The UK’s shock vote to leave the EU already appears to be a distant memory. Economic conditions are by and large improving in many parts of both the developed and developing world while central banks appear ready to do everything in their power to contain risks to growth, even as fiscal constraints are relaxed to some extent. What is more, corporate earnings are gathering strength, even in emerging markets. We therefore maintain our overweight stance on equities and our underweight position in bonds.
We keep our preference for equities in Japan, where valuations are attractive and an expanded monetary stimulus package is set to lift growth and stands to boost corporate earnings.
Japan is the developed market that will benefit the most from accelerating global growth. And with our indicators pointing to an expansion in growth rates worldwide, we expect corporate Japan to overcome some of the forces that have recently held it back, such as a strong yen, which has dented the attractiveness of its exports, and slowing growth in China. Also likely to support Japanese stocks is a rise in global government bond yields – which we see as highly likely.
Elsewhere, the prospects for emerging market stocks are also encouraging. Beijing’s fiscal and monetary stimulus measures have managed to stabilise the Chinese economy for the time being and helped shore up investor confidence after a surprise currency devaluation at the beginning of the year had unsettled sentiment. Even so, with emerging market stocks having gained some 15 per cent year to date, flows in some areas having built up too far too fast and as global monetary easing gradually becomes less effective, the rally may slow somewhat in the coming months.
Separately, while the euro zone seems to have weathered the shock of the UK vote to leave the EU, little has been done to address the fundamental vulnerability of Italy’s weakest banks, which may need to be recapitalised. This is why we are reluctant to lift our exposure to the region, even though it appears relatively inexpensive when measured against both its growth prospects and other major equity markets.
In a landscape of unprecedentedly low bond yields, we continue to find a pocket of value in European high yield credit in particular. But, more generally, we remain cautious about the fixed income market. We expect the downward trend in yields to reverse amid an improvement in global economic growth.
The US market is also attractive, though the scope for strong gains is limited. Implied default rates among speculative-grade borrowers are fair in our view, while financial conditions are becoming more difficult amid tightening bank credit standards, suggesting the credit cycle is about to enter a more challenging phase.
In currencies, we remain underweight the Japanese yen. We anticipate weak nominal GDP to trigger further and perhaps more extreme heterodox monetary measures in Japan, which makes the currency vulnerable to a correction given that it is at its most expensive level in at least 15 years on our valuation metrics. By contrast sterling is likely to stabilise as post-Brexit growth risks are less severe than we and much of the rest of the market had anticipated.
Finally, we continue to hold an overweight position in gold against the risks of policy turbulence, particularly ahead of this autumn’s US elections.”
Luca Paolini, chief strategist Pictet Asset Management