Pictet: Beware of exuberance

“Recent stellar gains – global stocks are up more than 10 per cent so far this year – mask the fact that the world economy is not out of woods yet.” “Global economic data has been below consensus expectations for 14 months in a row, the longest stretch since the financial crisis. World trade, on volume terms, is now at its weakest level since 2009 while business confidence in developed economies is falling.”

“At the same time, investors appear too optimistic about prospects for corporate earnings growth.”

“We think equities may struggle to add to their recent rally. We therefore maintain our underweight stance on stocks and remain neutral on bonds.”

“We believe a significant margin squeeze is inevitable. Indeed, by some measures corporate margins in the US have already started to fall and we think this trend has much further to run.”

“Hence, we are underweight on US equities, a view which is further supported by valuations.”

“In contrast, we are overweight on emerging market equities, where valuations are less stretched – especially in emerging Europe – and where the economic momentum is stronger than in the developed world.”

“In China, Beijing’s successful stimulus measures bode well for the Chinese stock market over the medium horizon although in the near term much of the good news may be already priced in. Their success in growing private sector liquidity is encouraging.”

“We also like the UK, which offers an attractive dividend yield of 4.8 per cent alongside a cheap currency.”

“Within our sector allocation, we maintain a fairly defensive stance, with overweight positions in consumer staples, utilities and healthcare. We are underweight on the two most expensive sectors – consumer discretionary and IT.”

“Global bonds have become so expensive that it leaves us questioning how much upside there remains for most of the fixed income market, from the riskiest corporate borrowers to the safest sovereign debt. Hence, we are neutral overall and retain our underweight stance on most credit and developed sovereign debt markets.”

“The market seems convinced that the US Federal Reserve now has a dovish bias. About a quarter of the global bond market now offers a negative yield, up around two-thirds since last October.”

“But investors appear to be ignoring the fact that while the Fed has some scope to ease, other central banks are bumping up against the lower bound for official rates. Globally, central banks are still shrinking their balance sheets – except for China.”

“While core inflation is low, it’s still above bond yields. As a result, real yields on global bonds remain deeply negative.”

“We are maintaining an overweight on emerging market local currency and dollar-denominated bonds on the back of the deep undervaluation of emerging market currencies. Their better growth prospects, thanks to China’s rebound, offers further support.”

“While the dollar is significantly overvalued, we largely retain a neutral stance in the absence of compelling alternatives. Still, we remain overweight gold on expectations that the dollar has peaked.”