Growth picture improves but with political risks

Global market overview: Political risk returns

Nervousness returned to markets in February as inconclusive election results in Italy fuelled renewed concerns about the euro zone sovereign debt crisis, while investors worried the Fed might be ready to slow or stop its open-ended asset purchase programme. Equities fell modestly, bond yields declined and commodity prices corrected.

Although Fed Chairman Ben Bernanke assuaged fears by reaffirming his commitment to the Fed’s stimulus efforts, the threat of sequestration underpinned US-Treasuries. Federal spending cuts estimated at USD 85bn for the current fiscal year were due to start on 1st March, with a potential impact on US growth of c0.5 percent in case of full implementation – though we continue to consider this unlikely. European equity markets were the weakest of the developed world. The political stalemate in Italy hit sentiment, which had improved on the perception that tail risk in the euro zone had receded. German bunds rallied and periphery bond spreads widened as investors shunned risk.

Japanese equities, by contrast, extended the rally started at the end of last year. The news of the appointment by the government of a dovish Bank of Japan governor and deputy sent the yen tumbling against the US dollar and boosted domestic stocks. Currency markets continued to be the focus of attention, with volatility in major currencies bringing renewed instability. The sterling fell sharply after Moody’s stripped Britain of its triple-A rating – a move which compounded pressure on a currency already weakened by prospects of further monetary easing measures to boost the ailing economy. The euro weakened 4 per cent against the US dollar. In emerging markets, Turkey cut interest rates to stem the rise of the lira, while the South African rand gained.

Asset allocation: Moving to a neutral positioning while remaining mindful of risks ahead

We move to a more neutral stance by upgrading equities to equal weight and switching bonds to a small underweight as we take heart from an improvement in economic momentum, a slowdown in the pace of downward earnings revisions and more benign market sentiment readings. Although the global economic backdrop has improved, we are reluctant to adopt a fuller risk-on stance in the absence of a clearer buy signal from our contrarian sentiment reading, and with Europe hostage to political risks and US growth potentially constrained by fiscal tightening.

Our small downgrade of bonds ref lects extended valuat ions, improving leading indicators and our belief that the long and slow process of bond yields normalisation has already started. We retain a long US dollar position, as the US economy is at a more advanced stage in the deleveraging cycle than the rest of the developed world.

Der vollständige Ausblick im pdf-Dokument