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December 2019

Barometer: Encouraged by the emerging world

The latest data gives some grounds for optimism, but the world economy is still not out of the woods. We remain neutral global stocks, but overweight emerging market assets.


Asset allocation: fighting a slowdown

Policymakers have so far been successful in preventing a sharp global economic slowdown. The US Federal Reserve and European Central Bank have opened the monetary taps, while some emerging governments have provided fiscal stimulus, with Europe and Japan likely to follow suit with more public spending. 

However, this doesn’t mean the world economy is out of woods yet. The missing piece in the global stimulus puzzle is China – where rising inflation and a build-up of corporate debt pose a dilemma for Beijing, which is under pressure to support the cash-starved parts of the economy hit by the trade war.

It therefore makes sense for investors to avoid the most expensive areas of the financial market. We maintain our neutral stance on equities and overweight cash. We also remain underweight bonds – European fixed income in particular is an unattractive, overvalued asset class offering limited potential for return in the coming months.

Monthly asset allocation grid

December 2019

barometer asset allocation grid

Source: Pictet Asset Management

Our business cycle indicators show global economic conditions are slowly improving.

Our world leading indicator has picked up three months in a row to hit its highest in a year, thanks largely to an acceleration in emerging economies.

Encouragingly, this comes at a time when monetary authorities are increasingly shoring up growth: the proportion of central banks cutting rates has reached around 40 per cent on a net basis – a figure last seen at the height of the financial crisis (see Fig. 1). That said, we still expect global output to expand at 2.7 per cent next year, which is below potential and this year’s reading.

Fig. 1: World leading indicators and central bank actions
World leading indicators

World leading indicator is GDP weighted. Central bank data is based on 40 central banks, with an 8 month lead. Source: Pictet Asset Management, CEIC, Refinitiv, data covering period 01.01.2000 to 01.12.2020

Our liquidity analysis shows central banks will provide monetary stimulus equivalent to a modest 2 per cent of GDP over the next half year, thanks primarily to the Fed and the ECB.

China has largely been absent from these efforts. This is because Beijing must walk a policy tightrope – economic growth has cooled to the weakest in nearly 30 years, while a recent jump in pork prices has pushed consumer inflation to an almost eight-year high.

According to our valuation readings, equities are neither expensive nor cheap at a global level. However, investors should find attractive opportunities in certain sectors and regions. We prefer stocks in the euro zone and emerging markets, where we expect corporate profit growth to accelerate next year. We also see value in health care and financial stocks.

Technical indicators remain unchanged, supporting our neutral stance on equities. These signals are however positive for emerging market assets – equities and local currency debt in particular.


Equity sectors and regions: emerging market stocks in the ascendant

Global equities are on track to finish 2019 fairly valued, having started the year cheap. The price-to-earnings ratio on the MSCI All World  index has climbed to 15.8 times from 14 times in January.

The slowdown in global growth appears to be easing, but our leading indicators suggest the bottom may yet be a few months away. Against this backdrop, we have kept our overall stance on global equities neutral, while slightly adjusting our sector and regional allocations to prepare for when economic conditions stabilise. 

Fig. 2: Expensive staples
Global consumer staples, net debt to trend EBTDA ratio
Global Consumer staples

Source: Refinitiv. Data covering 26.11.2001 to 26.11.2019.

Within sectors, that means closing our overweight on consumer staples in favour of a neutral stance. This defensive sector is relative expensive and would generally be expected to lag more cyclical industries in the event of a modest pick-up in growth. Debt levels have also climbed sharply in the past two years, which warrants caution (Fig. 2).

We continue to like financials – the second cheapest sector on our valuation model – and healthcare. The latter is a defensive sector that is increasingly benefitting from growing consumer demand for lifestyle products.

Among regions, emerging markets (EM) offer the best economic growth prospects, supporting our overweight stance in their equity markets. Valuations are reasonable, although there are notable differences within the EM universe. Stocks in Brazil, Taiwan and India are the most expensive, while those in Poland, Turkey and Chile are among the most attractive in terms of valuation.

More broadly, there are signs that investors are starting to wake up to the opportunity in EM equities, as the asset class has seen some of the strongest inflows in recent weeks. The same is true for European stocks – another of our regional overweights.

Elsewhere, we have closed our underweight in US stocks. Our US leading indicator score has improved to its highest level in a year.1 Regional Fed manufacturing surveys support the view that we have reached a cyclical trough for manufacturing and industrial production, but more data is required to call time on the 2018-19 manufacturing recession. Taken together with the fact that US remains the most expensive region on our valuation model, we believe a positive stance is not justified at this juncture, only a neutral one. 


Fixed income and currencies: a preference for local currency emerging market debt

The prospects for EM local currency bonds have brightened, with global manufacturing activity stabilising and trade relations between the US and China improving. This, in turn, should help EM currencies appreciate against the dollar, boosting returns from domestic currency bonds. What is more, even if the global economy has found a more stable footing, central banks in the developing world aren’t likely to take any risks. Monetary policy will remain loose, which means the 5 per cent plus yield currently offered by the asset class remains attractive. 
Fig. 3: Relative value

Yield spread between 10-year US Treasuries and German Bunds

Treasuries vs bunds yield spread

Data covering 15.12.1999 to 27.11.2019. Source: Refinitv.

Our optimism for EM assets doesn’t mean we are complacent, however.

Even if economic conditions are improving, we can’t rule out the possibility of an sudden adverse change in world trade dynamics. For this reason, we have decided to take out an insurance policy in the form of an overweight in long-dated US Treasuries. Compared to other defensive assets – whether they are government bonds in the euro zone or Japan – US Treasuries are attractively priced. The 10-year UST offers a yield of 1.75 per cent compared to around -0.35 per cent for its German equivalent (see Fig. 3). We are also overweight gold for the same reason. 

We retain our underweight stance on all other investment and speculative grade developed market bonds. 


Global markets overview

Hopes for some resolution of the China-US trade war and that central bank easing will shore up flagging economies inspired investors to rediscover their appetites for risk in November.

Equities jumped, setting new record highs in the US, while safe haven assets like sovereign bonds and gold struggled.

Global equities were up almost 3 per cent on the month for a stellar gain of more than 20 per cent on the year, even as analysts trimmed earnings forecasts across all regions. Most markets registered solid gains, though the US led the field with a near 4 per cent gain on the month. The stand-out performer this year, however, has been Switzerland, up a shade under 30 per cent for Swiss franc investors notwithstanding the market’s reputation for being defensive. Emerging markets were relative laggards.

Fig. 4: Soaring stocks

MSCI AC World Equity Total Return Index

soaring stocks

Source: Refinitiv. Data covering 26.11.2014 to 26.11.2019.

Cyclicals outperformed, with tech stocks leading the way, up more than 5 per cent on the month and more than 40 per cent for the year. By contrast, energy has been a laggard, up just 8 per cent since the start of the year even though oil prices were up three times as much over the same period.

The preference for risk trickled into parts of the credit market, with high yield gaining ground on both sides of the Atlantic, though European investment grade issues – already very expensive – dipped slightly.

Sovereign bonds, however, struggled. With the exception of Swiss government bonds, developed and emerging market government bonds edged back on the month in local currency terms. EM local debt was particularly soft, down 1.8 per cent on the month. The US dollar gained ground almost universally; the exception was sterling, which held ground amid expectations that the Conservatives will win the next election, and the yuan, which benefited from a modestly more optimistic outlook for trade. Gold was down more than 3 per cent on the month.


In brief

barometer december 2019

Asset allocation

The world economy is still slowing down. We remain neutral equities and underweight overvalued bonds.

Equities regions and sectors

We downgrade consumer staples, and upgrade US equities to neutral.

Fixed income and currencies

In fixed income, we favour emerging market debt and US Treasuries.