Over Easter I read an excellent article written by Pictet Asset Management. This boutique investment house run a number of specialist funds such as the Pictet Water and Pictet Clean Energy but also manage a very good multi-asset portfolio that I have recommended to a number of clients. Pictet are strong advocates of the view that getting the asset allocation right is the key determinant of investment returns, something which I subscribe to. It was therefore interesting to read their April “Barometer” review of the global economy and investment markets.
The principal thrust of the article was that the global economy is demonstrating a synchronised broad based recovery with surging business and consumer confidence and this was evident in both developed and emerging markets. Pictet concluded this from a variety of facts including the global Purchasing Managers’ Index (PMI), a key measure of business confidence, which is the highest in six years. In addition Pictet observed that global consumption is expanding at a fast rate and global private investment is surging. This has reinforced Pictet’s bullish view on equities. This is the most upbeat assessment of the global economy I have come across for a long time and perhaps makes my last blog post look like it had been penned by Eeyore (famed as Pooh Bear’s morose friend) or by Private Frazer, infamous for his “we are all doomed” warning.
That said Pictet are more bearish on US equities and have adopted a maximum underweight position here. The reasons they give are reasonable. The failure of Trump’s administration to overhaul the healthcare system raises doubts about Trump’s ability to deliver on tax cuts and infrastructure spending. Other factors are US corporate earnings forecasts have been trending lower whilst US equities are expensive. Whilst this is generally true compared to other equity markets Pictet observed there are significant variations in sector valuations. Industrials in the US are expensive, financials are cheap and attractive, technology continues to have reasonable valuations and further upside potential. It is important to make say this as a comment that “US equities are expensive,” is simplistic. The reality is more nuanced. I am therefore more bullish on US equities than Pictet but I selectively prefer value or recovery stocks and smaller companies.
Finally on the US Pictet explained that some indicators show that in the US consumer and business confidence has been at all time high which is not supported by hard economic data. This suggest a potential for disappointment especially if inflation running at 3% p.a. reduces consumer spending. Rising inflation is then likely to trigger interest rate rises which will be a further headwind for the US economy.
In contrast Pictet are ultra positive about Japanese equities with strong external demand, an improving labour market, an upbeat outlook for corporate profits and ongoing monetary easing by the Bank of Japan, including the purchase of equities. One point made which was new to me, is that Japanese equities have a strong historical correlation with US bond yields. If the US Federal Reserve raises interest rates aggressively bond yields will rise, suggesting Japanese equities will do so as well. I would add a caveat here that correlations are rarely permanent and may flip.
Pictet are also upbeat on European equities, which were the best performing in the first quarter of 2017. This was from strong corporate results and merger deals. Emerging markets, including China were also highlighted in a positive light.
In the fixed interest or bond markets Pictet are more bearish on US high yield but favour US government bonds, called Treasuries. Firstly they see US Treasuries as insurance against political upheaval. The bellicose noises coming out of Washington and Pyongyang are concerning. I would also add a financial crisis is a potential risk. You may recall in the 2008 crash UK and US government bonds rose due to their safe haven status. Secondly Pictet explained that US debt offers much better value than European debt. Apparently benchmark 10 year US Treasuries yield about 2% more than the equivalent German Bunds, a spread not seen since the fall of the Berlin Wall. If investors flee to US Treasuries in a risk-off rally bond prices will rise, rewarding investors who buy US Treasuries now.
Finally on the UK, Pictet are neutral to underweight equities but they commented very little on the UK.
My conclusion is that Pictet’s analysis is a reasonable if perhaps a tad over optimistic assessment on the prospect for equities. To try and reconcile my own view with Pictet’s I would say there is downside risk of a sell-off in the short term but good upside potential from equities in the longer term. So perhaps we are singing from the same song sheet after all with the odd note’s difference.
“Now where did I leave my thistles?” Said Eeyore. “Over there,” Pooh pointed to a corner of the Hundred Acre Wood.
This blog post is my own assessment of Pictet Asset Management’s article. Nothing in this blog post should be construed as investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.