Blue skies for equities, but with a chance of storms

Rising business and consumer confidence supports a broad-based, synchronised global economic recovery which reinforces our pro-equity stance.

This optimism, however, comes with a couple of caveats. First, consumer and corporate confidence readings, particularly in the US, are so strong that there is the risk expectations will be disappointed.

Unlike other major markets, US corporate earnings forecasts for 2017 have not been upgraded. Second, it would be dangerous to ignore political risks, especially those surrounding the French Presidential election.

We continue to be as underweight as we can be in overvalued US equities. Extreme corporate and consumer bullishness suggests the market might not take disappointment well – though the Trump effect shouldn’t be overstated.

Europe looks strong, reinforcing our overweight stance on European equities. With Europe lagging the global economic and credit cycle, the region’s equities have plenty of catching up to do on margins and earnings.

We would be even more positive were it not for the upcoming French presidential election. Investors may have become complacent about the likelihood of a Le Pen victory. Even a good showing by the National Front candidate in the first round of the polls could shake up the markets.

India’s economic stumble, triggered by last November’s demonetisation, is behind what we think will be a relatively short-lived deterioration. We are still overweight in emerging equities where we expect gains to continue to be strong relative to developed markets.

The BoJ, meanwhile, is the only major central bank we don’t expect to turn hawkish this year, keeping its policy of yield curve control intact, and will keep buying domestic equities. That, together with an upbeat outlook for Japanese corporate profits and the strong historical correlation of Japanese equities with US bond yields, means that we are sticking to a full overweight on Japanese-listed shares.

Global bond markets in aggregate are still expensive – worrying given the upbeat outlook for global growth, which has historically displayed a negative correlation with fixed income. A correction seems likely some areas, and there are early signs of it in US high yield debt, following outflows of USD10 billion with more to come. We’ve locked in recent profits by downgrading US high yield to neutral.

We are also neutral on European high yield and emerging corporate debt. This does not preclude relative value trades such as in investment grade debt, where US (overweight) looks markedly cheaper than Europe (underweight).

US Treasuries are reasonable value and well-placed to offer protection in case of electoral success by Le Pen, Brexit-linked market jitters in Europe or indeed disappointment with regards to the implementation of Trump’s growth agenda, and we retain our overweight. We have downgraded European and UK sovereign debt to underweight from neutral.

Luca Paolini is chief strategist at Pictet Asset Management

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