The ongoing Middle East conflict poses a threat to financial markets, leading to a cautious stance with a preference for bonds over stocks, shared Luca Paolini, chief strategist, Pictet Asset Management.
Despite improved stock valuations after the recent market pullback and resilient corporate earnings, Paolini said his firm would maintain a neutral stance amid muted economic growth.
According to Pictet's November investment outlook, this is attributable to the US being on the verge of a significant slowdown with the Federal rate hikes from the past year affecting consumers, coupled with "bleak" sentiment in China and Europe’s “sluggish” recovery.
“Our defensive stance is reinforced by our overweight in bonds,” Paolini stated. Fixed income markets faced turmoil this year, he added, with concerns over a potential surge in government bond supply due to public sector deficits, notably in the US.
However, Paolini highlighted that bonds have offered historically high yields, such as 5% on 10-year US Treasuries, alongside multi-decade high real yields in anticipation of an economic slowdown.
US equities appear overvalued compared to bonds, a situation not seen since 2001, he added. Stocks' 12-month earnings yield is now lower than the Fed funds rate, and the gap between the earnings yield and the real bond yield is less than 2%, a rarity over the past fifty years.
The firm's technical indicators show weakening equity trends, especially in Japan and the eurozone. Despite this, market seasonality remains favourable for the next month. Bond trends have also deteriorated, and sentiment suggests oversold conditions for the Eurozone and Chinese equities. In the fixed income sector, high yield credit and emerging market hard currency bonds also appear oversold, noted Paolini.
Both developed and emerging economies face vulnerability due to increasing geopolitical tensions, market volatility and weak earnings, leading to a focus on quality and defensive stocks. Paolini expected the Japanese market to show strong earnings growth and considered Swiss stocks as “attractive” due to higher interest rates and the safe-haven status of the Swiss franc.
Despite a gloomy economic outlook, there is an overweight stance on emerging economies, driven by their better growth prospects and increased exposure to energy as a defensive measure. Additionally, Paolini expected GDP growth in the US to lag behind other regions in 2024.
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