The US continues to lead the global economy and released another set of robust data points in September, leading the S&P 500 Index to another record high. Despite dovish sentiment from the Fed, we still expect interest rates to rise next year, leading us to an overweight position in developed market equities. As a result of this we remain generally underweight or neutral in fixed income.
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US Federal Reserve Chair Yellen assumed a dovish stance, which did not stop the Fed raising its median interest rate projections at the last FOMC meeting; now it predicts a rate of 1.38% by the end of 2015 (previously 1.13%). While US treasury yields widened across the board, high-yield spreads moved out even more as part of this month’s wider risk-off trend.
We remain underweight high-yield bonds relative to investment grade and government bonds. On a risk-adjusted basis, they remain expensive, and we believe most are prone to underperformance in the run-up to higher rates, as investors grow worried about the impact of that first hike.
The US continues to lead the global economy and released another set of robust data points. The ISM manufacturing and non-manufacturing indices hit 3-year and 9-year highs, respectively. While unemployment fell to 6.1%, average hourly earnings growth rose 2.1% in August, suggesting less slack in the labour market.
The S&P 500 Index notched another record high in September before pulling back late in the month. In Europe, an eventful month left equities flat, fixed income yields wider and the Euro weaker. We see low demand for corporate loans given a low-growth environment, economic uncertainty and recent, weak data points. Overall we see the US economy moving steadily forward, carrying US equity markets with it. Though returns are more muted than in the recent past, we continue to see developed equities offering better risk-adjusted returns than most bonds, even in Europe where rates are expected to remain grounded for the foreseeable future.
Premier Li Keqiang tries to steer the tricky course towards a soft landing for China. Markets reacted poorly to soft data
In China, the Q2 rebound seems to have lost momentum in Q3. Key indicators such as retail sales, fixed asset investment and manufacturing PMI were just shy of consensus, but for the most part worse month-on-month. Industrial production notably disappointed, reverting to its lowest pace since the Financial Crisis, 6.9% year on year. The mini-stimulus measures issued throughout March-July petered out quickly.
In partial response, Emerging Markets underperformed this month, affected also by the rise in US treasury yields. Overall we are neutral Emerging Markets Equities and strongly underweight Emerging Markets bonds. We see the risk of outflows as the normalisation process continues.
We see Emerging Market nations that rely heavily on exporting commodities underperforming going forward. Because commodities are for the most part oversupplied, prices will remain weak. Given the long lead times involved in commencing production, too many mines and rigs have come online too late. The Goliaths of the world, with lower overall operating costs, can continue to operate at low commodity prices, flooding the market with supply long enough to squeeze out the smaller players.