October 2017

Q4 2017 Outlook
Implementation Guide

Growth is cruising at above-trend rates across the world. We expect inflation to pick up in the U.S. but to move sideways at low levels in the eurozone, supporting monetary policy divergence. Remarkably steady growth is fostering subdued market volatility. This provides fertile ground for risk-taking in equities and emerging market (EM) assets.

Market views

We see economic growth pushing bond yields up from a dip caused by a soft inflation patch, geopolitical unease and a downshift in Fed rate increase expectations. Yet we see any yield rises capped by structural factors. The Fed's policy normalization lends support to the U.S. dollar, in our view.

  • Our outlook for low yields underpins our positive view on equities and other risk assets.
  • We are bullish on emerging markets: Valuations are attractive, investors are returning and EM stocks are increasingly tilted toward high-growth companies.
  • We like European and Japanese stocks and prefer equities overall to credit, where a lot of good news is already priced in.
  • We favor the momentum and value equity style factors.

Key themes

Sustained expansion: The increasing breadth of the global economic expansion is pointing to a longer lifespan. Roughly three-quarters of countries are improving growth, including all economies in the eurozone — a first in the post-crisis period. This broadening of steady growth gives us confidence the global expansion is sustainable.

Rethinking risk; rethinking returns: Market volatility (vol) has been plumbing lows. What is less appreciated is that this is happening at a time of historically subdued volatility in economic data.

Low vol also spurs risk-seeking across markets. We are concerned about valuations in some corners of the credit markets, but do not see broader signs of “irrational exuberance” in financial markets. We see no systemic risks on the immediate horizon that might undercut the economic expansion and spark a shift to a high-vol regime.

Flows: A bend in the river

We believe analysis of exchange-traded product (ETP) flows can provide insights into how investors might be positioned for the quarter ahead.

2017 is already a record year for ETP flows. The $419 billion of inflows recorded from the beginning of the year to the end of August has already surpassed 2016’s full-year flow record of $378 billion.

Investors appear to have become concerned about stretched equity valuations and potential geopolitical triggers for market corrections in Q3, however.

Flows into developed market exposures that had been gathering assets earlier in the year – such as European equities and U.S. investment grade credit – plateaued. Cyclicals also suffered as investors rotated into more defensive positions.

Emerging market ETPs – both equity and debt – continued to gather assets throughout Q3, shrugging off tensions in the Korean peninsula and expectations for Fed policy normalization. Many U.S. and global stocks with strong price momentum have posted double-digit gains. The correlation between emerging market equities and gold prices turned positive in February this year after a bout of dollar weakness but has been dropping since July. Flows into gold ETPs picked up sharply in Q3 as investors appeared to seek out perceived safe-havens that could provide a hedge against exposure to riskier assets.

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