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Scenario modelling has formed part of Peregrine Wealth’s investment process for two decades, and it enables us to better understand potential market outcomes and construct stronger portfolios. The Peregrine Wealth Investment team has a core or “High Conviction” scenario based on a three-year view, which is expressed as macro-economic and market assumptions, including economic growth, inflation, interest rates, price-earnings multiples, and credit spreads, to list a few. Based on these assumptions, our asset valuation models produce expected returns for various asset classes. This section is used to summarise our High Conviction view and the resulting asset signals.
Our current High Conviction scenario assumes that the global economy will grow close to capacity over the next three years. Headline inflation has moderated closer to target in most regions and this opens the door for central banks to start cutting interest rates, which should be supportive of growth. However, the effect of falling interest rates will, similar to rising interest rates, impact regions differently, and with variable lags. Overall, monetary policy is assumed to remain more restrictive than the previous cycle, with higher real interest rates.
Equity markets have done exceptionally well, and valuation expansion has been the biggest driver. Earnings growth has picked up this year and, under our High Conviction scenario, this is expected to continue over the next three years. From a price-earnings valuation perspective the United States (US) market and parts of emerging markets (EM) are expensive, while Europe and China are trading closer to fair value. Over the medium-term, global equity has a neutral rating, along with Europe and EMs, while US equity has a below neutral rating.
US cash is attractive under our assumptions. US government bonds and investment-grade credit are rated neutral, with yields and spreads close to our fair value assumptions. High yield bonds are less attractive, with tight spreads.
The United Kingdom (UK) economy is gradually recovering and inflation slowing towards target. The Bank of England started its rate cutting cycle in August, which should support consumers and businesses. UK bond yields are close to fair value and government and corporate bonds are rated neutral. The UK equity market continues to be attractive from a valuation perspective, but projected earnings remain weak. The expected return outlook is now neutral.
The table below offers a summary of our Medium-Term Asset Class Valuation Signals based on our three-year High Conviction scenario. It is important to note that medium-term valuation-based signals are typically not good short-term market timing tools.
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Outlook shown reflects the signals from Peregrine Wealth’s asset valuation models and is based on each asset class’s three year expected return. The model’s expected returns are compared to what investors historically expected from these asset classes. As an example a Neutral Outlook will be roughly 0% real return for Cash, 2% for Bonds, 4% for Credit and Gold, and 6% for Equity and Property. Note that no currency views are taken and currencies are assumed to change in line with interest rate differentials for modelling purposes.