Summary of key points


The key issues for investors to consider are:

  • While worldwide inflation and short-term interest rates remain lower than usual and are likely to do so for the next few years, long-term bond yields have started to move up, as we expected.
  • This will not severely impact equity prices until the US ten-year Treasury bond yield moves from where it is now, around 2.7% p.a., to over 4% p.a. This will probably take several years but it could conceivably happen within the next two years. We need to be watchful that the current strong momentum in equity markets doesn’t run out and reverse.
  • Equity market volatility is more likely than not to continue to be low (below 25 as measured by the VIX) over the next 12 months.
  • There are some potential triggers for a short term sell off, such as tensions and possibly war between North Korea and the USA or between Iran and Saudi Arabia, but the eventuality and the timing of these are hard to predict.
  • More likely catalysts include policy maker mistakes, such as too much monetary tightening in China or too rapid an increase in interest rates by the Federal Reserve in the USA. In addition, there is the prospect that the current de facto currency devaluation war between the US and Europe and Japan could escalate and become a source of greater instability. The early warning signs of these sorts of catalysts will be easier to discern and act on than geopolitical shocks.
  • In summary, with equity markets continuing their upward momentum at the same time as bond yields are rising, the tension between the two markets is rising and we are now closer to the resolution of the conflict, which usually comes in the form of an equity market decline. While we are closer to this, the current combination of benign monetary policy, stimulatory fiscal policy and synchronised world GDP growth will probably support equity markets through 2018 and possibly into 2019. We will continue to monitor conditions to anticipate the need to shift from growth assets to defensive assets.



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