– Moving to reduced Fed stimulus, but subdued inflation to keep interest rates low.
– Stocks more volatile, but still our preferred asset class; in emerging markets, we like energy and consumer-oriented markets.
– In bonds, BBB to BB credits offer best opportunities; real estate and selected hedge funds still with positive return prospects.
– Weaker JPY (and AUD); stronger USD. ….
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Nannette Hechler-Fayd’herbe, Head of Global Financial Markets Research
A more typical cyclical environment
The USA has moved closer to a normal cyclical environment from a state of structural repair. The recent rise in long-term yields relative to short-term rates signals this change in regime. In such an environment, the relation between interest rates, growth and inflation plays a stronger role again for financial markets. The best constellation is when low inflation allows central banks to let the real economy “run.” We believe this is the case in the USA, and we therefore remain positive on US stocks. Should growth disappoint, however, interest rates would likely decline, again providing some support to stock markets. In Europe and Japan, things are not as advanced as in the USA. Central banks have yet to buy time for structural economic reforms and fiscal consolidation with a highly expansive monetary policy and negative real yields. But here, too, lower discount rates should allow multiple expansion, which is also favorable for stocks.
Fixed income: Focus on BBB and selected BB credits
Core government yields have adjusted to reflect a higher risk premium for rising short-term rates. But subdued inflation should cap nominal yields. So we do not expect the recent increase in yields to signal the start of a bond bear market. However, the times of high returns in fixed income are probably over and bond investors have to be more selective about their bond exposure. High grade credits offer too small a spread to act as a buffer against more volatile benchmark yields. Deeply speculative credits in turn do not reward investors adequately for default risk. We continue to see best value in BBB and selected BB rated corporate and emerging market credits. By keeping maturities relatively short, investors in single bonds can at worst hold their bonds to maturity and “clip” the coupons. Looking across various markets, we continue to find Swiss benchmark yields too low compared to fair value, and expect a further rise in yields in coming months.
Equities: Cyclicals to take the lead; divergent emerging market stocks
We highlighted in our last Research Monthly the unusual pattern of defensive sector outperformance in the first half of 2013. We believe the return to cyclical normality will also imply a more normal cyclical-over-defensives sector lead. Our sector strategy therefore remains biased toward cyclical sectors, such as industrials – capital goods in particular, as well as autos in the consumer discretionary sector and IT. We also include financials among our overweights, but would reduce metals and mining weights instead. The transformation of China from a resource-intense growth area to a more consumer-led growth zone, as well as structural oversupply, are likely to lead to a more long-lasting drag on this sector. We have left our broad regional recommendations unchanged, maintaining overweights in the US and Japan. In Japan, we believe the market is ready for a rebound; a weakening JPY should give the market renewed impetus. Across emerging markets, we believe that the divergence between individual markets will likely persist.
We like energy-oriented markets such as Russia and Colombia, as well as tech- and consumer-oriented markets like Taiwan. We have a more cautious view on mining-focused markets, such as South Africa and Chile (please see our special emerging markets investment theme).
Alternative investments: lower returns than in H1
Higher interest rates, as well as credit and equity volatility, tend to have a dampening impact on hedge funds as well as on real estate investments – as was clearly demonstrated during the month of May. The result is likely to be lower returns in the second half of 2013 than in the quite buoyant first months of the year. We still see the best performance potential in directional hedge fund styles and also prefer real estate over commodities. For gold, although US real yields are less negative than before, they are still negative, and this provides some support to gold. But technical analysis patterns have deteriorated. The break below the important USD 1300 support level may lead to further outflows from gold, and will likely result in further short-term weakness.
Currencies: Weaker JPY and AUD, stronger USD
Capital repatriation from domestic Japanese investors has reversed some of the BOJ-led JPY weakening. We believe we are close to levels where the BOJ will take action and drive USD/JPY clearly above 100 again. For the AUD, we believe that a further downward correction is in the cards. This currency remains significantly overvalued even at current levels.
Across emerging markets, we continue to like the CNY, which we believe benefits from a structural appreciation trend.
Among the major currencies, the EUR remains well supported for now, but close to 1.35, the currency is expensive against the USD. Over the medium term, we expect the USD to gather strength. The EUR should appreciate against the CHF.
Much lower credit spreads for the Eurozone periphery are indicative of increasing investor confidence and should lead to outflows from the CHF. However, if this goes along with a further interest rate cut by the ECB, the CHF depreciation is likely to be a slow one.
2013 Top Investment Ideas – July update
We have moved the status of Investment Idea No. 6, “New Hard Currencies” to Amber from Green, as we think that the phase of softer emerging market currencies against the EUR and the USD may persist. The uptick in US yields leads us to move the status of USD bonds within our Investment Idea No.1 back to Green. Among our stock ideas, we expect recovery stocks to outperform the rest. (21/06/2013)
Strategic asset allocation (SAA)
The neutral allocations serve as a guideline and represent the average weighting over an entire market cycle. Since the global strategy is based on a medium-term investment horizon, it deviates from the neutral position. We recommend an overweight in equities and alternative assets, particularly hedge funds and real estate (selected markets). Conversely, we recommend underweighting fixed income investments and liquidity
Source: ETFWorld – CREDIT SUISSE Research
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