Matteo Germano, Global Head of Multi-Asset Investments, Pioneer Investments

Matteo Germano
Matteo Germano

With the retracement of government bond yields from 2017 highs and the US equity market range trading in April, many investors have started to question if the reflation trade is already over. We believe that this is not the case. In our view, it is just taking a pause and eventually will mature and become more widespread. While in the US we agree that markets have already discounted (and overestimated)  the positive effects of Trump’s fiscal stimulus, in Europe and Japan we are at an earlier stage of the reflation trade. Earnings growth acceleration in these areas could favour European and Japanese equities over US equities in the coming months. There are other signs that the reflation trade is going global. Global economic conditions remain relatively resilient, with confidence indicators in Developed Markets improving in both consumer and manufacturing sectors. Negative output gaps are closing in many economies and manufacturing prices are bottoming out, improving the inflation outlook. Monetary policies continue to remain accommodative, but Central Banks aim to gradually normalize their monetary stance. Fiscal policy, on the other hand, is turning more expansionary, even if the pace of this differs widely from country to country. The outlook is also becoming more positive for Emerging Markets, even if with differences among countries persist. We believe that China and India continue to be best positioned for the potential expansion of domestic demand and ability to perform structural reform. Consequently we are constructive on risk assets, especially  equity (mainly in Europe and Japan). However, we also see a resurgence of volatility due to a number of geopolitical risks ahead priced by the market: French elections with the threat of rising populism and anti-Euro sentiment, the UK Brexit process (and now a new election called for early June), and, more recently, a worrisome escalation in tensions with Syria and North Korea. Against this backdrop, we believe that investors should continue to keep hedging in place through volatility strategies, US Dollar exposure and Gold.

In recent months, three main themes have emerged, which may have an impact on asset allocation:

  • Reflation Going Global: The reflation narrative is still alive even though we are reaching a more mature phase. The Eurozone and Japan are in an earlier stage and should benefit from a more benign fiscal and monetary stance. The outlook for Emerging Markets is also improving, led by India and China.
  • Go Global on Equities: The improving global outlook supports a positive view on equities globally, with DMs and Europe in particular favoured vs EMs. Bonds remain exposed to rising rates and therefore require a flexible approach to manage rates sensitivity and search for opportunities across sectors and maturities.
  • Hedging Political Risks: After a first quarter of complacency, financial market are now getting more volatile as we enter the election cycle in Europe and global geopolitical tensions are also surging. Investors should consider adding sources of diversification, such as gold or USD exposure s hedging against tail risks

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