Global geopolitical concerns weighed on sentiment in equity markets in July, reflecting the ongoing crises in Ukraine and Gaza. In addition, US Q2 GDP print was well ahead of expectations at 4% annualised, raising fears that the US Federal Reserve could be forced to raise US interest rates sooner than markets currently anticipate. Risk assets struggled as a result, with the MSCI World index producing a return of -1.6%.
In contrast, with the exception of Russia emerging market equities generally had a positive month, the MSCI Emerging Markets index gained 2%, as signs of economic growth stabilisation in China surfaced. While emerging market debt was resilient, Russian debt performed very poorly as EU ambassadors approved upgraded sanctions following the Malaysia Airlines tragedy in Ukraine.
On the other side of the world, 10-year US Treasury yields moved higher in July, ending the month at 2.56%, up from 2.53% in June. However, 10-year bund yields fell as some weaker-than-expected sentiment surveys and a below-consensus reading for the harmonised index of European consumer prices for July stoked deflation concerns.
In our asset allocation model, we continue to dislike core government bonds as we see better opportunities in corporate credit. However, it is important to highlight that the period of strong excess returns from credit is over and therefore we expect coupons to drive returns this year. High yield had a difficult month following Janet Yellen’s comments that lending standards for leveraged loans and some lower-rated corporate issuers had deteriorated.
Absent a decline in credit quality, the recent weakness in high yield could be seen as a buying opportunity, and will certainly provide fixed-income-only investors with food for thought. However, at this stage, we are not inclined to add to our exposure in our multi-asset portfolios.
We remain overweight equities via the UK and Japan and property. UK equities can no longer be regarded as cheap, but an attractive dividend yield continues to provide support. Moreover, the UK remains an attractive destination for global companies to deploy their surplus cash and we expect M&A activity to continue given that many businesses are reluctant to commit to investment capex.
One potential headwind is political risk, with the Scottish independence vote looming and a general election due in 2015. In Japan, valuations are attractive relative to other developed equity markets and recent evidence suggests that the increase in the sales tax is not creating a major headwind for Japanese corporates.
Commercial property values in the UK continue to recover and being supported by the lack of new development post the 2008 financial crisis, which has left supply constrained in a number of areas. Perhaps more importantly, the high real yield available from commercial property remains attractive in an environment where by historic standards, bond yields are very low.
