It has been an investors consensus in Europe for a while now that US equities should be avoided because of their high valuations. Investor sentiment towards the asset class has continuously been negative for more or less three years, with a brief exception immediately after the US presidential elections last year. But the asset class hasn’t been held back by its high valuations. Instead, US equities have continued to deliver stellar returns.
Though valuations are likely to be a drag on future returns in the long term, they are not at all a reliable guide on a 12-month horizon.
“Many observers point at stretched equity valuations, but we think valuation is not an impediment for further rises,” Van Nieuwenhuijzen said at an event in London, where NN IP kicked off the unofficial ‘asset manager outlook season’.
Direction of change
What should investors then look at to get an idea of how markets will perform going forward?
“They should focus on the direction of change instead,” said Van Nieuwenhuijzen. With global GDP growth on a solid upward trend, company earnings set for another year of double-digit growth and default risk in bonds still stable and inflation pressure limited, equities can be expected to continue rising, he believes.
Little surprise, then, that NN IP’s recommended allocation for 2018 isn’t exactly contrarian: it suggests an overweight to equities, with a gearing towards cyclical assets.
“The conditions for equities come close to a Goldilocks-like environment,” said Patrick Moonen, a multi-asset strategist at NN IP. “Next to the benign fundamental picture, market dynamics have improved substantially in the past few months,” he added.
The same can’t exactly be said about fixed income markets. Contrary to expectations fuelled by Donald Trump’s election to the US presidency and subsequent steep rises in bond yields, US 10-year Treasury yields fell again in 2017, and government bond yields remain close to all-time lows across the board.
Credit doesn’t look attractive on a fundamental basis either, as spreads have tightened considerably since early 2016. However, spread products are still the ‘least bad’ choice in fixed income against the current macroeconomic backdrop, believes NN IP.
“Significant spread widening usually only happens in a risk-off environment and, given the positive fundamental backdrop, we do not expect this,” said Pieter Jansen, another multi-asset strategist at NN IP.