Pictet Asset Management has retained its neutral stance on equities, corporate bonds and cash despite some improvements in the spread of the Covid-19 coronavirus and a broad rally in markets during April.
In its latest barometer of financial markets outlook for May, the asset manager remained unconvinced that stocks and corporate bonds are back after the March slump, but warned complacency may be creeping in.
Actions of central banks have been instrumental in ensuring economies and financial markets are strong enough to withstand the lockdown conditions imposed since the onset of Covid-19. And as lockdowns ease, investors may be tempted to consign the last couple of months to the history books.
However, Pictet’s strategists believe there may be some tumultuous times ahead.
The global situation has reached a pivotal point, the strategists said, with the number of new cases peaking, nationwide lockdowns easing, and conditions stabilising.
Despite government and central bank stimulus fuelling the recent rallies in the markets, Pictet are cautious that there may be further difficulties ahead.
“We therefore retain a neutral stance on equities, bonds and cash, and have shifted allocations among regional equity markets and fixed income assets to reflect the risks and opportunities we see emerging over the coming months,” the strategists said.
Indeed, the asset manager are anticipating growth this year, predicting that the global economy will contract by 3.3 per cent this year, before recovering to grow by nearly 6 per cent in 2021, providing support from central banks continues.
And that support has been forthcoming since the onset of the pandemic with Pictet’s liquidity indicators pointing upwards as the US Federal Reserve pumped huge sums into the financial system.
“The US Federal Reserve has already delivered approximately 500 basis points of easing – through a mixture of interest rate cuts and balance sheet actions,” Pictet’s strategists explained.
G5 central bank liquidity injections graph
Source: Pictet Asset Management
The flood of liquidity into markets could also be affecting valuations, with consensus among the asset manager’s analysts that mainstream asset classes are looking increasingly less attractive, with government bonds looking very expensive, and equities set to outperform corporate bonds by 10-15 per cent over the next 12 months.
Indeed, after the sharp contractions in equity markets at the onset of the pandemic, indices are now back in all bull market territory.
“Now, much like many of its Asian and European counterparts, the US index is – technically at least – back in a bull market,” the strategists noted.
Nevertheless, with Pictet anticipating a fall of up to 10 per cent in corporate earnings this year, there is a general sense that the markets are overestimating the size of the recovery.
“Our models show that the EPS [earnings per share] and dividends should fall by around 40 per cent this year,” said the asset manager. “A concern is that while EPS fell by a similar magnitude during the 2008-2009 crisis, the recession then was 3-4x milder than the slump the world is currently grappling with.”
Yet, the asset manager is finding opportunities within specific equity markets and sectors.
One area finding favour with the Pictet strategists are previously-unloved UK equities, which are home to several large-cap defensive companies trading at attractive valuations.
However, the asset manager remains neutral on US equities, which have become one of the most expensive markets in the world after the 12-month forward price-to-earnings (P/E) ratio hit an 18-year high of 19x, up from 13x a month ago.
“Investors are banking on a speedy recovery for US corporations, but we see the prospect of more analyst earnings downgrades in the coming months,” the Pictet strategists highlighted.
Interestingly, Pictet has also downgraded its outlook for emerging markets to neutral despite Asia’s easing of lockdown conditions following the early stages of the pandemic with concerns arising elsewhere such as Latin America.
In fixed income, bond purchases made by central banks in efforts to stabilise the global economy has been good news for developed market sovereign and corporate bonds.
“For instance, the Fed is covering some 70 per cent of the US investment grade market’s borrowing needs this year, while both it and the European Central Bank have ventured into supporting parts of the high yield market – which hitherto has been taboo,” said the Pictet strategists.
As a result, the asset manager has upgraded European, Swiss, UK and Japanese government bonds to neutral from underweight, upgraded US investment grade credit to overweight from neutral and European high yield credit to neutral from negative.
Despite a neutral stance on the broad asset classes, there is one area that the asset manager is overweight: gold.
“While massive fiscal packages around the world may lead to higher inflation at some stage, we think investors will be more concerned about near-term deflationary forces as they wait to see the extent of damage from economic paralysis,” the asset manager’s strategists said. “This is an investment climate that supports safe-haven assets like the precious metal.”