A recovery we can believe in

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As the rollout of Covid-19 vaccines continues apace, equity markets look set to enjoy strong support in 2021, says Luca Paolini, chief strategist at Pictet Asset Management…

“The global economy is strengthening and remains supported by substantial flows of emergency fiscal spending. 

“This benevolent macroeconomic backdrop is a boost to corporate profits, and should offset any decline in stocks’ price-earnings multiples caused by a wind-down of monetary stimulus.

“At the same time, the risk of a policy mistake or a fresh jump in bond yields such as happened in 2013 when the US Federal Reserve decided to taper its asset purchases is low over the next six months.

“So although equity valuations and investor sentiment are both unusually high, the prospects of a near-term correction look limited. For these reasons, we have decided to upgrade equities to overweight from neutral and reduce cash to underweight.

“Having emerged from a turbulent 2020 up nearly 15 per cent, global stocks are set to build on their rally. We expect a V-shaped economic rebound led by China to boost corporate earnings growth.

“This doesn’t mean that equities will rise as strongly in 2021, however, as they will be constrained by high initial valuations and the risk of economic damage wreaked by a third wave of infections.

“Overall, global stocks should rise around 10 per cent this year, about half the 20 per cent gain typically seen at the end of a recession.

“Emerging economies, especially Asian, continue to benefit from China’s strong recovery, where economic activity is now back at pre-Covid trend levels and nominal exports are well above a six-year trend.

“Japan will also capitalise on Asia’s strength and a recovery in global trade, with consumer demand boosted by the latest fiscal stimulus. We maintain our overweight stance on emerging economies and Japan.

“With cyclical sectors likely to lead the markets higher in 2021, it makes sense to scale back investments in defensive stocks. Hence, we have cut Swiss equities (proportionally the most defensive market) to neutral.

“We remain a bit cautious on European stocks where the latest strict lockdown measures raise the risk of a technical recession; UK stocks are more interesting given cheap valuation, but have Brexit-related uncertainties to deal with.

“We remain underweight in the expensive-looking US, where IPO levels suggest markets are at risk of overheating whilst the defensive and tech-heavy nature of the US market is likely to be a negative.

“We prefer sectors that are exposed to the recovery likely in trade and capital spending, such as industrials and materials. Tech stocks look tactically unappealing given valuations and regulatory and antitrust pressures.

“With USD18 trillion of global bonds now trading at a negative yield, its going to be a tough environment for fixed income investors, particularly with inflationary pressures also on the horizon.

“But there are still opportunities to be found – whether the aim is to reduce portfolio risk or boost income.

“For income, emerging market bonds in general –Chinese renminbi debt in particular – are among the few remaining sources of positive real yield. China’s economy is firing on all cylinders, basically back to pre-Covid levels, and exports are surging while inflation remains low.

“Emerging market currencies remain very cheap and appreciation should lift emerging market local currency debt over the coming months, supporting our overweight stance on the asset class.

“In developed market credit, US investment grade debt has the most potential, but we are cautious on high yield corporate debt.”

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