Asset class outlook
As a state-space model, the EV Asset Model responds consistently and proportionately to changing market conditions, which drives the changes to asset class prospects as viewed by the model.
The increase in interest rates indicates a rise in the general level of asset class expected returns, particularly for fixed income. The change is more significant than what was seen in the quarter before last.
Rising interest rates and equity prices reflect rising growth expectations. For the first time since the financial crisis began, this is reflected in fundamentals, too, so price rises haven't eaten all of the expected growth already.
For overseas equities, both developed and emerging markets, the improvement is modest and less than we see for bonds.
Higher long term interest rates mean higher long term expectations for cash. Still, short-term rates have not yet moved, so the cash outlook has risen but only a relatively small amount in the short term and a diluted amount in the long term.
UK Government Bonds
Rising interest rates mean higher yields from bonds and less asymmetrical risks. A steeper yield curve is additionally attractive for bonds as yields are also expected to rise faster. As a result, expected returns from gilts and government bonds have risen significantly, even in the short term.
Index Linked Bonds
The rise in nominal interest rates was also carried through to real bond yields, so expected returns for index-linked bonds have also boosted. However, with long-term interest rates still hovering around the -2% mark, returns remain depressed. Still, this quarter’s marginal change is a noticeable improvement.
UK Corporate Bonds
Corporate bonds outperformed sovereign debt this quarter, but rising growth expectations on the back of economic recovery and improving expectations for corporate fundamentals are suitable for the credit outlook, so corporate bonds have enhanced prospects.
Global Government Bonds
A steepening yield curve across numerous developed economies means prospects for global govies are also on the up this quarter. A sizeable contribution from US sovereign debt and, to a lesser extent, Eurozone government bonds are the key drivers for the improvement.
High Yield Bonds
High yield bonds had a better quarter (and indeed year) than investment-grade bonds, and rising growth expectations mean that some benefit still filters through and prospects for non-investment grade credit are also up.
For UK equities, some uncertainty about the ability of UK companies to make it through Brexit and the Coronavirus crisis has been resolved. At the same time, there has also been good news from some important sectors such as mining. The result is a relatively strong showing for UK equities.
Despite the aggressive fiscal stimulus and the beginnings of recovery out of the Coronavirus pandemic feeding the reflation trade and increasing equity prices to record highs this quarter, fundamentals have kept up to an extent. The outlook for US equities has still improved, but not quite to UK levels.
There is an uptick in the outlook for European equities. Notwithstanding poor vaccine rollout relative to the UK and US, European equity prices were among the more significant risers amongst developed markets this quarter. More robust fundamentals on the back of pent up demand from the pandemic and the promise of a strong recovery budget mean rising prices have not completely eaten up growth expectations.
Another state of emergency, one of the slowest vaccination rollouts in the developed world and possible cancellation of the Olympics are bad. Still, Japan’s Covid crisis is not the same as ours, and equities had a strong quarter, albeit in terms of the weak yen. Nevertheless, spring is in the air in Japan too, expectations for fundamentals are elevated along with expected returns.
Asia-Pacific ex-Japan Equity
The easing of local lockdowns across the region and signs of economic recovery meant Asia-Pac equities benefited over the past quarter. Still, a rising US dollar makes non-dollar company earnings less attractive at the same time as squeezing them where they depend on US Dollar financing. Despite expectations of recovery, a strong US dollar means growth prospects have improved less than the major markets.
Emerging Markets Equity
As with Asia-Pac equities, a rising dollar makes non-dollar company earnings less attractive while squeezing them where they depend on US Dollar financing, which meant that emerging markets stocks also found themselves at the foot of the table this past quarter. These effects are expected but, with India and Brazil both still facing growing Coronavirus problems, prospects for this asset class, though up, are clearly laggards.
Property prospects have recovered slightly as the long term outlook has improved. This means a noticeable improvement from merely bleak, but the short term outlook remains below par.