The most dominant theme in our global tactical asset allocation strategies is our continuing overweight allocation to stocks and underweight in bonds. In addition, our portfolios hold a diversified basket of tactical bets. These are diversified across asset types, countries and currencies.

Stocks versus bonds
The performance of the global equity markets year to date depends on your reference currency. From a US dollar point of view, on average, global stock markets are up a little more than 13% year to date. However, from the perspective of an investor in the eurozone, they are up less than 2%. When we examine the underlying data, most of the stock markets evaluated in their local currency have performed in line with long-term expectations. The US market is up 10%, European markets are up 8% on average, and the UK market is up more than 9%. Earnings expectations have been the primary driver of market performance. On average, earnings forecasts are up more than 10% since the start of the year. At the same time, long-term interest rates have not had a significant change. They generally rose during the first half of the year and have fallen back since then, so that they have returned to levels similar to those at the start of the year. As a result, when we evaluate the valuation of stocks relative to bonds, we consider stocks to be cheap in most of the countries around the globe and therefore we continue to hold a significant overweight position.

View of Global equity markets
In implementing our global strategies, Mellon Capital Management makes its country equity market bets on a currency-hedged basis. However, here, presenting our views of the markets’ relative attractiveness from an unhedged point of view may be more appropriate.

If we were to invest in a global equity strategy without hedging currency exposures, we would be short US equities. The inflation-adjusted, forward-looking expected return from US equities is below average. That is because the real earnings yield is less than average, while the real expected earnings growth is not high enough to offset the valuation. The markets that we would overweight are Spain and Hong Kong. Both have above average real and currency hedged expected returns. Spain’s real earnings yield is above average, and in addition, its real earnings are expected to grow faster than average. The argument for Hong Kong is a bit different. It is attractive in spite of its above average multiple. That is because its expected earnings growth is more than fast enough to justify the valuation.

View of global bond markets
We find UK gilts attractive relative to sovereign bonds in most of the other developed markets. We see this whether we look at the term premium (excess return over rolling cash), or the real yield (yield in excess of expected inflation). In addition to capturing the higher yield, given that inflation expectations and risks are similar in the UK relative to the other markets, we expect the term premia to converge. When that happens, gilts should outperform due to the repricing of the bonds. We find the opposite situation in Canada. The term premium, whether measured versus rolling cash or versus expected inflation, is quite narrow.

Currencies
Our currency views are based on profiting from the carry trade as well as taking advantage of currency movements caused by capital flows and trade flows. We continue to favour the New Zealand dollar. Short-term interest rates in New Zealand are the highest in the major developed markets, and a beneficiary of the carry trade. In addition, we expect the above average interest rates to attract capital flows into the country, supporting the New Zealand dollar. The currency is a bit expensive from a purchasing power basis, but not enough to offset the other factors. We continue to avoid the Swiss franc. It has the lowest interest rate (other than Japan), so holders of the Swiss franc will lose on the carry. The Swiss franc appears inexpensive on a purchasing power basis, but not cheap enough to offset the loss from the carry and to fight the headwind from capital outflows.