Pictet: Market rally still has further to go
Emerging markets continue to benefit from the combined effect of a weaker dollar, a less hawkish Fed, recovering commodity prices and improving economic conditions in China.
In Asia, evidence of an underlying improvement in industrial production and exports is most encouraging. These positive developments have lured investors back into emerging markets. Overall, we stick to our overweight stance on equities and remain underweight bonds as monetary stimulus should underpin economic growth.
The most powerful boost comes from a steady economic improvement in China, the result of Beijing’ aggressive fiscal and monetary stance in the past year. There has been a strong rebound in construction activity which led to some stabilisation in the manufacturing sector; the stock of unproductive debt could prove to be a risk.
We retain our overweight stance on sovereign dollar denominated emerging market bonds – which are less volatile than their local currency counterparts – as these enable us to capitalise on improved economic conditions in the developing world while remaining insulated from potentially turbulent conditions in the currency markets.
One other beneficiary of the stabilisation of China will be Japan, whose economy has slowed under the weight of cooling global demand, weak domestic consumption and the adverse impact of a strong Japanese yen.
The country’s economic troubles will provide the trigger for additional monetary stimulus by the central bank. The Japanese equity market currently offers some of the cheapest valuations in the developed world. There are already signs that non-Japanese investors have started buying stocks back.
European stocks also look appealing. We believe that the trend of falling European and rising US corporate earnings is about to reverse, particularly as euro zone stocks enjoy a substantial valuation advantage compared to the US, which looks unattractive.
We maintain a cyclical sector tilt, preferring stocks that stand to benefit most from an increase in consumer spending. Strong job growth and low inflation will boost household budgets, benefiting consumer discretionary companies. Telecom stocks look good value and prospects for growth have improved with the first price rises in both Europe and the US in 20 years. The recent stabilisation in China and emerging markets and a recovery in commodity prices support materials.
We remain underweight developed market government debt based mainly on valuation. Investment grade European bonds are not attractive, either, as we believe the effects of the ECB’s extended bond purchase programme are already largely reflected in the market.
The near term prospects for US high yield bonds, by contrast, are bright. Although certain segments of the high yield bond market are experiencing difficult business conditions – heavily indebted bond issuers from the energy industry in particular – the asset class should fare well even if the economy expands at a modest pace. Over the long run, we expect default rates to climb steadily to about 5 per cent, concentrated in the energy sector.
Over the longer term, we expect the euro to appreciate against the US dollar, but are reluctant to overweight the currency ahead of the UK’s referendum on EU membership.
Luca Paolini, chief strategist Pictet Asset Management