Volatility is not the end of the road for investors

Dubai: Global markets have been on a rollercoaster since the beginning of the year triggering fear among investors. Despite the heightened volatility, data suggests that the global economy is not plunging headlong into a recession, rather there are signs of recovery that supports investment case in for equity, high yield and emerging market bonds, Luca Paolini, chief strategist of Pictet Asset Management Strategy Unit told Gulf News in an interview.

“The beginning of the year witnessed a massive correction on equity markets followed by heightened volatility largely resulting from a currency war triggered by the Chinese. Very erratic policy and bad communications combined with the Fed backing out on potential aggressive rate hikes have increased the worries over a potential global recession. But data tells a different story,” said Paolini.

Investors in general are very pessimistic. Inflation expectation is the lowest ever. Dividend yields seem to have peaked and bond yields are at an all-time low. The feeling that the US economy has been doing fine from the second half of last year is no more the same.

New data shows that the US is facing some amount of stress. But the consumer confidence is strong, the jobless rate is falling and job inflation is climbing. So there is nothing in data that suggests that the US economy is slipping into deflation.

Rates

The employment numbers and wages data show they are on the rise; it is but natural to expect the inflation is going to go up in the future and the Fed will be encouraged to raise rates further. So, in the medium term it could be inflation rather than deflation that could work against growth.

Even in a subdued market environment, Paolini said he is overweight on global equities and selectively positive on exposures to corporate bonds and emerging market bonds.

“We remain overweight on equities as we believe the market sell-off has taken valuations to attractive levels; bonds remain expensive in the main, particularly developed sovereign debt, but we do see opportunities in high yield and emerging debt,” said Paolini.

The market rally in developed government bonds that has unfolded over the past month has reinforced the view that the asset class was already expensive. Global government bonds are almost as expensive as they have ever been, well above any notion of fair value.

Paolini thinks, considering the current macroeconomic environment, investors should take exposure in the riskier part of the bond market. “We are increasing our exposure to credit in the US and some emerging market bonds where inflation is low. In the bond space we are moving into corporate credit,” he said.

Although default rates have jumped in some sectors in the US, especially mining and energy that are linked to the oil slump and commodities cycle, there is enough space for exposures in healthy credit. In the energy and mining sectors bonds yields are in excess of 20 per cent, implying the high risks they carry but for the rest of the US corporate credit, the yields are in the range of 6 to 7 per cent. So, even if the average yields look high, there are segments that are still less risky and give decent yields.

“The sell-off in US high-yield debt has largely been induced by a sharp fall in oil prices which has pushed yields to levels more typically seen during recessions. Such a weakening is improbable considering the US economy remains on course to expand, fuelled by a pickup in consumer spending.

Attractive valuations

Also, high-yield bonds offer a good insurance against an unexpected pick up in the pace of US interest rate hikes because of the asset class’s lower duration than other fixed income securities,” he said.

Currently valuations are attractive for local currency emerging market bond. The market had a torrid 2015, ending down some 15 per cent — its weakest year since the launch of the first local bond index. This year should see a turnaround.

In the currency market, Pictet expects the US dollar to trade within a narrow range over the short term.

In global equities Europe is the top pick as the region’s economic recovery is proving resilient. Aggressive ECB stimulus measures have been filtering through to the real economy and are boosting bank lending. Demand for credit is also on the rise from businesses, which bodes well for investment spending. Meanwhile, lower oil prices have increased consumers’ spending power, and this has served to drive retail sales higher across Europe.

But some of the risks can’t be understated. Poland’s new government is proposing policies that have triggered a credit rating downgrade, Spain is about to enter a period of political upheaval and there are growing concerns surrounding the solvency of a number of Italy’s regional banks. The UK’s looming referendum on EU membership is another investment risk for the region” he said.

“We are overweight emerging market stocks because of signs of growth stabilising across the developing world and have reduced our underweight in US stocks because the export-sapping rise in the US dollar may soon run its course, and the equity market may have reached a trough,” he said.

Factbox: Profile

Luca Paolini joined Pictet Asset Management in 2012 as chief strategist. Before that he was an equity strategist at Credit Suisse Securities. Pictet Group is one of the premier independent asset and wealth management specialists in Europe. At 30th September 2015, Pictet Asset Management managed €134 billion in assets, invested in equity and bond markets worldwide.