Up or down?, ‘Perspectives’, August-September 2017

Risk assets showed a considerable loss of momentum in the second quarter. Annualised rises of over 50% on the S&P500 for much of the first quarter declined to 5% in the second. The reason was the fading of any belief in the reflation trade that the election of Donald Trump was meant to foster via tax cuts and infrastructure spending. There has also been a palpable loss of momentum in European markets as the boost provided by receding populism has faded.

According to Pictet Wealth Management s (PWM) chief strategist, Christophe Donay, writing in the August-September issue of Perspectives, with valuations already high, equities could remain on pause for a while yet in the absence of some sort of new catalyst, such as co-ordinated economic policy stimulus that would put recent market gains on a sustainable footing. Without policy co-ordination (to take the place of the receding tide of monetary stimulus), Donay describes the current synchronisation of global growth as a “temporary fluke”. He also believes that continued earnings growth this year has already been factored into prices.

This does not mean that Donay is pessimistic about prospects for equities—only that we may have to wait until near the end of this year, when markets begin to factor in 2018 earnings prospects and we see (possibly) some sort of tax and spending package from the Trump administration, before equities receive another significant boost. “Before then, it is hard to see what might push equity markets much higher,he writes.

And yet, valuations remain high and volatility comparatively low. Concerned that the market might still be a tad too relaxed, PWM’s chief investment manager, Cesar Perez Ruiz, decided it was time to take some profits ahead of the recent spike in long-term yields and the mid-June sell-off of technology stocks. “With markets starting to look complacent, it seems prudent to take some profits and buy protection,” he writes. The focus of profit taking was largely US dollar high yield,which, according to Perez Ruiz, “looked especially exposed to a rise in volatility”.

PWM’s fixed-income strategist, Lauréline Chatelain, is of a similar view, with possible rises in volatility, unstable oil prices and restrictive credit conditions all pointing to renewed widening of spreads in the sector. “Given our expectations for US Treasury yields to rise, such widening would lead to negative total returns,” she writes.