Time to heed the warning signs and dial down risk
“Slower global growth could be the trigger that ends the equities bull run, but there is no cause for panic – either about the economy or about stocks.”
“Tech is one of the most cyclical sectors, and also one of the most expensive in our view, having returned 35% (MSCI ACWI Tech in USD) over the past 12 months. Whilst the long-term case for tech remains on track to benefit from the digital revolution (and is the sector with the highest expected return), tactically this is the time to take some profits. We have cut tech stocks to a single overweight.
“Tech is also a big part of the emerging equity world – 27% of the MSCI Emerging Markets Index compared to 17% of the MSCI World, so it also makes sense to reduce exposure to EM equities.
“What’s more, the asset class has enjoyed very strong inflows – we think it’s now “overbought” so if global equities do indeed witness a correction in the coming weeks, there are grounds to expect that EM stocks’ outperformance will come to an end. We’ve cut EM from overweight to neutral.
“Despite the fact that US equities remain by far the most expensive region, and we are still cautious in the long term, they have historically held up relatively well during periods of global equity downturns. Hence, we have upgraded US stocks to neutral on a tactical, short-term basis.
“Europe is one of the brightest spots in our equity universe, supported by still abundant liquidity and strong economic momentum, although gains mean valuations are no longer quite as attractive as they were in Q4 2016. But in dollar terms, it looks much cheaper than US, especially considering the earlier stage in the business cycle. We retain our overweight positions on euro zone and the UK, and also remain positive on Japan.
“A widening gap between the Fed’s hawkish guidance on monetary policy and the market’s dovish rate expectations has prompted us to take profits on US Treasury bonds and trim to neutral from overweight. Despite central bank signals of another possible rate hike in December, the market is ascribing just a 40% probability to this outcome. We think that market expectations have got ahead of themselves. Thus, it makes sense to reduce duration on Treasury bonds.
“Elsewhere, narrowing US investment grade bond spreads has prompted us to cut the asset class to neutral. We remain negative on European fixed income as yield spreads look overly tight. There’s a chance the ECB could end up making a policy mistake by prematurely ending policy accommodation – we expect them to announce an asset purchase “taper” as early as September.
“Emerging market local currency bonds are worth holding – we expect the dollar to weaken as the Fed moderates its policy stance, plus they offer an attractive yield of 6.2%.
“The euro, Swiss franc and gold all look positive. Sterling remains an underweight – Brexit negotiations are unlikely to produce anything positive soon, and the UK economy is starting to struggle – although the BoE appears to be shifting from its super-accommodative stance as pound depreciation-led inflationary pressures increase.”
Luca Paolini, chief strategist at Pictet Asset Management