Currencies
The BoJ's latest rate cut will not have much impact on the Japanese economy or currency. The BoJ and ECB are closer to the end rather than the beginning of their unconventional policies. The biggest policy event of the year will be a 180-degree reversal from the Fed. The divergence in monetary policies that drove the euro and yen lower is largely over.
Oil markets will continue to be buffeted by Russian overtures to OPEC suggesting a desire to orchestrate a production cut-back, while uncertainty over the Fed's next move keeps markets on edge.
Rising demand for U.S. dollars in EM and further yen depreciation, if it transpires, assures global exchange rate volatility will rise. Rising currency volatility, especially in the RMB, will push the global risk premium higher, weighing on global share prices. In Turkey, a wage-inflation spiral is unfolding and the central bank is behind the curve; the currency will plummet further.
It is highly unusual for equities to enter a bear market without the economy going into recession. Since we see the risk of recession as low, we recommend a neutral allocation between bonds and equities.
Any recovery in risk assets and selloff in safe havens is unlikely to extend into the cyclical horizon.
Last month, the model outperformed both global and U.S. equities in local-currency and U.S.-dollar terms. For February, the model is aggressively increasing its risk exposure and has included a bet on commodities for the first time since 2012. For equities, the largest overweight remains Europe, but EM and Canada enjoyed significant upgrades. For bonds, the model favors the European periphery.
While cyclical factors have contributed to the recent trade slowdown, there are many longer-term structural forces that will pose headwinds to globalization. A lack of aggregate demand will constrain growth and hurt trade in a global economy attempting to increase savings. Meanwhile, the bulk of economic dividends from free trade have already been reaped. The direct casualties from slowing global trade are economies with large export sectors: most commodity-producing countries and some south-east Asian nations.
The setback in global financial markets has not been enough to persuade the FOMC to alter its stance. Although the Fed is signaling that the tightening cycle has further to run, the U.S. dollar is showing signs of fraying at the edges.
Central banks follow backward-looking indicators but economies follow forward-looking indicators. So which indicators should investors follow? And what is the current message? Also, we see signs that London is cooling.
Corporate profits are more sensitive to selling prices than to volumes. Falling prices even amid mildly rising volumes could produce a meaningful profit contraction. Stay with deflation trades. In particular, maintain the short EM stocks / long U.S. 30-year Treasurys position. Indian stocks are still pricey and will deflate further in absolute terms.