The bull market in stocks may be testing historical boundaries but there is plenty to suggest the rally should continue, hence we retain an overweight position in equities and an underweight position in bonds.
Economic activity is gathering pace again, both in developed and emerging countries. Despite central banks starting to withdraw their stimulus, global monetary conditions remain favourable, not least because inflationary pressures are low.
For global equities, weather conditions are good. Not only do stocks benefit from positive seasonal trends – markets tend to do well in the final months of the year – but this time fundamentals are also positive.
Corporate earnings are extending a broad-based and synchronised recovery and, on a valuation basis, most risky assets appear yet to reach the excessively expensive levels usually seen towards the end of the business cycle.
Regionally, we see the most attractive prospects in the euro zone and Japan, and are increasing our exposure to both. The Eurozone is enjoying some of the best economic momentum within the developed world whilst Japan is one of the cheapest equity markets.
Both should benefit from a likely bounce back in the US dollar, which makes European and Japanese goods more competitive and boosts the value of exporters’ foreign earnings. Sentiment also plays a part, with investors in Japanese stocks tending to be particularly sensitive to shifts in the yen/dollar exchange rate.
Elsewhere, we are neutral on Swiss and UK stocks and whilst we remain encouraged by the long-term potential of emerging market assets, their strong gain so far this year and a likely rebound in the dollar prevents us from adding to our exposure at this juncture.
The already expensive US remains our least favoured equity region, particularly as valuations have stretched even further in the past month. The one saving grace could be its high weighting of financial stocks, as Fed rate hikes should benefit the banks – and we have raised exposure to financials.
We have also increased allocations to energy – not only are oil prices close to a two-year high, energy stocks are also under-owned and offer a close to 4 per cent dividend yield. We also continue to see opportunities in healthcare and technology, but have turned more cautious on telecoms.
Now seems a good time to take profits on emerging market local currency bonds, hence why we’ve cut our position on the asset class from overweight to neutral. Valuations are high and a strengthening dollar presents a potential risk.
The US dollar has suffered this year from Trump’s political travails, but there are signs that sentiment has swung too far. We have kept at overweight in US treasuries, largely because it continues to be a hedge against any sudden risk off move by the market.
Another corollary of dollar strength is weaker dollar crosses, including the euro, which we’ve cut from overweight to neutral. We have also cut the Japanese yen from neutral to underweight and we remain underweight sterling.
Luca Paolini is chief strategist at Pictet Asset Management.