While the withdrawal of quantitative easing and the raising of interest rates are likely to have a long-term impact on investing, markets are preoccupied with more pressing issues, according to Invesco Perpetual’s Nick Mustoe. 
Mustoe (pictured), chief investment officer at Invesco Perpetual, said markets are more focused on the headline-grabbing burgeoning trade war and whether the end of the cycle is nearing.
Since the start of the year, US president Donald Trump has embarked upon a series of trade negotiations aimed at ending existing ‘unfair’ agreements.
While the Trump administration has been successful in renegotiating with some countries, it has found itself at loggerheads with the EU, large economies such as China, and neighbours Mexico and Canada.
Indeed, US-imposed tariffs on steel and aluminium for Canada, Mexico and the EU were met with retaliatory measures on culturally-significant goods, such as bourbon whiskey and motorcycles.
Additionally, the Trump administration imposed tariffs on Chinese goods valued at $34bn in July with a further $16bn to be added late in August, over allegations of international property theft. China has responded by cancelling soybean imports from the US and imposing 25 per cent tariffs on over 100 other goods.
“The big one the markets are focused on obviously is the tariffs situation and the potential for a trade war,” explained Mustoe. “Nobody can really assess whether this is just brinkmanship or whether it is a situation where there is a lot of rhetoric and everything falls back.”
Ongoing concerns over the escalation of a potential trade war has riled markets in 2018, helping to fuel economic uncertainty and contributing to the greater volatility following a relatively benign backdrop in 2017.
Rolling one-year volatility of indices since 30 December 2016 (rebased in local currency)
Source: FE Analytics
Mustoe – who oversees a number of the firm’s funds including the recently-launched targeted volatility Summit range – said markets are analysing the US president’s positioning and looking for any signs of irrational decision-making. However, these concerns may have been overdone.
“Subject to there being an element of rational decision-making [by US authorities], and looking at domestic growth concerns in the US, I think equity markets should be fine,” he explained.
Another key area of concern for markets, Mustoe said, has been whether the end of the market cycle is nearing and the potential for a recession.
Some have speculated that the recent flattening of the US Treasury yield curve could suggest it is close to inverting with a recession to follow. Yet, those fears may too be exaggerated, according to the Invesco chief investment officer.
Year-on-year nominal US Treasury yield curve
Source: US Department of the Treasury
“The market does focus a lot on where the yield curve is across bond markets and follows really a historic precedent of saying whenever the yield curve flattens that’s been a great predictor of recessions or the end of the cycle,” he said.
“I think this time around it really is different in that I don’t believe it is the end of the cycle.”
Mustoe added: “I think bond markets have been so heavily intervened post-financial crisis with QE [quantitative easing] and also the search for yield that it’s distorted bond market valuation. So you can’t quite use longer history as a guide.
“I would say that over the past five years the bond market had predicted a number of recessions that haven’t actually happened and I think that is the case now.”
Indeed, the Invesco Perpetual chief investment officer said the current economic cycle looks set to continue given a number of missing end-of-cycle characteristics.
Mustoe said market growth hasn’t been accompanied by overinvestment and optimism usually seen at the top of the cycle.
“This cycle will continue for quite a while longer and therefore I am still very optimistic about equities,” said Mustoe. “I think everyone is being too short term and regressed back to always worrying about the end of the cycle.
“If you look at the fundamental earnings picture that we’ve had from most economies – and definitely in the US and Europe – we’ve seen good corporate earnings coming through and definitely no signs from companies of anything materially slowing down.”
As such, Mustoe has established overweight equity positions in the Summit range – which caters for varying risk appetites – compared with bonds.
Within equities, the manager has a bias towards European equities that he believes are still in the “recovery phase” compared with US, where valuations look less promising.
“The US has done so incredibly well it’s been the stand-out performer of developed equity markets for some considerable time,” he explained.
“Corporate America has done an incredible job in terms of delivering returns on equity. Some returns have been driven by buy-backs and very good capital management, so margins and returns are at the higher end. But so are valuations.”
Performance of indices over 10yrs (rebased in local currency)
Source: FE Analytics
Instead, Mustoe said there are better valuation opportunities to be had in Europe noting that – like the yield curve – investors tend to worry about Europe.
“Obviously, the Italian election been the latest reasoning for that but really what I focus on is the fundamentals of corporate Europe and results have been good,” he said.
Strong earnings growth has been ignored by the market and European companies continue to trade at sizeable discounts to their US peers, said Mustoe, leading to some attractively-priced opportunities.
As a valuation-focused manager, Mustoe noted that while the momentum trade and growth stocks have dominated markets more recently other sectors and companies have been left behind.
“In contrast if you believe in valuations or value investing then that’s been very out of favour but the long-run history shows that that [trend] tends to win out,” he said. “Companies are delivering and if you’re buying them at the right price you tend to make good returns.
“I think this is a big potential trade to come at some point in stock markets a rotation away from growth and momentum towards valuation. It’s a key time for an active manager to express that view clearly in their portfolio.
“As a long-term investor, you have to be way of overpaying for something that is seen to be growing or seen to be very good. A good company is not always a good investment and we’re at that extreme point.”