Aviva Investors, the global asset management unit of Aviva, is tempering return expectations for risk assets as global growth moderates and interest rates increase.
Global growth is expected to slow modestly in 2019 to 3.6 per cent from around 3.75 per cent this year, but remain at an above-trend pace in all the major developed economies. Last year saw growth pick up in the US, helped by fiscal stimulus, but slow in the eurozone and Japan. These divergences should not intensify next year, but look set to be maintained.
Above-trend growth should result in further erosion of spare capacity in major economies, leading to further falls in unemployment and gently rising wage inflation. This should lead to higher underlying inflation which is expected to be at, or approaching, central bank targets in 2019, even if headline inflation dips because of lower oil prices.
The US Federal Reserve is likely to raise rates three times - entering slightly restrictive territory - although the market is only pricing in one rate hike for 2019. The European Central Bank may start moving away from negative rates in the second half of next year and there is some prospect that the Bank of Japan will adjust its policy framework to deliver a steeper yield curve.
Michael Grady, Head of Investment Strategy and Chief Economist at Aviva Investors, said:
“In a slowing growth environment, investors tend to focus more on downside risks. Although the economic backdrop continues to provide a basis for positive returns for risk assets, the expected growth moderation along with tighter global liquidity and the impact of those risks justifies more restrained positioning.
“We prefer to overweight US and EM equities because of the expected relative growth outperformance. Valuations in Europe look more attractive in some areas, but downside risks such as Brexit and the Italian budget continue to weigh on the outlook.
“We are moderately underweight government bonds as yields will continue to move higher on expectations that central banks will tighten policy in 2019. With spreads relatively tight by historical standards, we have a bigger underweight with regard to credit, including duration. Our preference is for European over US high yield due to its lower leverage and reduced sensitivity to oil prices. We have a slight preference for being long US dollars, with the main underweight against Australia on domestic challenges and Chinese growth risks.”
The full document can be found here.
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