3rd March 2016
Pictet Asset Management’s chief strategist Luca Paolini asserts that while investor sentiment remains fragile thanks to some uninspiring economic data, some market gauges already imply the US is heading into recession. But he believes this is off the cards. Below he explains why…
Our main scenario remains one of continued, albeit slower, growth, underpinned by a steady improvement in economic conditions in China.
Whilst an interest rate hike from the Fed threatens to provoke more market disruption, other central banks are likely to be mindful of the fragility of their own economies and act accordingly.
As a result, we are maintaining our overweight in stocks and our underweight position in bonds.
In terms of equity sectors, we have a moderate cyclical tilt. Materials stocks are the most exposed to a recovery in China, and stocks have already ticked up on the back of easing measures.
We also like consumer discretionary and technology companies, which stand to benefit from a rise in consumer spending.
Consumer staples, meanwhile, look unattractive as they trade at their most expensive levels ever relative to other industry sectors.
Regionally, we keep our preference for equities in Europe and Japan, where central banks are expected to deliver additional monetary stimulus to support their economies. We also retain our overweight on emerging market stocks.
Japanese equity remains very attractive. Corporate profitability has held up well, whilst valuations haven’t expanded yet.
In Europe, corporate profit margins should receive a boost from low energy costs and a recovery in exports. Monetary policy should also become more expansionary, and we expect the ECB to deliver more stimulus as early as its next meeting in March and we cannot rule out that the ECB will start buying some senior bank debt to alleviate the funding pressure in the sector.
Risks to Europe’s recovery have grown in recent weeks. Italy’s banking system has been rocked by a spike in non-performing loans on the balance sheets of some regional lenders while the UK is due to hold a referendum on whether to remain in the European Union.
UK equities have been upgraded to neutral as sterling weakness will likely benefit exporters.
In the fixed income markets, we retain our underweight stance on government bonds and our overweight position in US high yield debt.
Valuations for US high-yield bonds look particularly attractive, implying that that bond default rates will climb to levels of around 13 per cent. Such deterioration in the creditworthiness of high-yield debt issuers is difficult to reconcile with the positive trends we see unfolding over the coming months.
For one thing, we expect the US economy to continue its expansion, fuelled by buoyant consumer spending. In addition, oil prices should also stabilise.
Emerging market local currency bonds are also attractive. Our proprietary indicators suggest economic activity has picked up considerably over the past three months across emerging markets, and we expect manufacturing-based countries within Asia to lead the recovery over the coming months.
We are underweight in sterling versus the US dollar as we expect the pound to decline further in the lead-up to the UK referendum on EU membership. We also retain our long euro, short US dollar position as we expect euro zone economic growth to gather strength.
Our decision to retain an underweight stance on the US dollar is in keeping with our view that investors are overly bullish on the US’s prospects.