Valuations

A global portfolio is likely to return only 5.3% a year over the next decade, compared to 6.7% in the past. Investors either need to lower their return expectations, or take more risk. Our total return methodology remains consistent with previous editions, with changes limited to the Alternatives section.

In part 2 of this series, we discuss mainstream EM equity valuations and present the results of our cross-country analysis. The goal is to identify overweights and underweights within an EM equity portfolio.

High-Yield municipal bonds have performed well in recent years, but valuations are now stretched. We recommend an underweight allocation, though we prefer high-yield munis over high-yield corporate bonds.

Although the RMB has cheapened, macro conditions are not yet favorable for the Chinese currency. We expect the RMB to decline by at least another 5% in the next six months. A weak currency and subdued economic growth lead us to maintain a cautious stance on Chinese equities.

The S&P 500 rally broadened in July, lifting this year’s laggards. Surging long yields are altering the macroeconomic backdrop, as the market absorbs that monetary policy will stay restrictive for a long time. Yet, a move down in yields is more likely than a move up over a tactical horizon. Q2 earnings were better than expected but investors were unimpressed – the good news is already priced in. The market is overvalued and is close to being overbought, which makes it vulnerable to disappointment.

Investors remain cautious about the US economy and still have significant cash that needs to be put to work which could extend the rally further. Earnings rebound later in the year will be supported by rising sales growth and surging earnings of the Magnificent Seven. A restocking cycle, and a pickup in freight activity support transports. Upgrade Transports to an overweight.