Baring Asset Management's multi asset team has upgraded equities, adopting the highest risk profile it has held in several years to take advantage of the differing growth dynamics in global equity markets.
Barings' multi asset team believes that equities look the most attractive asset class in part due to the poor returns available on alternatives such as government bonds that provide only a meagre coupon and cash returns that are derisory. With investment grade bonds at minimal spreads compared to governments, only junk bonds seem to have any potential left and, even there, spreads are getting slim by historic standards. The implied risk premium of equities looks high compared to bonds and earnings expectations are very low after last year's slowdown. Most importantly though for Barings is the fact that policy settings globally are resolutely in favour of promoting risk taking which should favour equities.
Percival Stanion, Head of Asset Allocation and Chairman of the Strategic Policy Group at Barings, said: "We have become overtly positive on risk assets and are getting more confident in the resilience of the US, where the economy is maintaining a steady pace of expansion even in the face of tax rises and the ongoing threat of the fiscal cliff. It appears that the underlying economy is probably expanding by around 3%. Banks are lending again both to businesses and to consumers, the housing market is buoyant and the number of people in employment, particularly in industries related to construction, is rising."
In Europe, the situation is still challenging but there are signs of a tepid recovery - the banking sectors in South Europe are beginning to show signs of normality. Even countries like Ireland are beginning to see the markets open up to funding.
Percival Stanion comments: "European sovereign bond issuance by peripheral countries is on track for the best quarter since the beginning of 2010. This is a dramatic turnaround compared to six months ago. Cyprus has threatened this improving picture, but we take some comfort that markets have scarcely reacted to the crisis and Southern bond markets have remained incredibly resilient in the face of this test. This indicates a degree of trust in the European Central Bank to do what it takes to keep the system intact."
The team believes that the Japanese government's determination to force through policy changes will break the deflationary pattern of the past two decades. The scale of the planned intervention by the Bank of Japan is very radical and greater than that undertaken by the US Federal Reserve in recent years. However in China, the team is less sure about policy settings, arguing that while the Chinese economy does appear to be off the lows recorded last year, the pace of recovery is muted. The new administration has tightened restrictions on the property market and appears determined not to permit any resurgence in activity in the sector. As property prices are the key indicator of social inequality, this links in to the new administration's desire to crack down on material excesses and corruption.
Percival Stanion continues: "There will be slow growth in the short-term, and a slower recovery in China will lead to weaker demand for commodities from both resource producing countries and also other emerging markets. This is also not good news for Western luxury goods manufacturers and when added to domestic macroeconomic strains, such as inflationary pressures in large emerging markets such as Brazil and India, we believe that it produces an unappetising environment for investors."
Barings' multi asset team is most positive on the UK and Japan. While underlying growth rates in both economies remains relatively subdued, it is encouraged by the determination of authorities to pull the policy levers sufficiently hard that they will engineer a fall in their currencies. This should both stimulate exports and produce substantial translation benefits for markets such as the UK and Japan, where the bulk of earnings in the index come from overseas.
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