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Beware of Greeks near Fed rate hikes

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We’re cautious heading into these events, but will be looking for opportunities if markets pull back.

Going forward, we still have a preference for European equities and dislike long-term interest rate exposure.

Financial markets are transfixed by two upcoming events: the negotiations around the Greek bailout and the timing of the first interest rate increase by the US Federal Reserve (the Fed). Will Greece stay in the euro? And will Fed chair Yellen announce the first Fed rate rise in nine years?

We expect a September rate hike and that Greece will stay in the Eurozone but there is a large amount of uncertainty around both events. Markets hate uncertainty, which points to rising volatility.

Our core views about the global economy are unchanged from those in the previous update to our global outlook, published at the end of March. We’re still looking for moderate growth in the US. We also think the European recovery is becoming more entrenched and that Japan is improving. Emerging markets economies remain under pressure and in our view the China slowdown has further to run.

Noting that US economic data points were soft over the early part of the year, our North American strategist, Paul Eitelman, expects a turnaround driven by robust mid-single-digit growth in corporate profits. He expects the economy to produce 2.5% to 3% gross domestic product (GDP) growth over the second half of 2015. However, expensive US equities and low bond yields mean he is cautious on both asset classes heading into the Fed policy shift.

European equities have given up some of their gains over the past quarter, but our senior investment strategist Wouter Sturkenboom sees rationale for staying the course on European exposure. Wouter thinks that any further Greek-related unrest is a buying opportunity. Wouter also thinks the big recent moves in long-term European bond yields is a case of “flows versus fundamentals.” Central bank-driven flows in his view should win out in Europe and keep German Bund yields low, but fundamentals should put upward pressure on US and UK yields.

Asia-Pacific is a mixed story. Graham Harman, our director of capital markets research, sees more signs of improvement in Japan, especially through Abenomics’ “third arrow” of corporate reform and rising female workforce participation. China, Australia and New Zealand continue to slow, but this is being offset by more policy accommodation. Significantly deeper downturns seem unlikely in his view, while Japan remains the pick of the regional equity markets.

Our investment strategy process is based on both qualitative insights from our team of strategists and a range of quantitative models run by Abe Robison and Kara Ng. Most of the quantitative models have moved toward neutral over the past quarter. These confirm our qualitative assessment that neither the Fed decision nor the outcome of the negotiations over Greece will contain any nasty surprises. Thus, our strong conviction in moving to a neutral asset allocation stance for global equities versus fixed income.

This is an extract from Russell Investments’ Q3 research

 

 

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