The 25 basis-point hike announced by the US Federal Reserve (Fed) after its March meeting was widely anticipated and, I would argue, well priced into markets.
Since the end of June last year, global equities have rallied more than 17%, with the S&P 500 rising close to 17% over the same time frame. Such a surge has been driven largely by cyclical sectors: the financials sector of the S&P 500 is up almost 35%, while industrials have surged nearly 20% since mid-year 2016.
This period of strong equity-market performance is reminiscent of the sentiment post-QE3, announced in September 2012 by the US Federal Reserve. The market performed strongly in the year following the announcement, led by cyclicals and, we would suggest, hope, and then spent two years unwinding all that hope.
This time around, the hope that ‘Trumponomics’ will propel growth and solve stubborn problems such as lacklustre productivity and stifling taxes is behind the equity-market effervescence.
Now Federal Reserve chair Janet Yellen and her committee have joined the jamboree, continuing with a rate-hiking cycle and intimating there could be as many as three more this year. The message they are relaying to the markets is that unconventional monetary policy and quantitative easing have worked, so it is time to put up interest rates.
Room to cut?
We think a more likely scenario is that, given we are seven years into a bull market (even if it has been a volatile one), the Fed is trying to get a few hikes in place to give it space to cut into the next recession!
From our perspective, the response of the bond markets has been more illustrative of the underlying growth potential in the US economy and, by proxy, global equity markets.
The shorter end of the bond curve has steepened, but the longer end has not. If the whole curve had steepened, it would be telling us longer-term rates were going up and that economic growth would be sufficient to support further rate rises.
We believe there are structural challenges to economic growth, particularly in Western developed countries. These include (but are not limited to) ageing populations, technological disruption and the burden of debt, which has increased significantly since the financial crisis.
With the longer end of the yield curve not having steepened, we are comfortable that our view of a challenged growth dynamic continues to hold. And it seems thatsome other market participants are coming round to our way of thinking. In the days following the rate hike, the US market has had its longest stint of consecutively negative days, while US Treasuries have been rallying.
Time to sober up?
Investors are reassessing the likelihood of Trump’s ‘pro-business’ policies being instigated as rapidly as first anticipated, and for the first time have identified potential stumbling blocks.
This year could well be a reversal of 2016’s ‘year of two halves’. For the first part of the year, defensives and government bonds may largely underperform while cyclicals rage, then at some point the veil may slip and risk-off sentiment could return. When that occurs, we would expect defensives to outperform and anticipate a correction in cyclicals.
It is too early to tell whether that time is now, and we are not minded to try and time markets. That is why we follow the same strategy and valuation methods day in and day out. Right now, we view cyclicals as overvalued – in the same way defensives were ahead of the UK’s Brexit vote in June 2016.
In the build up to the vote, our valuation discipline was telling us to sell defensives and bond proxies; now the opposite is true, and it is cyclicals that we think are looking ‘toppy’.
At the start of 2016, our Global Income strategy was overweight the US versus the comparative index (the FTSE World). Now we are 10% underweight. We are seeing much more value in European companies at the moment, so have reflected that in our positioning.
 All in US dollar terms as at 22 March 2017 and sourced from Bloomberg unless otherwise stated