Financial markets have recovered much of the losses suffered during the Fed tapering related sell-off during June, with equities leading the gains, according to the July 2013 investment outlook from Legal and General Investment Management, the UK-based asset management firm.

In its latest investment outlook paper, LGIM said that having increased risk appetite and the equity allocation after the sell-off at an intra-month meeting, it considered whether the rebound warranted taking profits and returning the risk asset position to a more modest overweight. Overall it was decided the market rebound had been fair, but the risks were now less skewed to the upside. As a result, the equity overweight was reduced back to the levels of early June, with the overweight spread evenly across US, UK and Japanese equities, the firm said.

LGIM said that macro fundamentals in advanced economies have been steady into early July as positive news in Japan and the UK offset developments in China. The firm maintained the view that global growth was likely to gradually increase heading into the autumn.

Meanwhile, central bank policy was expected to remain supportive, particularly with inflation now low almost everywhere. LGIM said that Chinese interbank rates have come back down, but there is still a risk of some lasting damage to growth as the economy reacts with a lag to the credit tightening. The firm expects modest near-term growth in the US, weighed down by fiscal constraint, but growth is expected to strengthen later in the year. The rise in Treasury yields, at this stage, probably reduces the chances of a more rapid acceleration, rather than derailing the recovery, the firm said.

LGIM said that equities have rebounded sharply after the tapering related sell-off and discussed whether rising rates would be a headwind for equities. Most believe that stronger earnings and a still significant valuation buffer would support equities, despite higher bond yields, while the risks are seen to stem from a disorderly upward move in bond yields and an economic disappointment.

The underperformance and related valuations discount of emerging market equities are seen as an opportunity on a longer investment horizon, but it was noted that valuations have no reliable correlation with short-term performance. From a tactical perspective, it was decided to wait for either an identified positive catalyst or signs of investor capitulation before adding to the emerging markets equity position. Overweights in Japanese, US and UK equities are maintained, the firm said.

In contrast, credit is seen to be considerably less attractive than equities, but spreads are likely to remain relatively tight providing liquidity is ample and growth prospects improving, the firm said.