We’re approaching the end of 2017, and the times are a changin’ for financial markets.
After years of central bank support, slowly but surely, they’re being left to stand on their own two feet.
The US Fed has been lifting rates and is about to start reducing the size of its balance sheet following years of asset purchases. And, more recently, the Bank of Canada has followed suit, lifting interest rates twice in the past two months.
Others, such as the Bank of England and Reserve Bank of Australia, are expected to join that list, potentially before the end of the year.
Throw in the prospect of tapering of asset purchases from the European Central Bank and it’s clear that the monetary punch bowl that has helped to fuel substantial market gains since the global financial crisis is slowly being taken away.
It’s got many wondering what will happen next.
Is the global economy really strong enough to deliver a self-sustaining recovery, or will tighter monetary policy deliver an unwelcome economic and financial shock?
Analysts at Citibank think it will be strong enough to absorb tighter policy settings, recommending that in such an environment emerging market stocks will outperform all other asset classes in the year ahead.
Here’s Citi’s latest medium-term recommended asset allocation mix.
In its opinion, emerging market stocks will thrive in the year ahead despite tighter monetary policy from major central banks, recommending an overweight allocation to investors.
“We increase our overweight in stocks this month by upgrading all emerging market (EM) equity markets to +3, continuing the trend from our last publication,” it says.
“The broad macro backdrop for EM is looking healthy, with data prints coming in strong since early 2015. And current account deficits — the biggest worry of investors a few years ago — are improving in large steps.”
Citi says this, along with low volatility, a softer USD, contained upside yield pressures and still attractive EM valuations should benefit these markets more than their developed market peers.
Outside of stocks, Citi says that government bonds in developed markets (DM) outside of the United States look set to underperform in the year ahead.
“In government bond space, we downgrade all DM government bonds excluding the US one notch,” it says, citing valuations and the potential for the ECB, BoE, BoJ to deliver hawkish surprises compared to the US Fed.
In the corporate credit space, it now recommends that investors go underweight.
“Within the asset class, we have downgraded US investment grade (IG) to neutral. We remain underweight in European credit where we are underweight both IG and high yield (HY), whilst we retain our -2 underweight in EM External,” Citi says.
On commodities, Citi says that it remains neutral the complex overall.
“Whilst retaining our neutral weights in the energy and base metal markets, this month we have upgraded gold back to neutral,” it says.
Finally, in terms of cash, it recommends that investors should hold a slightly overweight position in the 12 months ahead.
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