As­set al­lo­ca­tion: Over­weight China vs. EM

Financial Mirror (Cyprus) - - FRONT PAGE -

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.

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