Midyear Outlook: Four Big Macro Trends at Work
Our updated asset allocation framework reflects the four big macro trends we currently see driving returns across the global capital markets. First, in the developed equity markets we continue to see a lot of reasonably valued mid- and large-cap stocks with excess cash balances and low leverage. This backdrop remains a constructive one for certain private and public equity investments, and it too suggests that corporate M&A activity is likely to remain robust. Second, in a low rate environment we think the sizeable illiquidity premium that has been created by heightened regulation throughout the banking system remains compelling. On the margin, Europe appeals more to us than the United States, which represents a change in our thinking. Third, many emerging market companies now need to restructure or recapitalize their balance sheets at the exact time that the cost of capital in their countries is going up. This backdrop should reward both credit and equity investors, particularly in countries where there is now new government and/or central bank leadership. Fourth, while tapering is on track, many central banks around the world still remain committed to keeping nominal interest rates below nominal GDP. In such an environment, we believe owning real assets that can deliver yield, growth and inflation hedging makes sense....MUCH MORE
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6. We continue to significantly underweight government bonds and high-grade debt in favor of “spicier” credit. Our basic premise remains that non-traditional credit, including high yield, private credit, mezzanine, and special situations, will outperform low-yielding government bonds and high grade credit as long as we are right on the duration and pace of the current economic cycle. Since the recovery began in 2009, this strategy has unfolded favorably, though we fully acknowledge the strong performance of Treasury bonds in 1H14 tested our thesis. We remain undeterred; our base case for 10-year Treasury yields by December 31, 2014 remains 3.3% versus the current level of 2.7%. Further details below.
Exhibit 3Profit Margins Are High, But Earnings Relative to Trend Appear Reasonable
Trend, average and standard deviation for January 1984 to current. Earnings deviation versus trend = percentage difference between trailing twelve months earnings and trend earnings. Data as at April 30, 2014. Source: S&P, First Call, Factset.
