Appetite for risk returns but clouds gather in the East

The European Central Bank’s new bond-buying programme and the Fed’s third round of quantitative easing have boosted investor sentiment. However, China’s slowdown and continuing uncertainty in Europe is leaving wealth managers in a quandary, as they feel markets could swing in either way.

The world will witness slowing global growth with no inflationary pressure, believes Eric Verleyen, chief investment officer at Société Générale Private Banking. The private bank projects stable GDP growth of 3.4 per cent for the year, with a weak economy in Europe impacted by deficit reduction and subpar recovery in the US.

“The bond buying programme is acting as a mass stabilisation mechanism. A more stabilised economy brings confidence to the system,” says Mr Verleyen, predicting renewed mergers and acquisitions and investment activity.

The current uptrend is leading Société Générale to re-evaluate its equity allocations. “The short-term environment is more positive for equities,” says Mr Verleyen. “In spite of high risk premium, valuations are particularly attractive relative to bonds. We see high quality dividend stocks in banks, oil and gas.”

While government bonds for France, Germany, Japan, US and UK are unattractive at or near record lows, investment grade corporate bonds continue to offer relative value. “We find compelling yields in selected subordinated financial debt, such as Axa Bank and Barclays.”

In the short-term, Société Générale does not predict a US fiscal cliff, and expects the European markets to outperform, supported by ECB’s policy. Yet, the bank has no allocation to Greece or Spain, while it is positive on Italian banks, which are expected to recover.

Mario Draghi’s bond buying has given markets an excuse, says Jacob de Tusch-Lec, manager of the Artemis Global Income fund. “Markets have been going up and we are on a risk-on mode. We are overweight Europe and Southern Europe,” says Mr Tusch-Lec.

The market sentiment greatly differs from three months ago, he says, when everything looked bad. “Everyone was in bonds, not equities. Everyone was buying defensives like pharma. Now there is a rotation from defensives to banks and mining stocks,” he says.

Investors who were earlier buying yield are now buying more risky stocks, which they avoided in the past.

China’s slowdown is very worrying and complicated, Mr Tusch-Lec feels. “In Europe we know of the problems and the solutions. In the US we know of the fiscal cliff. But in China we can only observe the manufacturing slowing and car sales going down,” he says.

The main problem with China, he believes, is it is tough to know the extent to which the government wants to slow down or whether they want to move from investment-led to consumption-led growth. Therefore, Mr Tusch-Lec does not include any holdings in China in his fund, except for Beijing Airport.

Beaten up European stocks are also attractive. “We are finding opportunities in telecoms in Europe, such as TDC and Deutsche Telekom.”

Artemis is also finding opportunities in the US housing market, after the Fed’s announcement that it would expand its holdings of long-term securities with open-ended purchases of $40bn (€31bn) of mortgage debt a month.

“Is the QE3 a positive? Yes and no,” says Mr Tusch-Lec. “On one hand, yes, but on the other we are cheering for a morphine pill when we are gravely in trouble.”

In terms of commodities, gold is Coutts Private Bank’s favourite asset. “It is very cheap to run. At a time when real interest rates are negative, gold tends to perform,” explains Alan Higgins, UK chief investment officer at Coutts. “The official supply demand mechanism shows that emerging market central banks are adding to gold reserves, driving gold prices up.”

The private bank also finds high yield debt in a sweet spot. “Growth is moderate globally and defaults are low,” says Mr Higgins. “We look at the default-adjusted yield, which offers good value.”

In the fixed income space, Coutts prefers investment grade and corporate bonds. Within the investment grade, the bank is upbeat on financials and non-subordinated financial debt, as a result of the fundamental situation in the US improving and huge risk premia, while in Europe banks not being able to fund themselves have been alleviated by the two longer-term refinancing options.

On the equity side, the bank is picking up beta in emerging market stocks and gold related stocks and focuses on high quality dividend paying stocks. “We are looking at stocks with brand and franchise, such as Nestlé, which have the ability to hold their margins because of their competitive advantage and exports to Asia,” says Mr Higgins.

While it is difficult to assess the ECB’s bond buying programme, as no money has been spent yet, he feels it is a game-changer. “This will mean governments can fund themselves cheaply. Italian and Spanish 2-year yields at 7 per cent were unsustainable.”

The recent asset purchases have signalled a recovery for Bank Vontobel, which has moved its clients’ portfolios towards risk by taking equities overweight. Within equities, the bank likes US financials and emerging market equities and is bearish on pure materials.

“We are avoiding bunds as efforts are on to save the euro. The mutualisation of debt will mean bond yields will go up and peripheral bonds will benefit,” says Alan Zlatar, chief investment officer at Vontobel.

The bank is neutral on the dollar. “We used to like the dollar during economic growth. But now we think QE3 will be damaging for the dollar and debase the currency. A further weakness of the dollar is expected,” Mr Zlatar says. Nevertheless, he is not underweight the dollar as should any negative news arise, the dollar will act as a safe haven.

While Europe and the US are showing coordinated policies, Mr Zlatar believes China is going to slow down, as double digit growth is unsustainable. This is not to say that the Chinese government may not intervene. “The Chinese government can take steps with monetary policy, interest rates or fiscal policy by investing in infrastructure,” he says. “Our suspicion is that the change of government in China will lead to continued stimulus to keep economy growing. We think we need to see a change in China from an export-driven economy to a consumption driven one.”

Europe is a purely political play, according to Georgios Allamanis, director of investment management at Newton Private Client. Within the opportunities the unlimited bond buying purchases allow, the firm has a preference for companies with high returns in the pharmaceuticals and telecoms sector. “We are bearish on consumer durables as they require confidence about economic prospects and access to cheap credit,” says Mr Allamanis.

Unlike other asset managers who are overweight financials, Newton has small positions in banks. “The healing process in the global economy is not over. There is weakness in the banking sector, and it is vulnerable in terms of regulatory backlash.”

The ECB’s has signalled it will do whatever it takes and the Fed is also likely to do the same to save the global economy and that is a positive, according to Christian Gattiker, chief strategist at Bank Julius Baer.

“We are overweight US and favour eurozone,” he says. “We like Germany and Sweden, though there are concerns that the US might lag in the fourth quarter if the Fed weakens the US dollar. Global investors are shifting out of the US in a sign that after a strong performance, there’s a need for a breather.”

Mr Gattiker feels unstable political conditions in China, particularly the recent “mysterious disappearances” of policymakers is worrying. “Trends show the transition to a new government in China will not be a smooth one and there will be many hiccups along the way.”

Equally bearish, Monica Defend, head of global asset allocation research at Pioneer Investments says the world is not prepared for China to slow down, though the firm predicts a GDP growth in China of 7 to 7.5 per cent. “There are structural risks in China, such as unfavourable demographics,” she says.

The US Federal Reserve has announced it will expand its holdings of long-term securities with open-ended purchases of $40bn (€31bn) of mortgage debt a month

Pioneer Investments predicts GDP growth in China of 7 to 7.5 per cent

Eric Verleyen, Société Générale Private Banking