Market Update - April
Growth on track, but downside risks have increased
Growth indicators remain positive for the developed world, but there are a number of downside risks that could hinder growth. One of these is a concern about less supportive monetary policy. This is particularly the case in the US, with new Federal Reserve Bank Chair, Janet Yellen, implying that rates could be raised as early as the second quarter of 2015. Elsewhere, there are increasing concerns that the ECB is heading for a major policy error and is ignoring lessons learned from Japan’s deflationary experience in the 1990s by not easing monetary policy enough.
Rising risk of European deflation
Low inflation in the Eurozone is becoming a serious risk that could lead to outright deflation. While our central view is that Europe will not experience a Japanese-style episode as recovery continues, we cannot ignore the warning signs that the risk of deflation is escalating.
Fiscal headwinds to fade with inflation to remain well contained
The UK recovery risks are skewed to the upside as the government stimulates housing demand, but significant economic slack should limit any tightening of monetary policy. We do not anticipate any interest rate rises in 2014 or 2015.
Asset allocation policy
We continue to favour equities due to their attractive earnings and dividend growth prospects. However, valuations are less compelling than they were in 2013, so any market strength may provide an opportunity to trim back positions. Although bonds benefit from uncertainty, due to their ‘safe haven’ status, we still think yields are on an upward trend and we therefore retain an underweight position, particularly to government bonds. Conversely, we are able to achieve attractive income, as well as the potential for capital growth from the UK commercial property market, where we favour an allocation. In this low interest rate environment, and with the outlook for bonds poor and for equities less certain, we are comfortable with a reasonable allocation to absolute return funds.
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