The conundrum continuing to face investors is that valuations for most asset classes remain high. We see equity markets as more attractive than fixed income primarily on a relative basis. Expected returns for equities over the medium term are still likely to be below historical norms. To the degree that portfolios can accommodate them, emerging markets are the most appealing assets, specifically Asian equities and emerging market local currency debt. We see continuing domestic demand growth in Asia and a rising share of services in the Chinese economy driving corporate profits. Yields on emerging market government debt could continue to decline as central banks face easing inflationary pressures and the US dollar depreciates.
Within developed markets, our preferred asset class is European equities. Valuations in absolute terms are not low but they are lower than for US equities and margins are moderate. The European economic recovery has been delayed, but that means from here there is more room for the economy to expand compared to the US. Japan is also seeing a modest economic rebound (GDP forecasts for 2017 are up to 1.3%), but the large cap market remains vulnerable to swings in the yen-dollar exchange rate. The weakness of the US dollar suggests there is less room for the yen to depreciate, which has been a key driver of equity returns.