With the exception of northern Europe, rate cuts are no longer the name of the game. Bond markets have already priced in higher Fed fund rates, so that confirmation of a modest pre-emptive action should calm down investors in the mid-term. Still, there is the possibility of an overreaction when tightening materialises in combination with even stronger global growth figures and persistent higher inflation given the expected lag of effects from rising oil prices.
In continental Europe, we expect the ECB to remain on hold, leaving the benchmark-refinancing rate at 2.5% well into next year. Rate cuts are not the remedy the lagging large economies need. Low interest rates even bear the mid-term risk of an asset bubble in property.
We see no further threats on the long end of the curve, and consider European bonds being fair priced in the run-up to global economic recovery. In Switzerland, fixed interest investments currently ride in tandem with world-markets. One fails to identify any homemade factors for the time being.
A key risk for bonds lies in a further sell-off in reaction to improving economic data. A short-term overreaction on the bond markets is most likely. We have therefore reduced our bonds position and are underweight in this asset category.
Since growth recovery is in the pipeline for Europe as well, the case for overweighting European bonds vanishes. Swiss bonds are kept significantly below benchmark weight, given the lower coupon and benign risk against Europe’s single currency. In the run-up to a tightening by Greenspan, we decided to increase our liquidity held in the local currency.
Lower interest rates are no longer supportive to global stock markets. Corresponding with the observed recovery in European and Southeast Asian countries, corporate earnings are currently surprising on the upside. We believe that European companies can fulfil market expectations on aggregate. Additionally supportive to this case is the current euro weakness. Valuation though looks extremely stretched; particularly concern here is with US equities. It is our view that upcoming Fed tightening is not fully translated into US stock prices yet.
In Europe, liquidity remains favourable. With pension funds willing to diversify within the euro area, there is excellent demand for large European stocks. We expect this underlying trend to persist, and value EMU equities the most attractive dividend papers for the rest of the year.
Unlike bonds, Swiss stocks are not on Euroland’s pillion seat due to an over-representation of pharmaceuticals. The excellent performance of cyclical Swiss stocks though is not in question in light of global recovery and improving prospects for exporters.
The framework of recovering markets nourishes hopes for more earnings surprises. Typically it is a question of timing when earnings momentum disappears in favour of deteriorated valuation through higher bond yields. It is not yet the moment to leave the stock exchange.
We are increasing our position in European stocks, while we remain reluctant to invest in Japan and Asia with the six-month time frame of our tactical investment decisions in mind. Our overall stock holding is approaching the strategic position from the downside.
Our investment approach aims to identify relative attractiveness of bond and stock markets by scoring the six-month potential of widely approved influencing factors. These decisions are based on a global scenario covering GDP growth and inflation prospects for all major economies.
Traditionally, continental investors and regulators have been cautious when it comes to equities. This attitude is mirrored in legal investment limits set-up for Swiss compulsory pension schemes, which only allow a maximum holding of 50% in equities.
Reflecting the liabilities of a standard pension scheme, we have introduced a strategic benchmark. All tactical decisions resulting from the monthly investment process are measured against the strategic asset allocation.
This benchmark contains a larger equity stake than the Pictet BVG reference index, so our current position significantly overweights equities compared with an average allocation for Swiss pension funds.
Marc Alain Brütsch is economist with Swiss Life Asset Management, Zurich

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