Less of a tailwind for global equities

Chief analyst Bo Bejstrup Christensen from Danske Invest explains why we have reduced our equity weightings.

Published 26.05.2016


Spring has arrived in more than one sense – the dark days of January with their fears of a Chinese collapse, US recession and European bank crisis appear to have vanished and optimism has returned once more. The reasons are obvious – growth in China and the US has picked up, the US central bank has clearly stated it is in no hurry to raise interest rates and the ECB has delivered yet another pronounced easing of monetary policy.

The results are equally clear – equity and commodity prices have increased, yields have fallen and the hardest hit emerging markets have recovered strongly. Unfortunately, we do not see this continuing and expect less of a tailwind and greater uncertainty in the coming months – which is why we have decided to reduce the equity weightings in our balanced portfolios from overweight to neutral. This time we are mainly selling off emerging market equities and in this blog we explain why.

Good news from the US
Growth in the US has picked up, which is reflected in rising business confidence among other things. We currently estimate growth at 1.5-2.0% and expect it to rise to around 2.5% as, for example, the negative shock of a firmer US dollar fades. The housing market, meanwhile, is continuing to recover, and while the bank system is clearly suffering losses on oil and gas-related loans, the banks are still steadfastly supporting households with access to consumer and home loans. We therefore expect to see around 150,000 new jobs created per month, lower unemployment and rising wages – all of which will benefit private consumption.

Eurozone growth remains stable
Eurozone growth clearly peaked in summer 2015 and has fallen slightly since then. No surprise really, as the region is no longer being supported by falling oil prices and a continuously weakening currency. Nevertheless, growth remains very stable and somewhat above the long-term potential, as the banks are continuing to ease credit conditions and thus support consumption and investment. Given the ECB’s continuing, rock-solid determination to stimulate bank lending and its very accommodative monetary policy in the shape of low interest rates and QE, we expect growth will continue at around the 1.5-2.0% level in the eurozone.

But – Chinese headwinds
However, what’s new – unfortunately – is that we now expect lower growth in China. Home sales have rocketed 35% in just four months, while house price growth has accelerated to more than 10% nationwide (annualised), with some cities hitting close to 50%. The driving force has been the cut in the down-payment requirement for home loans – from 30% to 20% for first-time buyers over just three months. Naturally this is a temporary phenomenon – encouraging people to buy today means they will not be buying tomorrow. We now expect this – combined with measures designed to slow activity in the most bubble-prone segments – will cause a fall in housing sales later in the year, which should slow the tailwind home construction has enjoyed.

While the authorities are continuing to stimulate the economy through, for example, infrastructure investments, they cannot continue to raise these investments indefinitely. We estimate the latest easing campaign has increased the overall budget deficit to more than 10% of GDP – financed through new and opaque channels. Total national debt growth has increased to more than 20% – which is simply not sustainable. We therefore now expect Chinese growth to slow, although we would again reiterate that China is not heading for a collapse, as the authorities have full control of the banking system.

We are now neutral on equities
The overall story therefore is: After falling sharply at the start of the year, global equities have enjoyed tailwinds from rising US and Chinese growth, increasing commodity prices and fewer worries about a tighter US monetary policy.

Looking ahead, however, we see modest headwinds from China in the shape of lower growth, while US growth will be robust enough to reduce unemployment further – which means the US central bank will have to get back to work and raise interest rates. Hence, we see fewer positive drivers for risk assets going forward, which is why we do not wish to hold more equities than normal. Roughly speaking, this means we no longer have more equities in our balanced portfolios than we would expect to have over the long term.

We expect the cocktail of economic forces outlined above will create mild headwinds for emerging market equities, while political risk in Europe, including the threat of a Brexit, means a deteriorating risk/return ratio for the region. We have therefore reduced our equity holdings to achieve a neutral equity weighting.