Following the sell-off of all asset classes post the FOMC meeting, AXA IM notes that a substantial part of the news is priced in and markets will shift toward a kind of ‘business as usual’. “It seems that the Fed is more confident with regard to the growth backdrop and thus convinced that tapering is justified. We (and the consensus) have a marginally less optimistic view and think markets will in fact continue to struggle over which route to follow – ‘fading easy money’ or ‘weaker (US) recovery’”, signals Axa IM in its July Investment Strategy Report.
Such uncertainty will most likely continue to weigh on the mood of investors in the near term
AXA IM has long held the view that any adjustment to a new regime is usually accompanied by higher volatility, as investors adjust to a new equilibrium. This is exactly what they have seen in the course of the month of June and is presumably best illustrated by their in-house risk appetite barometer (RAB), which moved into mildly negative territory in June but recouped de facto all of the lost ground at the beginning of July.
Stock market valuation has hardly changed
The combination of lower stock markets and marginally better earnings pushed the overall valuation metrics for the MSCI World down to 16.3x, versus 16.5x last month.
“Overall, we think that some more silver linings have appeared on the horizon and consequently suggest raising the equity weighting back to overweight as the cyclical head winds fade”, remarks the asset manager in its report. “If anything, the very clear message from the Fed Chairman, who reiterated the conditionality for starting the tapering, remains in our view the strongest support for risky assets (and a headwind for fixed income in the longer run).”
Axa points out that the ‘sustainable improvement’ in the labor market will be the acid test for the FOMC in the months to come. Against this backdrop, the liquidity withdrawal should come at a time when the underlying economic momentum is robust (even though not brilliant) enough to bridge the gap between the liquidity-driven market rally and an earnings push With regard to fixed income, Axa IM suggests remaining prudent over the longer-term horizon despite the recent substantial rise in yields. “We view the Fed tapering as the beginning of a normalization process which will distinguish three different episodes: i) less liquidity injection, followed by ii) a period of relative calm (mid-2014 to end 2014), followed by iii) the higher short rates in 2015.”
From a more tactical perspective, Axa IM suggests moving back to neutral as far as safe haven bonds are concerned, as the Fed’s tapering talk will most likely calm down.