Asset allocation: Overweight China vs. EM

We remain neutral on global equities. Monetary policy is still supportive, as are global liquidity and the economic cycle, although we are less convinced of the latter.

We see valuations as neutral, as long as earnings expectations are met. The recent drop in equity markets corrected some upbeat investor sentiment, but volatility is still quite low. A more constructive view against emerging markets is reflected in our recently implemented overweight in greater China (including the mainland, Hong Kong and Taiwan) versus global emerging markets. We think negative sentiment is overdone and reflected in low valuations and net short positions.

We are also overweight the eurozone versus the UK. The UK economy has been doing much better than the eurozone, but we think there is more room for company earnings to improve in the eurozone. While earnings in UK and US have recovered, the bounce has not been meaningful in the eurozone. Analyst expectations for UK earnings are improving, but we do not expect this to last.

It could even reverse again. A normalisation of monetary policy in the UK and the US, while the ECB is still easing, should have a positive currency effect on eurozone earnings. Finally, we see more room for higher priceearnings ratios in the eurozone than in the UK.

We have been adjusting our exposure to European highyield corporate bonds tactically. The June ECB meeting allowed us to take profits, but when yields rose, we raised our exposure. With default rates mainly low and company balance sheets generally decent, we like the carry on these bonds.

We also like the carry on emerging market debt in local currencies, especially now that currency volatility has faded. The unhedged currency position has been switched quite recently to a hedged position, due to the the substantial weakening of the euro against the US dollar over recent weeks.

While government bond yields look set to go higher, central bank policy and low inflation should ensure that any rise is gradual. At this point, we lack the conviction to take a short duration position in Germany or the US.

We are long eurozone inflation-linked bonds versus nominal government bonds on the view that the inflation discounted by linkers is too low. If inflation expectations rise, these bonds should outperform nominal bonds. We are neutral on real estate globally. We are neutral convertible bonds, commodities and cash.

In principle, the euro should weaken further in the longer run with more monetary stimulus in the eurozone and increasingly less in the US. If however investors become convinced that ECB policies are supporting growth and inflation, capital inflows and the region’s trade surplus could support the euro.

We have implemented a new core position: long European equities vs. European real estate. Strategists have become increasingly cautious on the European outlook and have downgraded earnings forecasts over recent months, but we are more optimistic about the outlook for European equities. European real estate has done reasonably well. A quite favourable environment is now already priced-in. The earnings outlook for European real estate appears much more modest due to low inflation limiting earnings growth in this sector.

Flexible multi-asset positions

In our flexible multi-asset approach, we are overweight Italian government bonds versus UK government bonds.

Yields are higher in Italy than in the UK, which results in a (small) positive carry, but the main rationale for this trade is that yields in Italy could fall further thanks to the ECB.

The more hawkish Bank of England, which could start hiking rates late this year or early in 2015, may drive up UK yields. If this scenario plays out, price developments of these bonds should work in our favour.

In Germany, after triggering the stop-loss-level, the long 5year German bunds vs. 30-year German bunds has been closed.

We are overweight Mexican USD-denominated debt versus US 10-year Treasuries. We expect Mexican bonds to benefit from sound and improving fundamentals, falling inflation and low official interest rates. We think Mexico is shielded better from downside risks in China than other countries in Latin America. In the US, we are long five-year forward inflation swaps (hence the expectations of inflation five years from now).

When expectations dipped in late April, we established a long position. In Europe, we are long five-year forwards in investmentgrade debt. With less flattening at the long end of the curve than at the short end, there is a relatively large gap between spot rates and five-year forwards. This position should pay off if the gap starts to narrow.