Global stocks markets are likely to face increased volatility as the US-China trade war resumes and economic conditions deteriorate in many parts of the world, according to strategists at Pictet Asset Management.
The Swiss investment house, which has asset under management of £143bn, is maintaining a defensive asset allocation stance in its portfolio, being underweight on stocks, neutral on bonds and overweight cash.
Underpinning its concerns is the trade tensions between the US and China. Last month, the US raised tariffs on $200bn of Chinese goods from 10 per cent to 25 per cent, prompting China to retaliate with a similar move.
Pictet’s monthly asset allocation grid - Jun 2019
Source: Pictet Asset Management
“The escalation of trade tensions between the US and China has intensified concerns about the strength of the global economy and corporate earnings,” the group’s strategists said.
“If prospects for global equity markets looked unfavourable before US president Donald Trump’s latest salvo in the trade battle, then they are even more discouraging now.”
Analysis by Pictet suggests that the planned increases in tariffs go ahead, then their cumulative impact could shave up to 0.3 percentage points from global GDP this year. The firm noted that this is “a sizable amount” that does not take account of any knock-on effects throughout the global value chain.
“What is particularly concerning is that this hit comes at a time when the global economy is already stuttering,” the strategists continued.
The group’s business cycle indicators suggest economic conditions have deteriorated in many parts of the world. This includes China, the world’s second largest economy, which witnessed an “abrupt slowdown” in April; this appears to show that the economic boost from its stimulus measures have faded in recent weeks and does not paint an encouraging picture with renewed trade tensions on the scene.
It is not all bad news in this part of the world, however. Pictet added: “That said, emerging markets generally remain on a much stronger economic footing than their developed peers. And China still has plenty of stimulus at its disposal, both fiscal and monetary.”
China is one of the few countries where the group’s liquidity indicators are positive, with the flow of credit across the Chinese economy is improving and some signs that small and medium-sized enterprises are finding it easier to access bank lending.
Pictet’s world leading index, 3m/3m growth, %
Source: Pictet Asset Management. Data covering 1 Apr 2017 to 1 Apr 2019
In contrast, liquidity conditions in developed markets are not as positive for riskier assets because central banks are continuing to shrink their balance sheets. This makes Pictet consider emerging market assets to look more attractive than the developed world.
When it comes to valuations, the group said that global equities seem “fairly valued” with a price-to-earnings ratio of around 15 times and a dividend yield of 2.9 per cent.
That said, earnings prospects are “uninspiring” and the firm expects corporate profit growth will slow further over the coming months. Its models suggest a 3 per cent increase in profits across 2019, compared with the consensus view of 7 per cent.
In another downbeat point, Pictet’s strategists added: “The technical indicators we monitor, meanwhile, show that seasonality has turned deeply negative for equities across the board, ahead of what is traditionally a volatile summer period.”
“What the equity markets gave to investors in April, they took away in May. And with a trade deal between the US and China unlikely to be struck anytime soon, the market’s recent slump looks likely to worsen.”
Pictet argued that US stocks look particularly vulnerable to this. The US economy is slowing and company earnings look set to weaken, even though there was a “surprisingly good” Q1 earnings season; US corporate earnings have been downgraded for growth of just 3 per cent this year.
“The US market looks even less attractive once its relatively high valuation and its disproportionate weighting towards cyclical sectors are taken into account,” the strategists said.
“It is now more weighted towards cyclical stocks than any other major market, bar Japan, and for the first time ever is more exposed to economically-sensitive sectors than emerging markets. We consequently remain underweight US equities.”
Given their concerns about the lacklustre path of global growth, the strategists are pessimistic on stocks that are heavily geared to the economic cycle. Within the MSCI AC World index, cyclical stock sectors are trading at a premium of around 17 per cent relative to their defensive counterparts, which is significantly above the long-term average of 10 per cent.
Performance of UK vs US over 3yrs (in local currencies)
Source: FE Analytics
However, they do consider the UK stock market to look “good value”, noting that valuations have been hit by Brexit concerns but many members of the FTSE 100 generate their revenues outside of home shores.
“A cheap currency, low valuations and the fact that the economy has so far managed to weather the political storms are reasons for maintaining an overweight on UK equities,” Pictet said.