Pictet: No need for panic?

“We remain overweight equities as we believe the market sell-off has taken valuations to attractive levels; bonds remain expensive in the main, particularly developed sovereign debt, but we do see opportunities in high yield and emerging debt.

The market rally in developed government bonds that has unfolded over the past month has reinforced our view that the asset class was already expensive. Yields on sovereign debt are far more likely to rise than fall. Global government bonds are almost as expensive as they have ever been, well above any notion of fair value. 

Not only is the Fed tightening monetary policy, albeit gradually, but core inflation is also on the rise. What is more, even if the ECB further loosens the monetary reins, its actions would most likely benefit corporate bonds. 

The sell-off in US high-yield debt has largely been induced by a sharp fall in oil prices which has pushed yields to levels more typically seen during recessions. Such a weakening is improbable considering the US economy remains on course to expand, fuelled by a pick-up in consumer spending. 

Also, high-yield bonds offer a good insurance against an unexpected pick up in the pace of US interest rate hikes because of the asset class’s lower duration than other fixed income securities. Hence, we increased our overweight to US high yield debt. 

Valuations are attractive for local currency emerging market bonds, too. The market had a torrid 2015, ending down some 15 per cent – its weakest year since the launch of the first local bond index. This year should see a turnaround. 

In the currency market, we expect the US dollar to trade within a narrow range over the short term. Still, we remain long the euro versus the US dollar although the exchange rate is nearing our medium-term target.

Europe is our top equity pick as the region’s economic recovery is proving resilient. Aggressive ECB stimulus measures have been filtering through to the real economy and are boosting bank lend-ing. Demand for credit is also on the rise from businesses, which bodes well for investment spending. Meanwhile, lower oil prices have increased consumers’ spending power, and this has served to drive retail sales higher across Europe.

There are risks on the horizon, however. Poland’s new gov-ernment is proposing policies that have triggered a credit rating downgrade, Spain is about to enter a period of political upheaval and there are growing concerns surrounding the solvency of a number of Italy’s regional banks. The UK’s looming referendum on EU membership is another investment risk for the region. 

Japan’s economy, meanwhile, is expected to continue to recover moderately after falling short of expectations in 2015, and this should prove supportive for stocks. Growth is set to gather speed, led by private consumption while corporate investment can be expected to rise steadily. 

We also retain our overweight stance on emerging market stocks. There have been signs that economic growth is stabilising across the developing world and this sets the stage for a recovery in the earnings of emerging corporates. 

We have reduced our underweight in US stocks because the export-sapping rise in the US dollar may soon run its course, and the equity market may have reached a trough. 

We have cut our exposure to financials as the policies implemented to address the solvency of Italy’s regional banks are inadequate. Meanwhile, consumer discretionary remains one of our preferred sectors. Although valuations are not spectacularly cheap, rising wages and low inflation will increase disposable income and boost consumer spending, benefiting companies in the sector.”

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