Taking a step back from the usual economic and market insights, my September commentary is devoted to a topic that I’ve been long overdue in addressing. Financial advisors have frequently asked about my approach to asset allocation, and I’ve outlined my strategy for diversifying within the US equity space in my commentary, “Harnessing the Market’s Natural Rotation: An Asset Allocation Strategy.”
Here, I’d like to provide a summary of my outlook, which remains unchanged from the previous month.
Risk assets moved higher in August
Global equities advanced in August, closing just below the all-time high set in June, as measured by the MSCI All Country World Index.1
Leading for the month were US equities, up 3.8%, followed by emerging markets, up 2.1%.1 European equity returns were basically flat in August, up 0.2%, while Japanese equities sold off, down 2.2%.1 (Regional equity markets are represented by the MSCI USA Index, MSCI Emerging Markets Index, MSCI Europe Index and MSCI Japan Index, respectively.)
Emerging market equities registered the fourth consecutive month of outperformance relative to global equities and brought their year-to-date return to 8.5%.1 Latin American equities have been surprisingly strong: up 7.8% last month and 24.6% in the six months ended Aug. 31, 2014, led by Brazil, up 10.8% and 31.8% over the same periods, respectively.1 The excitement about new political leadership in India (up 24.8% year-to-date) this year has spread to Brazil.1 The markets appear bullish that a new, pro-growth leader could be elected in October, as Brazil fell into recession earlier this year. (The equity market performance of the emerging markets, Latin America, Brazil and India are represented by the MSCI Emerging Markets Index, MSCI EM Latin America Index, MSCI Brazil Index and MSCI India Index, respectively.)
Once again, liquidity seems to be trumping fundamentals, as low interest rates encouraged investment in risk assets. US small-cap stocks, which have been tracking US high yield corporate bond spreads, rose 4.85%, outperforming large-cap stocks, up 3.92%, in August.2 (Small- and large-cap stocks are represented by the Russell 2000 Index and Russell 2000 Index, respectively.)
US: Overweight
The disappointing payroll gain of 142,000 in August is likely an outlier data point, as I believe it appears inconsistent with the rise in the Institute for Supply Management Manufacturing Index and the sustained decline in unemployment claims.3
I continue to like US equities because gross domestic product growth is strong enough for companies to potentially grow earnings and valuations are elevated but not extreme enough to stifle the market’s upside potential. The US Federal Reserve’s accommodative monetary policy may continue to drive capital into equities.
Europe: Neutral weight
The European Central Bank took bold steps in early September, lowering interest rates and pledging to buy asset-backed securities to provide additional capital for banks. Excess liquidity has been a primary driver of US and Japanese equity performance and could trigger a similar result in Europe.
Japan: Overweight
The prospects of additional liquidity injections, a corporate tax cut and additional fiscal spending may take the Nikkei 225 Index higher. Additionally, in early August, the Nikkei broke out of a seven-month trading range, suggesting further upside potential.4
Emerging markets: Underweight
The MSCI Emerging Market Index has continued to rally despite deteriorating fundamentals in some major markets. The largest economies in emerging Europe, Asia, and Latin America — Russia, China and Brazil — are slowing.5 However, improving investor sentiment and momentum could continue to take this asset class higher, if interest rates stay low. That being said, I continue to believe the risk-reward profile is unattractive.
1 Source: Bank of America/Merrill Lynch, Sept. 1, 2014
2 Source: Bank of America/Merrill Lynch, Sept. 2, 2014
3 Source: Gluskin Sheff, Sept. 8, 2014
4 Source: Bloomberg LP, Sept. 16, 2014
5 Source: Bloomberg LP, as of June 30, 2014
Important information
An investment cannot be made directly in an index. The S&P 500® Index is an unmanaged index considered representative of the US stock market. The MSCI All Country World Index is a free-float-adjusted market-capitalization-weighted index designed to measure the equity market performance of developed and emerging markets. The MSCI USA Index measures the performance of the US equity market. The MSCI Emerging Markets Index is a free-float-adjusted market-capitalization index designed to measure equity market performance of emerging markets. The MSCI Europe Index is a free-float-adjusted market-capitalization-weighted index designed to measure the equity market performance of the developed markets in Europe. The MSCI Japan Index measures the performance of Japan’s equity market. The MSCI EM (Emerging Markets) Latin America Index is a free-float-adjusted market-capitalization weighted index designed to measure the equity market performance of emerging markets in Latin America. The MSCI Brazil Index measures the performance of Brazil’s equity market. The MSCI India Index is a free float-adjusted index designed the measure the performance of India’s stock market. The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. The Institute for Supply Management (ISM) Manufacturing Index is a commonly cited gauge of manufacturing conditions based on surveys of more than 300 manufacturing firms conducted by the ISM. The Nikkei 225 Index (or Nikkei Index) is a price-weighted index measuring the top 225 blue chip companies on the Tokyo Stock Exchange and is commonly considered representative of Japan’s stock market.
The European Central Bank (ECB) is the central bank responsible for the monetary policy of the European Union.
Past performance is no guarantee of future results.
Asset allocation does not guarantee a profit or eliminate the risk of loss.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
Smaller companies offer the potential to grow quickly, but can be more volatile than larger-company stocks, particularly over the short term.
Junk bonds involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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