Economics & Strategy 

Sentiment Shifts

— Sean Darby, Global Head of Equity Strategy

A perfect storm hit equities in 4Q18 – high oil prices, a strong dollar and a shift upwards in the U.S. yield curve – which altered perceptions towards risk assets and encouraged investors into cash. No sooner had the U.S. yield curve shifted upwards when investors began to worry about an inversion of the yield curve and concerns over a U.S. recession forced further liquidation of equities. Selling beget selling as the desire to de-risk and run cash over-ran all other considerations running into year end. Small changes in volatility have led to sharp outflows as investment strategies that tended to perform well during Quantitative Easing (QE) have become strained during Quantitative Tightening (QT).

In one sense investors appear to have already priced a recession into global equities during 2019. While global growth is likely to decelerate modestly, many economies will benefit from lower oil prices, and certainly Emerging Markets (EM) central banks will not necessarily tighten policy that aggressively in response to inflation concerns. Moreover, worries over a prolonged U.S.-China trade war appear also unfounded given the recent concessions made.

The stampede out of equities has left the equity asset class inexpensive versus government bonds while the price-to-earnings (PE) multiple has already incorporated a sharp drop in earnings forecasts. Corporate cash-flows and dividends provide a wide margin of comfort even incorporating two further hikes by the Fed in 2019. We have been upgrading EM equities recently while seeing evidence of under-valued securities in Europe. We continue to favor Convertible bonds as well as some closed-end funds trading at exceptional discounts to net asset value (NAV).