to underperform
Global Equity Strategy - Among global equity markets, we are overweight Japan, the US and Emerging markets, neutral in non-Japan, and underweight Continental Europe, UK and Australia. We like emerging markets as the increased global liquidity has historically benefited these markets. They also rank high on our earnings and valuation models. We have an overweight position in the US, as monetary, fiscal and currency policies remain highly reflationary. Earnings are recovering while the economy is set to accelerate to over 3.5%.
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