Market outlook for October

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We increase our allocation in emerging markets and reduce our exposure in cyclical consumer equities. Thus, we increase our underweight position in US equities and US dollars and our overweight position in the financial, energy and technology sectors. Fixed-income instruments in the portfolio remain unchanged.

Gradual tightening of liquidity

The Federal Reserve announced that it will start selling bonds acquired in the period 2008-2014 as from October through so-called quantitative easing (QE 1, 2 and 3). The balance will gradually be trimmed from the current USD 4 500 billion to around half of this during the period up to 2022.

This was well communicated in advance, and many believe that the ECB will follow suit in a year's time. It was more unexpected that the FED signalled a rate hike in December and further increases next year, even though the inflation rate is still well below target. The central banks will probably normalise their monetary policies step by step, but this is a new situation for the market.

To us, this signals the end of the goldilocks1) period of accommodating central banks, low volatility and high returns on both equities and bonds. This, combined with high valuations and geopolitical risk, is the reason why we retain our neutral weight for equities even though we increase our cyclical exposure in the portfolio. We believe that equities will generate a higher return than other assets over the next six months, but that there is a high risk of a correction at some point
matrix
The matrix above shows recommended short-term deviations from a balanced portfolio across multiple asset classes. Deviations from the long-term distribution should not represent more than 5 to 15 per cent of the total portfolio to ensure that the short-term risk taking is not too dominant. The scale must be seen in the context of investors’ risk willingness and investment horizon.

Good prospects for cyclical equities

There were healthy returns on equities in September, despite the sabre rattling between President Trump and North Korean leader Kim Jong-un. Norwegian equities showed the best performance, followed by Europe, while energy and manufacturing were the best equity sectors in a global perspective. In the fixed-income market, high-yield bonds fared best, while there were weak yields on Global Investment Grade, reflecting increasing US and European interest rates.

We think this trend will continue due to the sound growth prospects. In the short term, we expect the hurricane season to affect US data. However, leading indicators and business barometers in most regions point towards continued expansion in the private sector.

Strong demand and lower supply growth have given a rise in commodity prices, which is positive for our overweight position in energy equities, though it will drive costs for the rest of the business community and consumers. Parallel to this, the current tightness of the US labour market will normally imply increasing wage inflation. This combination will lead to gradually higher price inflation through 2018.

Historically, GDP growth has had a lead time of about six quarters on inflation. In our opinion, the risk for higher inflation is not reflected in the bond markets, and we believe that the central banks will have to raise rates faster than what is priced in by the market.

If interest rates rise on the back of stronger growth and increasing inflation, there will be greater volatility, though it will not necessarily mean the end of the bull market for equities. Still, market participants will shift from interest rate sensitive and stable growth equities to more cyclical sectors and value equities.

If this situation arises, our overweight position in emerging markets and Norway/the Nordic countries, as well as energy and finance, will show a stronger development than the market at large. It will also be positive for the Norwegian krone and the Swedish krona, which we believe are undervalued. There is one more argument supporting an overweight position in the Nordic countries compared with other regions.
1) Period where growth has been at a level where the central banks have continued to step on the gas, which has been positive for both equities and bonds.

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