Summary

Global growth is decelerating and corporate earnings forecasts are being lowered, but stock markets are climbing to record highs. This is not entirely easy to understand. All else being equal, it suggests that caution is advisable.

We believe that in the near term, the stock market is excessively optimistic. Sentiment has shifted from pessimistic to highly optimistic in the course of a few months. It therefore looks like a stock market correction is in the cards. A better economy has largely been priced in, which limits upside stock market potential in the near term. For tactical reasons, we thus recommend holding a smaller proportion of equities than usual.

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Summary

Brighter international picture

Yet this autumn’s share price gains are supported by a number of positive forces. The international situation is stabilising, with progress in trade talks, bright spots in the Brexit gloom and – especially – central banks that are rushing to rescue economic growth by means of key interest rate cuts and bond purchases. We expect recession to be avoided, due to a soft landing in growth. Meanwhile interest rates and yields will remain low for a long time.

Stock markets reaching new record highs

Stock markets are reaching new record highs, despite weak macroeconomic statistics and gloomy purchasing managers in manufacturing. The latest quarterly report period has surprised markets on the upside, compared to low expectations. Together with the above-mentioned positive forces, this has been enough to support share prices.

Challenging valuations but few alternative sources of returns

Share prices may very well keep rising, but the risk picture should still make prudent investors cautious. This year's sharp share price upturns imply that much of the good news is already priced in. This opens the way for price declines. Challenging valuations and muted corporate earning growth will also limit stock market potential. Meanwhile there are few alternative sources of returns in today's ultra-low interest rate and bond yield environment.

Investors are being driven further out on the risk scale

Because of the increased presence of central banks in the fixed income market via quantitative easing and their extremely low key rates, interest rates and bond yields remain low – although since early autumn they have moved higher. Our view is that there is still room for yields to fall from current levels. We prefer credits (corporate bonds) with a higher risk to government bonds. Fixed income investments in emerging markets are also attractive.

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