The state of the world’s “risk assets” markets do not suggest – yet – that investors should fret about a price bubble, according to UBS Wealth Management.

The state of the world’s “risk assets” markets do not suggest – yet – that investors should fret about a price bubble, according to UBS Wealth Management as the Swiss firm announced it was taking a more bullish stance on eurozone and Chinese equities.

The firm sought to address the issue of whether global equity indices and other “risk assets” are unduly inflated by the sheer volume of central bank money printing, or quantitative easing, noting that markets have rallied considerably in some places while the underlying state of the global economy is not yet particularly strong.

The comments by UBS fit with a generally bullish attitude towards global stock markets, but with a lingering air of caution, as demonstrated recently by a poll of global fund managers by Bank of America Merrill Lynch. (See here).

A debate on whether market valuations have become stretched means that a critical issue remains on exactly when, rather than if, the US Federal Reserve reduces, or tapers, its QE programme. Meanwhile, the Bank of Japan is currently still aggressively boosting Japanese monetary growth under the expansionary “Abenomics” programme of the government.

“It has been a highly favourable period for investment returns. Yet it has, at the same time, been a distinctly mediocre period for the global economy. This disconnect is now leading some to question whether QE’s reflation of asset prices represents the creation of a bubble,” Alexander Friedman, global chief investment officer, UBS Wealth Management, said in a note issued today.

“Ultimately, all that long-term investors should truly care about is whether such sentiment has pushed valuations beyond reasonable levels. And by most measures it does not appear as though we are in bubble territory,” he continued.

“Share valuations today are fair to slightly high. This means there may be scope for earnings growth to drive price appreciation, but investors should not expect a repeat of the 15 per cent -plus annualized returns enjoyed over the past five years. Annual returns of 7 per cent to 8 per cent are more likely. Equally, it is highly unlikely that high yield credit will continue to produce double-digit percentage returns,” he said.

“Of course, relative to government bonds, both remain attractive. Equities’ cyclically adjusted earnings yield of 5.4 peer cent compares favourably with real government bond yields. In our view, the extra yield, or spread, on high yield debt compared with sovereign equivalents still more than offsets the risks at this stage in the business cycle. Bottom line, we do not believe investors need to fear that we are in the midst of a dangerous bubble in risk assets,” Friedman added.

Asset allocation

The outlook for US and eurozone equities looks attractive as global growth is accelerating and central banks remain supportive, UBS said.

As part of its adjustment, UBS is adding a short position in the Japanese yen, relative to the US dollar, to replace a long position in Japanese equities. It is adding to its position in eurozone equities in light of the recent European Central Bank interest rate cut.

As far as regional market positions are concerned, UBS has upgraded Chinese equities to “overweight” after the proposed Chinese government beat the market’s expectations. UBS points out that Chinese equity markets are at more than a 20 per cent discount to Asia ex-Japan equities, so there is a scope for this gap to narrow to the five-year historical discount of 11 per cent as sentiment about China improves after recent wobbles.

Finally, UBS is sticking to its overweight stance on sterling and its negative view on UK equities.