Fixed income valuations are currently within reason and stock prices can continue to move higher as long as the current financial landscape of moderate US growth and tame inflation stays in place, according to Barclays’ latest flagship quarterly research publication, Global Outlook: Window for risk assets narrowing. However, the risks to rising asset prices are growing and the bar for stronger equity performance has gotten considerably higher. “The primary threat to market stability during the early months of 2014 is a greater-than-expected pickup in the US economy, which would lead investors to anticipate a quicker start to rate hikes and challenge current fixed income and equity valuations,” said Larry Kantor, Head of Research. “However, as long as growth stays in the 1.5%-2.5% range seen since the start of the expansion, we believe that the Fed will continue to provide extraordinary support and be able to convince investors that rate hikes are still over the horizon, allowing them to stay safely on the equity bandwagon.” Anticipating a benign near term environment, the Global Outlook maintains its existing asset allocation recommendation to stay modestly overweight equities and underweight fixed income over the next few months. However, the risks to stocks are likely to increase through 2014, as investors begin to anticipate the start of Fed rate hikes. There is less slack in the US economy than commonly perceived, and both growth and inflation are likely to grind higher over the next year. Before 2014 is over, fear of the onset of monetary tightening is likely to produce another leg up in bond yields and threaten stock valuations as well. Given the sharp rise in equity prices that has occurred already, investors should take advantage of current attractive opportunities to hedge long stock positions and adopt a more cautious approach through a balanced portfolio.
Recommendations in the Global Outlook include:
- Underweight US equities in favor of Europe and emerging markets equities
- Favor internationally exposed Japanese stocks
- In fixed income, focus on long duration assets and avoid the "belly" of the curve, which remains vulnerable to concerns about policy tightening
- In credit, favor high yield over investment grade in the US and prefer European over US corporate bonds