Schroders: Signs of stabilization in Europe

In Europe, meanwhile, we are seeing signs of stabilisation in the cyclical environment, equity valuations look relatively attractive and monetary policy will be supportive. After Europe, Japan looks the next possible candidate for an upgrade, but for the time being we remain neutral on the country. How effective Abenomics has truly been so far remains unclear and we await clearer signs of improvement in domestic demand to appear in the data before we consider changing our stance.

We have been awaiting an opportunity to upgrade emerging market equities since 2011, and for the time being that wait will continue as the strength of the US dollar will continue to weigh on the region. There are also country specific problems such as those facing Brazil (Petrobras scandal) and Russia (Ukraine crisis, sanctions). Within emerging markets we prefer Asia which is best placed to benefit from better global growth and is likely to be more resilient to a rise in US rates.

In fixed income markets we remain neutral government bonds as we do not see an immediate inflation or growth trigger to generate enough upside yield volatility to overcome the carry. However, we have turned negative on US Treasuries and moved to neutral on Bunds. Offsetting this is a more positive view on UK gilts. Quantitative Easing by the ECB and BoJ will weigh on global yields at the long end, but the prospect of tightening in the US later this year will put upward pressure on the yield curve. In the UK, the Bank of England is likely to follow the Fed in raising interest rates and similar to the US, we continue to prefer the longer end of the curve. Otherwise, our sovereign bond position is primarily a play on global QE and a hedge against the sort of secular stagnation worries discussed above.

Within alternatives, we are neutral on commodities. Although prices are depressed, oil could remain under pressure until there is more evidence of a cut back in supply. Saudi Arabia will wish to be more confident that there has been a shift in US shale production toward more of a swing producer role. Meanwhile, there is the potential for an increase in supply from Iran following the recent agreement with western powers over its nuclear programme.

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