By Giordano Lombardo
With summer comes a vacation, and with a vacation comes a journey. No journey is complete without packing the GPS and checking weather conditions. Similarly, no risk-minded investment is complete without first checking the financial climate – currently placid, although history suggests it could soon turn – and reviewing the GPS of global markets.
Our “GPS” for navigating market conditions (valuations) is pointing out that some areas of the financial markets are getting stretched. Core government bonds, credit markets and US equities are the most likely candidates for a bubble.
Focusing on equities, our valuation models based on Capital Adjusted Price Earnings (CAPE) indicate that Europe and some emerging markets (China) remain the most interesting investment opportunities. US equity markets appear less compelling according to models, cash flow and by profits.
Going forward, improvements in the global economy and the ongoing financial repression from central banks should continue to be mildly supportive for risky assets. With the lower and lower returns that we expect for all the main asset classes, we have already implemented a more defensive approach, reducing the size of our investment decisions without changing their direction.
We could also change the direction if our main scenario – multiple transitions in the main economic regions – were to be undermined or in the case of major unexpected events. With respect to the latter point, we prefer to focus on hedging what we believe are the main risks: deflation in Europe and an abrupt change in US monetary policy (i.e. a policy mistake).
At the same time, facing tighter financial market conditions, it’s important to continue to monitor valuations closely, in order to see when the “odds” with respect to our stance become less favourable.
More than ever, we believe that now is the time to keep our GPS switched on.
Giordano Lombardo is group chief investment officer at Pioneer Investments
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