According to our Global Investment Strategy service, increasing macro risks against a backdrop of elevated valuations warrant a more cautious stance (neutral allocation) on global equities:
- The probability of a December hike has tracked the steepness of the OIS curve. In essence, by signaling to markets its intention to hike rates in a few weeks, the Fed has pushed forward the timing of future rate hikes. Given that the Fed’s “dots” are still a fair bit higher than current market expectations, the risk is that rate expectations will continue to adjust upwards, tightening financial conditions in the process. Such an outcome would be bad news for stocks.
- A strong greenback and an increasingly hawkish Fed is bad news for emerging markets, given that over 80% of EM foreign-currency debt is denominated in U.S. dollars. If emerging markets were on solid footing, this might not be much of a problem; unfortunately, they are not. The ratio of private-sector debt-to-GDP has doubled since 2001. Remarkably, debt levels continue to rise in most emerging economies. If things are tough now, imagine how tough they will be when debt begins to decline. Reducing debt in a smooth and orderly manner is hard enough in advanced economies with their strong economic institutions; it is virtually impossible to pull off in emerging markets. According to ourGlobal Investment Strategy service, there is a high probability that shocks from the EM world will spill over into developed markets.
- Apart from the impact of Fed hikes and emerging market stress, the potential for a growth slowdown in Europe is another reason that makes us increasingly worried about the outlook for global equities.