In the short term, equity markets could remain fragile and highly volatile. Our current position on equities in our balanced portfolios is neutral with a negative bias. The key question is the US economic situation. Will the current slowdown be transformed into a global recession or will it be followed by a moderate recovery?
Our central economic scenario is a weak and wobbly recovery during the second half of the year. Significant Fed easing (–150 basis points) since the beginning of the year with a further 75bp cut expected in the second quarter, lower oil prices and tax cuts should favour the US recovery. This, in turn, will have a positive impact on global growth and reassure investors about earnings prospects. In Euroland, the expected repo rate cut from the ECB and tax cuts should support growth and favour a strengthening of activity in the second half of 2001.
In Japan, the monetary policy change, aiming to reflate the economy, and measures in preparation to support the equity market are potential positive factors for the future. Hence, in the medium term, global monetary easing and tax cuts are expected to create a more positive economic environment for equities. However, until this scenario is confirmed, stock markets will remain jittery. The market drop has lowered valuation ratios to a cheaper level but we see no excess level to date.
In terms of equity asset allocation, we are overweight on the euro markets. The Euroland economy is affected by the US slowdown, but should be supported by dynamic domestic demand, stimulated by job creation, monetary easing and tax cuts. We are slightly underweight Japan, where the economic and financial situation remains weak. US equities are slightly underweight because of the sharp slowing in activity and the expectation of a euro recovery. In our portfolio, we are close to neutral in the UK and the Pacific ex Japan. Valuation ratios are excessively low in the UK. Pacific ex Japan market valuations are low but should benefit from further Fed rate cuts.
In Euroland, our sector allocation is close to neutral with a slight overweighting on financials and energy. Financials should benefit from central bank rate cuts and restructuring, energy will benefit from the stabilisation of oil prices, under OPEC control.
For the bond component of the portfolio, we favour euro markets, to the expense of the US and the Japanese markets. The main reason for this is our expectation of a recovery trend of the euro versus the dollar and the yen. The growth differential between the US and Euroland should be positive for the euro in the next few months, and the net capital flows are also expected to become positive euro. The yen is expected to remain weak versus the US dollar.
Michel Poletti is head of investment strategy at SG Asset Management in Paris

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