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With the recent turbulence in equity markets, our Multi-Asset Class developed market (DM) equity forecast has now turned neutral from positive for the first time in over a year. The drivers of this forecast are quite intuitive and this shift in the signals is notable given the changes in market dynamics in recent months. Global interest rates started to increase a few months ago driven by the anticipation and actual winding down of central bank quantitative easing programs as well as interest rate hikes by the Fed and a few other central banks. This stimulus withdrawal from developed economies led to a negative contribution to our forecast (dark green area in Figure 1) over the past few months from the stimulus component of our framework.
At the beginning of 2018, when equity markets were rallying, sentiment (momentum) and credit conditions were very strong and thus made materially positive contributions to our forecast (as represented by the darker orange and red areas in Figure 1). However, as markets turned in February, the positive contributions from these themes neutralized.
We still find global DM equities attractively valued (dark blue area in Figure 1) – this is because we compare valuations to the level of short-term interest rates. Even though U.S. short-term rates have been increasing, they are still low relative to history and other large developed market countries such as Japan and Germany have short-term rates at or below zero.
Finally, while these broad market forecasts are part of the MACS process, the majority of the risk budget comes from market neutral asset selection – that is why our current strategies are absolute return in nature.
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