Bilton noted that markets have been in the grip of what he calls a ‘reflation trade’, which is where investors have switched from bonds towards equities, and into those equities that do better in a world of higher inflation and economic growth.
Financial and mining stocks are typically viewed by the market as beneficiaries from an improving economic outlook.
Many investors now take the view that this trade has reached a peak, and that there may be little value left, particularly with the ream of uncertainties that currently populate the world.
But BIlton believes value remains in this theme. He said, ‘The reflation trade is in its infancy, but the muscle memory of ultra-accommodative policy will continue to profoundly influence asset markets in 2017. The world economy is currently enjoying its best period of coordinated growth since the aftermath of the financial crisis.’
He continued, ‘Economic momentum should broaden out further over the year, justifying continued faith in equities – hence we’ve increased our overweight conviction. Notwithstanding a possible period of consolidation, we think the aging bull market should continue to perform over 2017. Our preference is for US and emerging market equities and particularly for Japanese stocks, which have attractive earnings momentum. We’ve also upgraded our optimism on Asia Pacific ex-Japan equities on the basis of better data from China. European equity, while cheap, is exposed to risks around the French election, so for now we maintain a neutral stance. Meanwhile, UK stocks are our sole underweight due to the risks that Brexit poses to the UK economy. We’re maintaining diversification broadly across equity regions as a reflection of the more upbeat global environment.’
He concluded his comments with the remark that, ‘In extending our preference for stocks over bonds, we are reflecting two factors – first, that stocks should be well supported in an environment of coordinated global growth, and second that global yields are past their lows and set to slowly rise as the reflationary environment becomes more established. Aggregate equity valuations currently stand a little above their through-cycle average, but earnings are also beginning to rebound after lying fallow for much of the last couple of years. After taking account of valuations – both standalone and relative to other assets.’
Bonds traditionally perform poorly in a world where inflation is expected to rise. This is because, in the first instance, rising inflation is typically associated with an improved economic outlook. Because the income from bonds is fixed, investors typically reduce their exposure to that asset class in order to achieve higher returns from shares.
Bonds also tend to perform poorly in a world of rising inflation because the fixed income offered by the asset class because less valuable as inflation rises over time.