Global economic performance has been weaker than expected; nevertheless, financial markets were relatively unfazed by these developments, as central banks’ policies remain highly accommodative. “After having seen weak growth in the first quarter, we’re staying positive on the economic outlook and expect more solid activity, buoyed by good news”, says Patrice Gautry, Chief Economist at Union Bancaire Privée (UBP).
The trend towards risk assets – especially equities – is still there thanks to recoveries in both growth and earnings. With this in mind, the scenario set out at the end of 2013 remains valid and should crystallise over the coming quarters.
Accelerated world growth
The economic recovery is set to firm up; growth is improving in the United States and Europe is out of recession. Beyond the cyclical upturn, the key factors for a durable recovery are being put in place thanks to corporate investment and more solid domestic demand in developed countries. “A new productivity cycle should start to appear, feeding growth over the next few years”, predicts Gautry. The United States has resumed its place as leader of the pack at both economic and industrial levels, as well as in terms of the financial markets.
Some emerging countries – notably China – are changing their growth models, which will act as a drag on activity in the short term, but this action is set to be positive in the medium term. We remain confident that the authorities in China will make sure that this transition will happen without any major impact on world growth.
Equity bias remains in place
“The scenario of a rise in US long rates and a steepening of the curve has not come about”, stresses Jean-Sylvain Perrig, UBP’s Chief Investment Officer. The fall in long rates – which came as a surprise to several investors – is, in our opinion, the result of three major phenomena: an unwinding of strong short positions on long bonds; disappointing economic activity in the first quarter; and the US Federal Reserve taking a stance that was more accommodative than expected.
“It should be remembered that this trend does not call our scenario into question: this sees a rise in rates stimulated by stronger growth in developed countries”, continues Perrig. In this framework, corporate debt continues to be favoured, particularly the high-yield segment and the external debt of emerging countries, given that carry trade is still attractive, even if the expected returns are lower than a year ago; short durations are therefore recommended in such an environment.
Equities remain the asset class of choice. Their higher valuation levels (in absolute terms) do not seem to be a constraint at this stage given the upturn in earnings, the recovery in economic activity in developed countries and the high price of bonds. “It is true that, since the beginning of 2014, we have been seeing a sector rotation out of growth assets and into defensives; nonetheless, we remain convinced that innovation is still a central theme in both the medium and long term”, concludes Perrig. Further, the number of mergers and acquisitions, coupled with share buy-back schemes should continue to support equity markets.
Consequently, themes such as innovation (especially US growth stocks), and the EU and its periphery, are still to be favoured. Emerging markets are offering relatively low valuations, but any potential improvement in company margins remains highly uncertain given their low levels of commitment to boosting productivity. For this reason, we are maintaining our bias towards the major stock markets in developed economies.