A variety of private banking houses have set out their asset allocation and economic views as the second half of 2014 gets under way.

As the longest day of the year comes and goes, it is common for the big wealth management houses to set out views on asset allocation and economic trends. And the half-way point of 2014 sees firms wondering whether markets will continue to see a mix of rising equity prices and low bond yields.

Equity markets in the developed world, as measured for example by the MSCI World Index, have delivered total returns (capital growth plus reinvested dividends) since the start of January of 7.02 per cent, which is respectable, if hardly shooting the lights out. In emerging markets, the BRIC Index, for example, shows returns of 5.9 per cent. Last year, developed indices heavily outperformed their emerging counterparts, as concerns rose that the US Federal Reserve will turn off the monetary taps.

A recent relatively tranquil period for markets – and an unexpected (for some) fall in bond yields – has spooked some investors wondering if conditions are almost too calm. One measure of equity market volatility, the COBE Volatility Index, or VIX – known sometimes as the “fear gauge” – has fallen below pre-crisis levels in recent weeks, standing at around 10.46. (In 2007, the average daily closing value was 17.5, spiking to over 32 in 2008 before coming down subsequently.) Is this calm before a storm?

A variety of firms have laid out their half-year opinions. Below are a sample from [tag\Pictet">Pictet, Societe Generale, JP Morgan Private Bank and HSBC.

Pictet likes Japan, emerging markets
“World equity markets look overbought and we have dialled back risk by cutting our exposure,” Luca Paolini, chief strategist at Pictet Asset Management, said in a note. “Valuations for developed market stocks and bonds look stretched as corporate earnings growth remains sluggish and US liquidity conditions seem to be worsening,” he continued.

“Emerging market and Japanese equities are the most attractively valued, and we retain overweight positions in both. This is justified by the fact that, whilst emerging equities have recovered significantly from February, inflows are rising and there are signs that Chinese growth is bottoming out. We also expect to see a modest improvement in economic growth momentum and moderate export growth,” Paolini continued. “Japanese equities are supported by the ongoing liquidity injection by the BOJ, which may ease policy further at the very end of this year. The weak JPY is boosting corporate earnings. The Japanese market offers scope for further gains as it is trading close to its deepest ever discount to world stocks,” he said.

Paolini, on the other hand, isn’t keen on the US equity market: “US equities are not appealing. Although economic and corporate earnings growth look good and the central bank is accommodative, the recent rally has taken valuations to excessive levels. In addition, corporate margins are likely to fall from record levels.”

“With market volatility at historic lows, investors might have become too complacent about risk. In particular, we think that investors are too sanguine on the Fed exit strategy, as inflation risks in the US are underestimated,” he said, adding that he does not say the US equity bull run is over, but there could be a setback that will give investors a better point to enter the market. He is also cautious on European stocks, which he says are “very expensive”.

JP Morgan Private Bank takes profits on peripheral European debt
The US bank has used the compression of bond yields between “peripheral” European nations such as Spain and Italy as a reason to take profits and sell out some of these positions.

That, according to César Pérez, chief investment strategist, EMEA, at the bank, is a reflection of countries such as Spain and Italy, which saw their bond markets mauled by the problems of the eurozone post-2008, have benefited to some extent from the fiscal measures put in place and the recovery – to some extent – of the eurozone economy.

“We have benefitted from the compression in sovereign yields and have taken profits on our peripheral bond trades in our JP Morgan Private Bank discretionary portfolios,” he said in a note.

He continued: “We believe that equities offer good opportunities for plays on the recovery in Europe, especially in the periphery, which is coming back from a recession marked by the lowest levels of consumption seen in decades,” Pérez said.

As domestic demand and structural reforms kick in – in parts of Europe – this should bode well for small and medium size firms, he said, which is an area JP Morgan is interested in, he said.  

On bonds, he added that one reason for the low level of bond yields is that accounting rules and other pressures force organisations such as pension schemes, for example, to continue buying debt to match liabilities; China and Japan remain large holders of US Treasuries.

HSBC Private Bank
With equity markets having risen to the extent they have – the Dow Jones Industrial Average scaled above the 17,000 mark this week – some investors could be excused for getting a dose of vertigo, HSBC Private Bank commented in a note.
“However, this ignores the fact that earnings are also at or near record highs. With prices (P) and earnings (E) both at high levels, valuations (the P/E ratio) are not stretched in our view; in fact, most valuation measures are at or only slightly above historical averages,” the firm said.

“Regionally, the US may be more expensive and emerging markets cheap, but overall, the MSCI World [Index] sits at reasonable valuations, in our view. When we take a long-term view, indices still have some catching up to do before they return to their long-term channel, providing further comfort,” the bank said.

On a regional view, the firm said European stock markets will continue to benefit from their valuation discount relative to the US and that the valuations gap will close, while emerging market multiples may need to wait till later in the year to move higher significantly.

As far as debt markets are concerned, HSBC Private Bank said most opinion in the market are too bearish, noting that contrary to expectations, bond yields have fallen, not risen.  Investors may be pricing in rate rises that are “too aggressive in the US and the UK”, it said.

“We believe that credit will be the main beneficiary if Treasury yields trade in a range, as many investors will continue to look for yield to boost the potential performance of their portfolio. We see attractive opportunities in USD denominated bonds of European and emerging market corporates, as well as European financials. Floating rate notes (FRNs) can offer a way to take credit risk without taking much duration risk, in portfolios where interest rate sensitivity needs to be reduced; we think this makes most sense in the GBP market,” the bank said.

Societe Generale Private Banking
The French bank said that after a period of several years when monetary policy and politics have dominated market direction, behaviour is more likely to be driven by company results and hard economic numbers.

The bank said there are still “pockets of value” in some specific areas, such as the Asia-Pacific region, due to positive economic prospects, low valuations and loose monetary policy. “We also see upside in CEE [Central and Eastern Europe] equities, as these economies will benefit from the improving health of the Western European banking sector, which controls more than two-thirds of bank assets in the region,” the bank said.

“We continue to buy equities, but we are turning from the eurozone to Asia-Pacific, where we see more value,” it added.