At the top level, Standard Chartered prefers global equities due to the supportive environment of benign inflation and accommodating monetary policy, Brice said.
“A lot is being made about valuations being stretched in the US market. But if you look through the inflation lens, valuations are slightly cheaper than they normally would be if inflation was around 2%, which it is now.”
Within equities, the bank prefers Europe, which is currently trading at an extreme discount to the US, he said.
“The weakness in the euro currency should provide a significant boost in the second half of the year. Over half of the revenues in Europe come from overseas sales.”
Change in equities leadership?
Brice pointed out that business confidence indicators in Europe seem to be down, but conditions are supportive of growth.
“Individuals and companies want to borrow and banks want to lend and the central banks are giving liquidity to lend with. I don’t think the slowdown will be prolonged.
“There are inflation concerns, but Europe will come out of this [downturn] very well. So going forward, the discount of European equities to US equities will be less extreme.”
At the same time, in the US, investors are concerned about the Federal Reserve raising interest rates. But Brice said volatility happens around the time of rate hikes and it is usually short lived.
“Normally after the first 12 months of a rate hike, markets are up. It really takes interest rates to get through a neutral level before equity markets struggle — when the central bank starts focusing on combatting inflation rather than supporting growth. We believe that point is at least two years away.”
That raises a key question: Is equity market leadership sustainable? Standard Chartered believes the current preference for European will shift toward the US in the next 12 months.
RMB bond allure
Within bonds the bank’s favorite asset class is Chinese RMB local currency bonds. It doesn’t have a large allocation, but Brice believes that absolute returns will be very healthy.
“The yield is just under 6% on short duration investment grade bonds. That’s attractive in the current environment. The currency appreciated significantly and now there is less scope for appreciation but we don’t believe it will give up returns.
“The interesting thing is that when we looked at the taper tantrum that happened last year, Chinese RMB bonds were one of the few asset classes to deliver positive returns during that five-week period.
“So if you look at developed market equities, emerging market equities, Asian local currency bonds, US dollar bonds — all saw significant loses during that five week period. So this has significant diversification benefits in a rising yield environment.”
Gold bear
Brice said the bank has been bearish on gold in February 2013. Rising long term yields and bullish equity markets mean the cost of holding gold is high. Another impediment is the rise of the US dollar. The bank therefore remains bearish. One risk, however, is that inflation expectations start to rise.
“But even in inflation adjusted terms, gold is still elevated so you need quite a ramp up in inflation to validate where we already are.
“Gold is heading lower. $1200 is key support. If it breaks that, it opens up to significant downside. It had been a darling in investors’ eyes and a lot of people held it too long.”
Two out of three
The bank’s main investment themes at the beginning of the year were global equities, a diversified income basket and a bearish position on G3 investment grade bonds.
The global equities theme seems to be working out, as they are up 10% year to date. Global income is not too dissimilar, up 8.8%.
“Our bearish theme hasn’t worked so far. We’re expecting negative returns, though we are still up 1.2%. Our view was that yields were very low and ultimately yields would have to rise at a pace that would lead to negative returns. Despite the weakness of the past four weeks, we’ve been less convinced about that because inflation is taking longer to come through.
“We do believe yields will go higher, but more gradually than we initially thought and that still might allow for positive returns to continue in this asset class. So that we got wrong. But that reinforces the income theme, which is outperforming our expectations. The income basket has exposure to bonds.”
