Within the core part of our balanced portfolio, we cover traditional liquid assets such as equities, fixed income and commodities. The chart shows how we would currently design a balanced portfolio, including alternative asset classes.2
The U.S. equities “bull” market may soon become the third longest ever. As a result, U.S. valuations have reached high levels and sector selectivity is needed, particularly given uncertainty over future corporate earnings growth. Valuations in some other developed markets may look more attractive. Japan is benefiting from upwards revisions to earnings estimates. After their rally European shares have closed their valuation gap to the United States and trade at historically high valuation levels. Within the emerging markets, we continue to favor Asia over Latin America and EMEA (Europe, the Middle East and Africa) and would suggest staying focused on markets showing solid economic fundamentals.
The divergence between U.S. Treasury yields and German bund yields is set to continue. The ECB’s QE program is smaller than the Fed’s in relation to GDP, but much larger in relation to net bond issuance, and this is reflected in negative yields for shorter maturities in several Eurozone economies, not just Germany. As regards corporate bonds, history suggests that high yield spreads tend to narrow after a Fed rate-hiking cycle begins. Opportunities will also exist in emerging-market bonds, although these will vary between hard currency and local markets and according to the investor’s home currency.
We are a little more optimistic on commodities as we expect to see some stabilization in prices around current low levels. However, while commodities have in the past outperformed during periods of rising inflation and/or interest rates, both oil and gold prices continue to face headwinds. For oil, the problem remains essentially one of oversupply. Reductions in U.S. rig count have not translated into falling output, and U.S. oil inventories have continued to rise. As a result, any further recovery in oil prices is likely to be gentle. Gold prices are likely to be range-bound for the next quarter or so, but could benefit later in 2015 from any evidence that a stronger U.S. dollar is depressing U.S. growth.