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Favour equities over bonds in 2018, says UOB Private Bank's CIO
FAVOUR equities over fixed income in 2018, says UOB Private Bank chief investment officer Neo Teng Hwee. But rein in expectations of returns as valuations are elevated this year.
2017 has turned out to be a Goldilocks environment for investors, thanks to easy monetary policy and synchronised global growth amid the absence of inflation. The consensus global growth forecast is "healthy" for 2018 at 3.6 per cent.
"One of the most important factors to consider is the sources of growth. Businesses are starting to invest; non-residential capex is recovering in many parts of the world," said Mr Neo.
Mr Neo said markets are past the point of "peak liquidity" as central banks in the US and Europe are poised to begin to reverse quantitative easing, but this isn't likely to be a drag on markets as "there is real earnings growth". "Peak liquidity will not be a constraint on growth as the actual credit creation has been smaller than what would have been explained by QE." The Federal Reserve is widely expected to hike rates once in December, and two to three times more in 2018.
He added: "The cycle still has legs; there is still room for growth. We're past the most accommodative point of peak liquidity, but it's not a show-stopper for growth."
Equities, he said, are expensive relative to history, but they are not as expensive as bonds. "The key thing is earnings. We believe there will be prospects for earnings growth in 2018." One driver for this is revenues, which are linked to GDP, and the other is margins. In terms of profit margins, Asia and the emerging markets offer the greatest potential to expand to the previous margins peak in 2007.
Stock markets in Asia and the emerging markets have outperformed the MSCI World and the S&P500 indices year-to-date. The MSCI Asia ex-Japan Index has returned over 32 per cent this year, and the MSCI Emerging Markets 27 per cent. The S&P500 and MSCI World have both returned over 17 per cent.
Asia's performance this year is unlikely to be repeated in 2018, said Mr Neo. "But we expect returns to be pretty decent at 8 to 15 per cent." His preferred markets include Europe, Japan, China, Korea and India where valuations are more attractive. In fixed income, Mr Neo notes that credit spreads are tight. His preference is for US high yield, Asian investment grade and emerging market local currency debt.