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2018 Mid-Year Outlook

A New Narrative Emerges

Our aging business cycle continues, but the underlying narrative has shifted. Today the Fed is in tightening mode. U.S. Congress and the Administration are dumping massive stimulus on the economy at a time when the unemployment and U.S. savings rates are low and inflation is slowly trending upward. We anticipate strong U.S. growth in the second half of the year, with a risk that this growth could drive the U.S. dollar higher and/or speed Fed tightening, either of which could hasten the cycle’s end. A more likely scenario: an environment not unlike the mid-2000s, characterized by decent U.S. growth, widening U.S. trade deficits, modest inflation, emerging market strength, and rising foreign reserves. This base-case outlook favors equities, particularly emerging market and global cyclical stocks, and relative stability in credit, the U.S. dollar, and interest rates.

Global Landscape

We’ve examined macroeconomic conditions (PMI), policy guidance (interest rates), and current real yields to help you understand some of the most crucial factors for global investing. Explore selected economic and financial data for countries around the world below.

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Regional Views

What risks will tighter U.S. monetary policy pose to the global economy? How do international equity valuations stack up against U.S. stocks? Should credit investors consider adding international exposure, especially to emerging markets?

For answers to all of these questions and more, take a closer look at the investment implications of policy and valuations on a regional level.

2018 Mid-Year Outlook
  • United States

    Countries 1

    Total GDP $19.7T

    Total Population 334M

    While U.S. growth remains solid, the intensifying risks to the expansion from a strong dollar and higher U.S. Federal Reserve (Fed) policy rates loom large over the current U.S. outlook. Additional fiscal stimulus, however, will help maintain growth in the near term and inflation looks set to remain subdued, leading to a still-positive outlook for the second half of 2018.

  • International

    Countries 20

    Total GDP $26.0T

    Total Population 608M

    So far, 2018 has seen a cooling of the optimism that accompanied the strong Eurozone growth of 2017. The Citi Economic Surprise Index (CESI) has indicated that almost all of the economic releases for the Eurozone this year have disappointed. This masks a continued strong growth story from the Eurozone, and sentiment may have grown too pessimistic on the continent.

  • Emerging Markets

    Countries 23

    Total GDP $27.6T

    Total Population 3.8B

    Emerging Market (EM) growth continues to exceed expectations since bottoming in 2016. Recent jitters related to Fed tightening in the United States has caused some EM currency weakness. This may be a buying opportunity for EM assets, however, as any dollar strength will likely be transitory and the underlying economic story remains strong.

Policy
  • Easy monetary policy helped drive the initial years of the current business cycle and suppress financial market volatility. It is of little surprise then that Fed balance sheet reduction and interest rate hikes returned volatility to more typical levels.

    Investors should expect this new regime to persist, especially as the Fed attempts to raise interest rates multiple times over the next two years. Fortunately, the usual trappings of the end of a business cycle—high and rising inflation, an inverted yield curve, an unstable U.S. dollar—are still not evident.

    Source: FRED, 4/30/2018. Past performance does not guarantee future results.

  • The European Central Bank (ECB) remains accommodative, even as it has declared its intention to cease quantitative-easing-related and bond buying this year. This has helped keep sovereign spreads on most European debt at low levels, which helps to support the recovery even as optimism from 2017 cools.

    Source: Bloomberg, OppenheimerFunds, 5/11/18. Note: Sample Return = point-to-point, buy-and-hold strategy since 2003. Excess Return = Median Return minus Sample Return. Success Rate = % of positive returns from contrarian strategy since 2003. CESI = Citigroup Economic Surprise Index. MSCI Euro Index net total returns in euros. Past performance does not guarantee future results.

  • Lower inflation has helped most EM economies maintain accommodative monetary policy. The recent strength of the U.S. dollar and higher U.S. interest rates, however, have forced some weaker countries with large current account deficits, like Turkey and Argentina, to take more aggressive steps to shore up their currencies through higher benchmark rates. This does not look like an EM-wide inflection point, however, and most economies, particularly China, remain in robust financial health and can continue to support their economies through policy.

    Source: Bureau of Economic Analysis 3/31/18. Past performance does not guarantee future results. 1*: Economic Growth and Tax Relief Reconciliation Act of 2001; 2*: Jobs and Growth Tax Relief Reconciliation Act of 2003; 3*: Tax Cuts and Jobs Act

Valuation
  • The outlook for equities broadly remains positive, despite stretched valuations in the United States and higher market volatility. Opportunities remain in U.S. equities, but selectivity remains key. International and emerging market stocks still present more compelling value at this point in the cycle. Within fixed income, credit spreads remain tight by historical standards in the United States. There, too, investors would be better served by looking to non-U.S. markets for total return and yield, notwithstanding recent strength in the U.S. dollar, which we believe is temporary.

  • European equities are trading well below their U.S. counterparts on a price-to-forward earnings basis, and offer significantly higher dividend yields. Global investors looking to diversify away from overvalued U.S. equities and credit should consider opportunities present in Europe, where much-anticipated earnings and credit cycle upswings are currently underway despite the negative headlines and modest underperformance in the first half of 2018. We believe this remains one of the best opportunities for equity investors today.

  • Compelling valuation opportunities exist at a time when many emerging economies have stabilized and expanded. Also, EM sovereign and corporate bonds offer better value for global fixed-income investors seeking potentially higher total returns, in our view. The bottom line is that those who remain underexposed to international and EM assets may need to rethink their allocations, especially as near-term currency weakness offers attractive entry points for U.S.-based investors.

Equity
Fixed Income
Current
Average
Discount/Premium

Sources:  Bloomberg, FactSet, 5/31/2018.

Asset Allocation Views

Equities remain the asset class of choice, but investors who remain underexposed to international and emerging market assets may need to rethink their allocations. Further, the risk in the U.S. credit markets, given current valuations, is higher than it is in equity markets. Investors should maintain exposure to U.S. credit, but proceed with caution. Here too, international exposure, particularly in emerging markets, may prove beneficial despite near-term weakness in many EM currencies.

FavoredFavoured Equity Assets
Details
Related Funds
Emerging Markets
Developed Markets
Equity - Emerging Markets
Why is this favoredfavoured?

Emerging market equities continue to offer attractive valuations.

United States
International
Equity - International
Why is this favoredfavoured?

Developed market equities outside the U.S. are likely to appear more attractively valued as the earnings cycles in Europe and Japan continue to evolve.

Equity - Growth
Why is this favoredfavoured?

In an environment of moderate U.S. economic growth, investors will pay a premium for growth stocks. Value requires a catalyst (i.e., a steeper yield curve) that we do not believe is imminent.

FavoredFavoured Fixed Income Assets
Details
Related Funds
United States
International
Fixed Income - International
Why is this favoredfavoured?

Despite near-term higher yields in the U.S., investors should still look to non-U.S. markets for higher real yields supported by solid economic fundamentals.

Corporate Credit
Treasuries
Fixed Income - Corporate Credit
Why is this favoredfavoured?

U.S. credit spreads remain tight by historical standards. Investors should look to U.S. credit today for income only, rather than total return.

Short Duration
Long Duration
Fixed Income - Short Duration
Why is this favoredfavoured?

Short-term rates are now above the rate of inflation and not significantly below that of long-term rates. Shorter maturity securities provide investors with flexibility to reinvest at potentially higher rates. The better risk-return profile is at the short end of the curve.

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