UK and European equities should remain attractive to investors despite rising Covid cases and China-inspired volatility, according to strategists at Pictet Asset Management. 
Equities have had a decent run over 2021 so far, powered on by the coronavirus vaccine rollout and the re-opening of the global economy.
However, the MSCI AC World index was flat in July after investor sentiment was dented by the spread of the Delta variant and a surprise regulatory crackdown on some sectors by China.
Performance of global equities in 2021
Source: FE Analytics
Luca Paolini, chief strategist at Pictet Asset Management, said: “There is no summer lull for investors this year.
“The global economy is powering ahead despite the resurgence of Covid-19 infections while inflationary pressures continue to build, particularly in the US. Then there’s renewed upheaval in China.”
Pictet currently has a neutral allocation across equities, bonds and cash, although within this it does favour assets that will benefit from a stronger post-lockdown economy.
This includes European stocks, which the £180bn asset management house has recently upgraded from neutral to overweight.
The Euro STOXX index has gained 18.3% over 2021 so far (in local currency terms), matching the rise in the S&P 500 and significantly outpacing the likes of Japan and emerging markets.
“Prospects for European stocks are improving as a smooth vaccine rollout allows governments to lift lockdown measures,” Paolini said.
“The region is now taking the lead in the recovery from the Covid crisis from the US, with business activity across the region expanding at its fastest rate in 21 years and mobility indicators having already returned to pre-Covid levels.”
In addition, Pictet expects European stocks to benefit from any an upward move in real bond yields. This is because European equity indices contain a greater proportion of value stocks, such as financials, which tend to outperform when real rates rise.
Pictet’s monthly asset allocation – Aug 2021
Source: Pictet Asset Management
Swiss equities have also been upgraded to overweight in August as the market is home to a large number of quality stocks, which tend to perform well during the middle phase of a bull market cycle.
Meanwhile, Pictet continues to like UK equities.
“It is a market with a high dividend yield of 4.2%, more than double the global average, and is also attractively-valued on other valuation metrics,” Paolini explained.
“Also in the market’s favour, the UK economy is expected to rebound to post growth of some 7% this year after suffering its biggest contraction in more than 300 years of almost 10% in 2020. Next year’s expected growth rate is the same as the US, among the fastest of all major advanced economies.”
The strategist added that the UK equity market continues to underperform its counterparts despite these positives. UK stocks currently trade at a 33% discount to the MSCI AC World index, which is the widest since Britain was forced to withdraw sterling from the European Exchange Rate Mechanism in 1992.
“We think the discount will begin to fade away in the coming months,” he said.
Pictet is running a neutral stance on China and other emerging markets, noting that leading indicators for the Chinese economy have fallen for 11 months in a row. “China’s growth has clearly peaked with industrial production, retail sales and construction all coming in below their three-year average,” Paolini added.
The country’s regulatory crackdown on industries such as tech, education and property has given cause for concern about future profitability and could push down valuations for high growth sectors.
However, the asset management firm does not think a full-scale withdrawal from Chinese stocks is warranted at the moment, pointing to the hints from the People’s Bank of China that it might loosen policy as being supportive of risk assets over the medium term.
It also has a neutral weighting towards Japanese equities, on the back of disappointing economic data and slow progress in its vaccine rollout.
Pictet’s only underweight equity position is the US, which it considers to be overvalued.
With price-to-earnings ratio of 21.5 times, this can only be sustained if US stocks’ profit margins are stable at high levels, bond yields remain low and trend growth is unchanged.
“The S&P 500 index has gained 15% in the first half of this year, thanks to corporate strong earnings. But it is unlikely the index will repeat the stellar performance in the second half, especially when corporate profit margins, already at record highs, will struggle to rise further,” Paolini finished.
“Our models suggest US stocks’ price-earnings ratios will decline by as much as 15% by the end of the year.”