The world’s biggest wealth manager reckons there is more scope for positive surprises after markets fell back recently as investors changed expectations but it has decided to bet on further falls in emerging markets, as they face mounting headwinds.

The world’s biggest wealth manager reckons there is more scope for positive surprises after markets fell back recently as investors changed expectations but it has decided to bet on further falls in emerging markets, as they face mounting headwinds.

UBS announced the latest adjustments to its asset allocation stance in the monthly letter from Mark Haefele, global chief investment officer, wealth management. Overall, the tone of the note was upbeat but contained several cautionary points.

The past few weeks have seen a sharp jump in market volatility as fears about the sluggish eurozone, decelerating China growth, geopolitical issues (Middle East, Russia) and heightened prospects of an end to loose US monetary policy took their toll. For example, the VIX Index of US equity market volatility – the “fear gauge” - recently hit an intraday high of 31, the highest since December 2011 amid considerable fear of a eurozone crack-up. In terms of market levels, for example, the MSCI World Index of developed countries’ equities now shows total returns (capital growth and reinvested dividends) of just 1.6 per cent since January. A week ago, it was in the red. A number of fund and wealth managers, however, have since stated that the market pullback represents buying opportunity.  

“Our view is still that the glass is half full. As markets have rebased their expectations for global growth lower, there is now greater scope for positive surprises. We expect equity markets to recover and credit spreads to contract over our six-month tactical investment horizon,” Haefele said.

“We are trying to position in a way that can perform well when the market sees the glass as half full, but also be better insulated when it sees it as half empty. While we retain a positive view on risky assets, we are concentrating our overweight positions in the US, specifically US equities and US high yield credit,” he continued.

“Meanwhile, we are reducing exposure to more cyclical markets, where the growth impulse is weakest, where declining commodity prices pose a threat, and where central banks have less flexibility,” he said. UBS has already taken the action of ending its overweight position in Canadian equities, where declining oil prices have made their risk-reward profile less attractive, he said.

Submerging markets
Haefele said UBS has taken out an underweight stance on emerging market equities to protect itself from a “renewed period of market volatility”, he said.

Crunching some numbers, he says that in the 16 sell-offs of more than 5 per cent taking place in the MSCI World Index since 2009, emerging markets lagged in 10 of these declines.

“We also believe that emerging markets could underperform global equities even in a glass-half-full world. The region’s corporate profitability has been falling and neither the sharp declines in commodity prices nor US dollar strength over recent months are likely to help, due to the high weighting of commodity sensitive sectors within emerging markets, and the presence of some dollar-denominated debts. We remain somewhat cautious about the economic leading indicators in many of the larger emerging markets,” he said.

Haefele said growth in Russia and Brazil is “very low”, and China’s state-owned enterprises are vulnerable to reforms and potential recapitalisation over the next six to 12 months.

“We are shifting our underweight position in emerging market dollar-denominated sovereign debt to an underweight in emerging market dollar-denominated corporate debt. Spreads on sovereigns have widened relative to corporates in the recent sell-off, and the EM [emerging market] corporate earnings environment represents a risk to balance-sheet health," he said.