Where are the asset class investment opportunities?
The chart illustrates the effect of current valuation on expected return over the next five years.
Buying undervalued assets results in positive valuation returns. Buying overvalued assets results in negative valuation returns.
Reflecting confidence in the sustainability of the recovery and the support of Fed policy, investor preference for US equities continues to drive relative valuations higher. Conversely, the lack of investor confidence in the nascent recoveries and central bank support in Europe and Japan continues to make those equity markets most undervalued. Relative outperformance of small cap in most markets globally in recent years has made them pricier versus large cap. Emerging market equities are a mixed group, with some markets very undervalued and others very overvalued – resulting in a fairly valued asset class. The potential ending of generous major central bank monetary support looms overhead as the primary concern for emerging market investors.
This monetary support continues to prop up all risky asset globally, while reducing the attractiveness of major government bond markets. Low and high quality credit enjoy the same support as equities. The potential for monetary policy spurring rapid growth and inflation, and potential policy tightening, is the major risk for all bond investors. US high yield and high quality credit spreads are just below normal while emerging market spreads are near record lows. Developed market non-US government bonds offer better near term cyclical value despite overvalued currencies.
