A long-in-the-tooth bull market, sluggish economic growth and stagnating corporate profits are some of the reasons why strategists at Pictet Asset Management are overweight cash while maintaining an underweight position in stocks and bonds. 
Last month saw turbulence return to markets thanks to a range of headwinds and many investors are expecting volatility to remain higher than the rather muted levels that were witnessed for much of the post-crisis bull run.
In a recent update from Pictet– subtitled Struggling For Inspiration – the firm’s strategy unit explained why it remains underweight equities and bonds while being overweight cash. That said, it does see some bright spots in “an otherwise uninspiring equity market”.
“Corporate profits are barely growing. Almost $15trn of debt trades at yields below zero. And trade disputes are rumbling on,” the Swiss asset management house said. “There is, then, not much for investors to be enthusiastic about. Not in the near term at least.”
Pictet’s monthly asset allocation grid – Oct 2019
Source: Pictet Asset Management
Pictet’s global leading indicator suggests economic conditions will remain sluggish over the coming months and it now expects the world economy to grow at a pace of less than-3 per cent. This is down from a pace of just over 3 per cent that it was forecasting in June.
The group’s strategists added that this “muted reading” for the economy is offsetting the positive signals that its liquidity and technical analysis might be showing.
The liquidity models show conditions are neutral to positive for riskier asset classes because of loose monetary policy, although China’s monetary policy taps “have not opened by as much as many investors had hoped”. Meanwhile, technical indicators appear positive for equities: stocks should benefit from seasonal effects of the final three months of the year while investors' unusually bearish positioning limits the potential for any sharp fall in stocks.
These positives aside, Pictet’s business cycle readings don't give much to be optimistic about (mainly because of trade: export orders are shrinking as a result of tariff hikes and other protectionist measures, with the US and China seeing the most impact).
When it comes to valuations, the strategists suggest global equities are fairly priced but this masks wide divergences among regions. The US, for example, looks like one of the one of the most expensive equity markets; its cyclically-adjusted price-to-earnings ratio (CAPE) of 29x means they are “poor value” both in absolute terms and relative to peers.
“Equity markets are undoubtedly getting a near-term boost from monetary stimulus,” the Pictet Asset Management strategy unit continued.
“The ECB recently launched a series of easing measures, the US Federal Reserve is trimming rates and Chinese authorities are also loosening the monetary reins. But we think the latest market gains represent nothing more than a bear market rally.
“For one thing, the US expansion, already the longest on record, is beginning to show its age. Not only have warning indicators such as the US bond yield curve been flashing recession for some time, but corporate earnings are rising more slowly. At the same time, the trade war between the US and China continues to have a depressive effect.”
MSCI World Value vs Growth
Source: Pictet Asset Management, Refinitiv. Data from 23 Sep 2009 to 25 Sep 2019, in US dollar terms. Rebased 23 Sep 2009=100
Another reason for caution are changes in market dynamics – especially the strong outperformance of value stocks in September. Pictet argued that it is not surprising for growth stocks to lag value given the recent uptick in bond yields; rising yields depress the present value of expected future earnings.
“All of which leads us to take a more cautious view on equity regions and sectors,” the firm added.
As part of this, Pictet strategists have downgraded emerging market equities to neutral from overweight, to trim financials to neutral from overweight and to lift technology to neutral from underweight.
However, the firm does see some bright spots in the global equity market despite the glum outlook. “We maintain our overweight stance on the eurozone and the UK, largely on valuation grounds,” it said.
“Even if the downturn in world trade threatens to push the German economy into recession, this possibility has already been reflected by the country’s stock market. The growing likelihood of fiscal stimulus – corporate tax cuts and infrastructure spending – makes it likely that once investor sentiment turns, it will do so robustly.
“The backdrop is similar for the UK. Brexit has left UK equities as the cheapest of all the global stock markets, while sterling is also undervalued. With plenty of bad news priced-in, any resolution to the country’s political turmoil is likely to see a big snap-back. We figure there’s the prospect of a 20 per cent upside to the market.”
In the fixed income space, Pictet argued that bonds have become “very unattractive investments”. A record $17trn of bonds are currently trading on a negative yield while the real yield on global debt – measured by the JP Morgan Government Bond index – has dropped to an historic low of -1.5 per cent.
Negative yielding bonds, in $bn
Source: Pictet Asset Management, Refinitiv. Data from 31 Jan 2014 to 25 Sep 2019
“But that doesn’t mean they can be discarded altogether,” the strategists said. “The investor’s task is to distinguish the expensive from the really expensive.”
The asset management house is underweight European sovereign and corporate bonds, noting that the continent has a higher proportion of negative yielding bonds than any other region. Over 60 per cent of euro-denominated, investment-grade corporate debt has negative yields, an all-time high.
It’s also underweight Japanese government bonds, as a large proportion of these are also yielding below zero.
“We retain a market-weight stance on emerging market [emerging market] local currency debt. Even though their yields are, in aggregate, at a five-year low of 5.2 per cent, emerging market bonds should get a boost from an appreciation in emerging currencies,” the firm added.
“Our model shows that emerging currencies are undervalued by some 25 per cent versus the US dollar, a discount that is hard to justify given the emerging world’s stronger economic growth.”
Elsewhere, Pictet Asset Management is maintaining an overweight stance on the Swiss franc and gold, arguing that their safe-haven status should help them outperform in times of increased volatility and high uncertainty.