UBS: Bias towards European equities-Global Perspective

Overview

Equities: Equities continued to be supported by accommodative central bank policy in August and by the belief that key interest rates will stay lower for longer. Against this backdrop, emerging market equities outperformed their developed world peers. The MSCI All Country World Index returned 0.7% in local currency terms.

Fixed Income: Ten-year US Treasury yields rose marginally over the month, while UK gilt yields dropped sharply. Yields on major investment grade and high yield bond indices also fell as investors’ quest for yield continued.

Commodities: Oil prices rose significantly on hopes for a supply cut by the Organization of the Petroleum Exporting Countries (OPEC) in the coming months.

The month in review:

• August witnessed more central bank stimulus measures. In a bid to mitigate the risks posed by the UK’s vote to leave the EU, the Bank of England (BoE) implemented a broad package including an interest rate cut of 25 basis points. Less expected was the BoE’s decision to resume its quantitative easing (QE) program and expand its QE asset purchases to corporate bonds. Elsewhere, the Reserve Bank of Australia cut interest rates to new record lows in response to Australia’s slowest rate of price growth in 17 years, resulting in a sell-off in the Australian dollar.
• Data released during August showed the pace of growth in US employment cooling more than what was expected, reducing the likelihood of policy tightening in September. This was despite Janet Yellen, Chair of the US Federal Reserve, taking a somewhat hawkish tone in an eagerly anticipated speech at a meeting of global central bankers.
• Risk assets continued to grind higher over the month, albeit at a slower pace than July. In aggregate, equities posted positive returns with emerging market and UK equities leading the way. Japanese, European and US equities also registered positive returns, while Asian ex-Japanese equities were slightly down on the month. Most key government bond markets were slightly weaker over the month. The UK was the notable exception in this regard, experiencing a pronounced fall in yields. Inflation-linked gilts fared even better than their nominal counterparts, posting very strong returns as a weak pound pushed inflation expectations higher. Within credit, spreads narrowed across the month in the US and Europe. In the commodity universe, oil prices rallied sharply in the first half of August due to hopes for a coordinated cut to supply by major producers.

Outlook:

• We believe that political risk is likely to be one of the biggest drivers of market sentiment, with the US presidential elections rapidly approaching. Meanwhile, investors continue to wrestle with the broader economic implications of the “Brexit” vote. While fears about a slowing Chinese economy have faded due to improving economic data, we believe that long-term challenges still remain a concern and need to be monitored closely.
• We also favor emerging market equities and have recently lifted exposure here. On our valuation analysis, emerging market (EM) equities have been cheap for some time. We now see them as supported in the short term by catalysts including the “lower for longer” backdrop plus improving economic and earnings momentum.
• Within fixed income, we favor investment grade corporate bonds which we believe remain well-supported when an ever-growing percentage of sovereign bonds trade on a negative yield. We continue to favor inflation-linked bonds in the US over their nominal counterparts due to emerging signs of wage inflation that we do not believe are reflected in prices.

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