Having been on an upward trajectory since 2009, investors are now debating whether the US equity bull run is on its last legs and how long it will take the rest of the market to follow suit.
But while economists argue over the timing of interest rate rises and how far into the market cycle we are, Christofel, multi-asset income manager at BlackRock, believes that real economic growth still has some way to go.
“Over the last few years we have observed quite a meaningful divergence between the real economic cycle and financial market cycle,” he expanded.
“We are a lot further into the financial market cycle than the real economic cycle, so we are pretty optimistic on the prospects for global growth on a forward-looking basis.
Christofel points out that the globe is still working off the tremendous amount of slack that was created during the financial crisis.
“The global recovery has frankly been pretty anaemic, particularly in the US and Europe, where slack is still quite significant,” he said.
But, he added: ““We are now starting to see a meaningful response from European economies. It is playing out at different speeds in different countries, due to respective starting points and structural factors. But across the swathe of data we are seeing progress, and we expect to see stronger growth from both the US and Europe.”
While he is positive on the prospect of further real economic growth, relatively high valuations across the global market mean investors should tone down their return expectations.
“Some of what we are seeing is driven by central bank actions,” said Christofel. They are engaged in trying to inspire confidence in both financial markets and the real economy – so far most the impact has been felt in the financial market.
“In financial markets, asset prices in both equities and fixed income are fair, bordering on expensive. While we may still have a number of years to go in terms of where we are from a real economy stand-point, going forward, return expectations need to be much more modest.”
Straying from the beaten path
So how should investors approach this cyclical contrast?
“Investors need to far more wary of the risks, because at the moment the margin of safety being invested in any number of assets is much thinner given the higher valuation starting point,” Christofel expanded.
“To generate attractive income against this backdrop, investors need to go beyond the obviously lower-quality or long-duration trades that characterise a lot of income strategies. We have pulled back significantly on our exposure to interest rate risk.
“One thing we continue to like in equities, especially given that returns are likely to be muted, is employing a covered call strategy, where we are long individual stocks but sell out of the call options to generate incremental income. We typically sell call options that are 5-8% out of the money with one to three months to maturity.”
Christofel also favours the housing market, particularly in the US and UK, though he believes that in order to use their money to maximum effect, investors should employ debt instruments rather than buying equity-related investments.
He said: “A lot of income-orientated investors buy REITs or property-related [equity] investments, whereas we have little exposure to equity-related property investments and prefer to gain exposure to the strengthening housing market cycle, particularly in the US, via debt investments.
“Housing fundamentals continue to be strong both inside and outside the US, such as in the UK, so we have been buying distressed mortgages at significant discounts and playing the housing market recovery through those instead of relatively expensive equities.”
