Investment Strategy, November 2012 - Wealth management
GLOBAL STRATEGY VIEWS
CHASE FOR YIELD FAVORS HIGH YIELD CREDIT AND SEARCH FOR GROWTH WILL BENEFIT EM EQUITIES
As we approach year end, investors are keen on taking profits and cleaning their books. While abundant central bank liquidity and glimmers of a silver lining in the macro outlook can be seen as risk on factors, window dressing and lingering political uncertainty will continue to compel investors to keep a relatively cautious stance in the short term as political uncertainty weighs on market sentiment. However, brace for a risky asset rally in early 2013 with a re-rating of massively undervalued asset classes. We identify investment opportunities both in credit and in equities as investors are eagerly looking for alternatives to cash and may turn more bullish on the back of the improvement in the macro outlook and receding political risks.
Global growth is picking back up slightly, supported by loose monetary policies and an improving macro outlook in the US and China. With the exception of the Eurozone, the macro outlook is turning more supportive with EM economies massively outpacing debt-trapped DM economies.
In spite of dispelled systemic risks, investors have so far remained shy about investing in equities as attractive valuations are offset by elevated uncertainty surrounding the course of fiscal policies and low growth prospects in DM economies. From a micro perspective, improving corporate margins, at historical highs, can no longer drive profits without a stronger pickup of growth. The Q3 earnings season posted disappointing figures more for top line sales than for earnings, with Q4 likely to be worse. Yet, on DM markets, we tactically prefer Eurozone equities to other markets as most of the bad news has been priced in and rock bottom valuations offer greater upside.
Our biggest call for equities is on EM markets. Below average valuations, potential for additional policy easing and sustained growth make these markets compelling. The biggest catalyst for a broad-based improvement in EM equity performance is the growth turnaround in China already reflected by the bottoming out of leading indicators. Capital inflows to EM have so far mainly benefited fixed income markets and are likely to partially reallocate in favor of equities.
In the fixed income universe, corporate high yield is still the most attractive asset class. The year-to-date performance has been impressive (23% in the EZ, 13% in the US) with further spread compression expected in some markets given the positive carry in a zero policy rate environment. Investment grade looks comparatively more richly valued and more exposed to any yield pick up on benchmarks considering the much thinner spread cushion.
On sovereign bonds, central bank policies have anchored sovereign yield curves at ultra-low levels, making sovereign bonds unattractive. Only short-dated peripheral debt that offers both positive real yield and an ECB “put option” for issuance with maturity up to three years seems attractive. Here, Spanish and Irish debt are our preferred bets.