CIO Views: UK value and income, ECB policy and China’s disinflation
KEY POINTS
UK market offers income and value
Soft growth, sticky inflation and fiscal challenges have undermined confidence in the UK. However, the FTSE 100 index recently hit a new all-time high. As elsewhere, the UK market has seen its price-to-earnings ratio increase in the last three years. But valuations remain cheap relative to other markets, with a current multiple of just 12.8 compared to 22.5 for the S&P 500 and 14.3 for the Euro Stoxx. Earnings-per-share forecasts for both large- and mid-cap indices have also moved higher over that period, underpinning prospective returns. But income has been a huge contributor to UK equity returns. Over the past 20 years, total returns (dividends included) have been more than double the pure price return, with dividend returns averaging over 3.5%. With growth improving, inflation potentially set to fall, and gilt market real yields at multi-year highs, the UK offers income and value opportunities across both equities and bonds - despite the headline macroeconomic gloom.
Assessing the ECB’s policy stance
Eurozone interest rates have halved in just 12 months, and European Central Bank (ECB) policymakers believe monetary policy is now close, or closer, to neutral. We can assess how much closer the ECB’s policy rate is to this by looking at the gap between interest rates and core inflation. A year ago, rates were at 4%, and core inflation was running at 2.9%. This gap has evaporated – today rates are at 2% and core inflation stands at 2.3%. Another interesting metric is provided by forward curves. A year ago, both the one-year and five-year forward short-term euro interest rates were trading 100 basis points (bp) and 150bp below the deposit facility rate, respectively. But today’s rates stand right in between those forward rates, with the one-year forward trading 20bp below the deposit facility rate and the five-year forward 50bp above it. Note, the Eurozone’s potential growth and inflation target is probably 2.75%. Therefore, a long-run policy rate around 2.5% is not too distant from neutral.
Exporting disinflation risks
China’s deflationary backdrop persisted into its 34th month in July, with its Producer Price Index (PPI) unchanged. Persistent PPI weakness raises overcapacity concerns and affects export prices, increasing the risks of exporting deflation, ultimately challenging growth in other manufacturing economies. While this is largely tolerated, as many importers still grapple with elevated inflation, it could become problematic once their inflation rates fall within target ranges. China’s ongoing weak domestic consumption and strong manufacturing pose lasting disinflationary risks, and a weaker renminbi could be another potential conduit for deflationary spillover to other markets. China’s export competitiveness is broad-based, from technology to basic metals. With its trade increasingly redirected away from the US to European, and Asian economies, it makes them more susceptible to potentially greater competition from China. Meanwhile, emerging markets are increasingly exposed to a potential disinflationary impulse, with essential ‘core’ goods forming a larger part of Consumer Price Index (CPI) baskets and higher imports from China, as a proportion of consumption.
Implementation ideasUS HIGH YIELDRationale SHORT-DURATION INFLATIONRationale ROBOTICS AND AUTOMATIONRationale |
Asset Class Summary Views
Views expressed reflect CIO team expectations on asset class returns and risks. Traffic lights indicate expected return over a three-to-six-month period relative to long-term observed trends.
| Positive | Neutral | Negative |
|---|
CIO team opinions draw on AXA IM investment team views and are not intended as asset allocation advice.
Rates | Fiscal and inflation concerns underpin curve steepening | |
|---|---|---|
US Treasuries | Potential Federal Reserve easing supports short end of curve but may push long yields higher | |
Euro – Core Govt. | Core rates steepening reflects policy rate probably being below neutral | |
Euro – Govt Spread | French political and budget risks suggest preference for Spain and Italy | |
UK Gilts | Markets await budget proposals on tax, but total returns remain mildly positive | |
JGBs | Steady increase in long yields adds to global concerns on bonds | |
Inflation | US inflation risks are tilted to the upside; short duration strategy preferred |
Credit | Spread volatility remains low but depends on macroeconomic and equity risk | |
|---|---|---|
USD Investment Grade | Income returns on track to make 4%-5% this year with stable credit backdrop | |
Euro Investment Grade | Strong demand for credit with stable European Central Bank interest rates | |
GBP Investment Grade | Total returns healthy but vulnerable to gilt curve volatility | |
USD High Yield | Attractive income return, with less drawdown risk than the equity market | |
Euro High Yield | Healthy income returns to potentially continue above Eurozone inflation | |
EM Hard Currency | Attractive diversifier to US credit with higher yields |
Equities | Positive momentum continues to drive new highs but macro and valuation risks remain | |
|---|---|---|
US | Earnings growth expectations continue to defy potential slowdown risks; AI theme still strong | |
Europe | Price/earning multiples have increased; dividend income and valuations more attractive vs. US | |
UK | Better performance despite macro risks, with large-cap companies less exposed to tariffs | |
Japan | Steady performance since April, with rates on hold and signs of improved global capex cycle | |
China | Technology and policy are positive catalysts; broader earnings challenged by deflation | |
Investment Themes* | Long-term positive on AI and carbon transition strategies |
*AXA Investment Managers has identified several themes, supported by megatrends, that companies are tapping into which we believe are best placed to navigate the evolving global economy: Automation & Digitalisation, Consumer Trends & Longevity, the Energy Transition as well as Biodiversity & Natural Capital
Data source: Bloomberg
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