Editor's note: Here are comments from James Butterfill, Global Equity Strategist at Coutts. The remarks are taken from the regular "Spotlight" publication sent out by the bank. While this publication is pleased to share such views it does not necessarily share all the opinions in this article. As ever, readers are most welcome to comment.

US growth seems to be slowing down as we head into the second quarter of the year. Recent economic data has surprised to the downside, probably a result of the fiscal tightening that is currently taking place in the US.

While core consumer price index (CPI) inflation has remained fairly stable around the 2 per cent target, the Federal Reserve’s favourite measure of inflation, the core Personal Consumption Expenditure price index, has been falling consistently and is now approaching the lowest level seen since the Great Recession.

The housing market continues its stable recovery, which will continue to have positive effects on consumer confidence and spending. This is likely to be further supported by the “wealth effect”. US asset prices have risen substantially, which tends to move together with confidence and spending. The US banking sector is also now in a much healthier position and more willing to lend to households and businesses. We think these factors are likely to offset some of the drag from falling government spending and increased taxes.

Foreign exchange

Heading into 2013 we were positive on the US dollar, reflecting our view that US growth will be stronger than in most other major economies this year. This theme has worked well in the year to date, with the broad-based DXY dollar index up around 2.8 per cent. Sterling, the euro, the yen and the Swiss franc have all weakened against the dollar over this period.

The timing, extent and perceived effectiveness of additional policy support will likely be the key driver of the dollar’s medium-term prospects. Meanwhile, aggressive monetary expansion by the Bank of Japan also suggests further upside for the dollar against the yen. We expect dollar gains versus the Swiss franc, with investor demand for Swiss assets likely to moderate as concerns ease about systemic risks facing the euro area.

Fixed income

The market is pricing in no change in US interest rates until 2015. However, once the Fed stops purchasing bonds (though that is not yet envisaged) this will reflect a tightening of policy that precedes and signals the scope to raise interest rates. We expect bond prices to be supported in the coming months amid seasonal factors, weaker economic data, potential Japanese investor interest and lower inflation expectations.

Lower inflation expectations have led index-linked government bonds prices to fall, and they may potentially become attractive as longer-term insurance against potential increases in inflation. Government bonds also still perform an important role as a hedge against risk in portfolios but we continue to prefer credit with a maturity of five to seven years and rating of A and BBB.

Equities

In an unusual twist, the strong rally in US equities this year has been driven by investor appetite for safe and defensive equities. This unusual behaviour has important ramifications as to how equities are likely to perform over the rest of the year. Holders of high-dividend equities tend to own them for the long run, so any correction is likely to be much smaller than if the rally were driven by stocks that were more cyclical, or sensitive to the economic cycle. However, there is now a substantial difference in relative valuations, with defensives being very expensive.

We don’t see cyclicals bouncing back until the US recovery becomes firmer and more sustainable. At this juncture it is still unclear when GDP growth will return to its longer term trend level. Despite the recent rally, US equity valuations remain below their long-term average, thanks to strong earnings growth, which has beaten expectations for 15 consecutive quarters (with the exception of the fourth quarter of 2011). But there has been a considerable slowdown in sales as a consequence of the slowing economy.

As quantitative  easing is likely to maintain demand for income, we therefore continue to favour the defensive healthcare, medical devices and consumer staples sectors.