Luca Paolini (pictured), chief strategist at Pictet Asset Management, explains the recent moves to reduce exposure to high yield bonds to neutral and why the valuation gap is unwarranted in the tech sector.
With European speculative-grade fixed income securities having returned about 3 percentage points more than government debt so far in 2015, we believe it makes sense to scale back our exposure to high-yield bonds to neutral. We have also upgraded sovereign debt to neutral from underweight.
Although high yield bonds should draw support from the euro zone’s economic recovery and the ECB’s heavy dose of monetary stimulus, the asset class’s yield spread looks increasingly unattractive compared to that offered by either Italian or Spanish sovereign debt.
Amid the recent sell-off in government bonds, the yield gap between Italian and German sovereign debt widened by about 50 basis points. Similar shifts have occurred in Spanish bond markets. In our view, these yield differentials are unjustifiably high, particularly as the ECB remains focused on keeping a lid on the borrowing costs of economies in the euro zone’s periphery.
As such, we are overweight long-dated Italian and Spanish government bonds. More broadly, we believe government bond markets could evolve into a rich hunting ground for tactically-oriented investors over the coming months as market interest rate expectations are becoming increasingly volatile.
We keep our regional allocation unchanged – we are overweight Europe and Japan and cautious on the US and emerging markets. European and Japanese stocks stand to benefit from continued central bank support.
In our sector allocation, we keep our preference for attractively-valued sectors most likely to benefit from strengthening global economic growth. The technology sector’s prospects look particularly good and we upgrade it to a full overweight. The tech sector now trades at a discount to the global equity market based on prospective earnings. To us, this valuation gap is unwarranted as tech stocks are expected to deliver 30 per cent more earnings growth than other sectors over the next five years. Companies operating in the sector are also better equipped to hold up in a rising rate environment because they are cash rich.”