Market outlook

Barometer June 2014 – Cheap assets in short supply

World equity and bond markets rose in May as the prospect of continued monetary stimulus from major central banks lifted investor sentiment.

Financial markets were positioned for additional easing measures from the European Central Bank after its president Mario Draghi said the central bank would take steps to tackle the region’s sluggish growth and persistently low inflation.

Meanwhile, the US Federal Reserve chair Janet Yellen reassured investors that the Fed was not ready to tighten monetary policy and would continue to support the world’s largest economy.

The dovish central bank rhetoric set the stage for a broad rally in equities, led by emerging markets. The Russian benchmark index rallied amid hopes that Petro Poroshenko’s victory in Ukraine’s presidential election could bring stability to the region. Elections were also the trigger for double-digit gains in Indian stocks (see chart), as investors cheered what was a resounding victory for the Hindu nationalist Bharatiya Janata Party. The hope is that the new prime minister Narendra Modi will deliver on his pro-business manifesto and revive India’s economic growth. Thailand’s equity market was among the laggards after the country’s military seized power in a coup.

US stocks, meanwhile, also drew encouragement from an improvement in corporate earnings: more than 75 per cent of companies reporting results delivered profits that beat expectations. The picture was similar in Japan; Japanese stocks were among the best-performing developed equity markets.

Information technology and consumer discretionary stocks rose while materials and energy sectors lagged the global index. Small-cap stocks underperformed large caps.

Yields on the bonds of developed market governments remained close to record lows. Expectations of modest growth and low inflation in the US have kept a lid on US bond yields. The yield on the 10-year US Treasury note fell below 2.50 per cent, close to its lowest in 10 months.

In Europe meanwhile, yields on peripheral government debt continued to fall in anticipation of an ECB rate cut. Spanish 10-year bond yields fell to a record of 2.81 per cent; yields on Italian and Portuguese government bonds also declined. Investors seeking higher-yielding sovereign debt turned to emerging market bonds which were the best-performing segment in fixed income; both USD and local currency denominated emerging debt gained.

Overall we keep our neutral position on riskier asset classes; our underweight in bonds is maintained as the decline in bond yields looks unsustainable. Regionally, we continue to favour Japanese and emerging market stocks, which are attractively valued. Sector wise we add to our cyclical bias by increasing our exposure to consumer discretionary stocks; energy is cut to neutral. And finally high-yield and emerging market USD debt are our preferred asset classes.

Source: Barometer June 2014, Pictet Asset Management.