Still safe to lean to equities
After recent rough weeks in the international equity markets, investors wonder whether they should still hold a significant equity overweight in their balanced portfolios. We would argue yes, at least for an investor with a six-month time horizon. We are convinced that there are five good reasons supporting this position.
First, the risk that a meteor will hit the investment world has decreased dramatically. The recent concerted intervention in the foreign exchange markets to support the euro, indicating what level is unacceptable to the international central banks, allied with the decision by the US authorities to release part of their oil reserves, are potentially significant factors for both the equity and bond markets. The effort to put a lid on oil price gains will limit any worsening in inflationary expectations, while support for the euro reduces the risk of further upward pressure on European inflation and the danger of excessive margin erosion, which has already caused a lot of high-profile profit warnings.
Second, the price actions based on such disappointing corporate news as well as on already anticipated ones have improved valuations, which offers a more healthy base for a new upward move. These profit warnings, however, not only had an enormous impact on stock prices, but also on investor sentiment. This is causing portfolio managers to increase cash within equity portfolios – at least in Europe.
Third, the liquidity factor is still very powerful. Over the past few months the Europeans have again put fresh money into equity mutual funds at new record rate. But also Marshallian K (M3 growth minus nominal GDP growth) is indicating that there is good support for the European equity markets, which will help them absorb the still high demand from IPOs and secondaries especially from the telecom sector.
Fourth, we would argue that the central banks have done most of their work. The impact of their rate increases has on global growth over the course of the last 18 months coupled with the “tax” effect of the “oil-shock”. The next Fed move should be a cut, whereas we expect that the ECB will complete its work with another move of 25 basis points. Last but not least, there are powerful seasonal factors, which promise above-average equity returns from November to March.
So is that a risk-free situation? Certainly not. There is the risk that higher energy costs will feed through the pipeline, which could speed up inflation, slow down worldwide growth and reduce corporate earnings. This scenario, however, we only put a probability of 20%.
What regions and sectors to overweight? We confirm our positive stance towards continental Europe. The earnings situation still looks good, we see record retail investor demand and non-TMT sectors are fairly valued. We also hold an overweight position in emerging market equities, as we believe growth sentiment is too weak.
We still like banks and pharma stocks. We have cut back our energy positions – based on the scenario that the oil price has topped. Our food exposure will be reduced into further strength. Within technology we will continue our rotation principle. We have upgraded telecoms to neutral – rather for trading – because we still regard them as overvalued. We expect portfolio managers to lock in profits on their sector bets in energy and insurance by a move to more neutral sector weightings.
Overall, we don’t expect drastic moves in the fixed income market during the next six months: returns should be close to the coupon. Short term there are risks of a brief hiccup caused by some surprisingly high CPI figures. The market will, however, realise that these are one-off effects, which are not changing anything concerning the structural deflationary trend.
The duration of our global bond portfolios is benchmark neutral, positioned in a barbell structure. Our recommendation is to increase the euro, Swiss franc and sterling position funded out of dollars and yen.
To cut a long story short, we are still convinced that equities will outperform bonds during the next sixmonths, as well as cash.
Philipp Vorndran is chief strategist with Credit Suisse Asset Management in Zurich