Liquidity will remain a key issue for asset class returns.

Cross asset strategy

Although Fed “dot plots” have dropped since December, the normalisation of the financial environment in the US could have its second phase in September, the month for which economists consensus now expects a first rate hike.

However both in Europe and in Japan, central banks continue to ease financial conditions. The ECB and the BoJ will continue to inject huge amounts of liquidity into financial markets (EUR 60bn/month and YEN 80trn/year respectively) for some time: in Europe, for instance, the duration of the programme is linked to an improvement in the inflation outlook and will last until September 2016 or “until a sustained adjustment in the path of inflation”, according to Mr Draghi. Nonetheless, we anticipate more volatility, especially on the European government bond markets, as we have seen that during certain months, such as May or September, the ECB will buy less than the total net issues, potentially creating a lack of demand.

However in a context of a gradual global economic recovery, these financial conditions are clearly supportive of equities.

From a valuation perspective, equities are still more attractive than bonds, despite a less appealing absolute valuation.

Absolute valuations are still less attractive than some months ago, as the current 16.61 level of the MSCI World PE ratio is above the 15.67 median level. Nevertheless, despite more volatility on the bond markets, interest rates remain at low levels, mainly thanks to the abundant liquidity injected by central banks around the world, particularly in Europe and Japan, where significant action is being taken. In this context, equities continue to have a more attractive relative valuation than bonds.

Earnings growth will also continue to support equities. Expected earnings have been revised upwards in the Eurozone during this positive earnings season. The single currency area is clearly expected to make the difference this year. Indeed US and UK earnings growth are expected to be in deceleration or negative this year, mainly due to the impact of the oil sector.

Positive medium-term scenario

As expected, the short-term outlook for equities has been more challenging, with more volatility on financial markets. But medium to longer-term fundamentals (in terms of growth and global financial conditions) are not yet in question, and clearly favourable to risky assets, especially equities. With this in mind, we have maintained our overweight in this asset class.

REGIONAL EQUITY STRATEGY

Euro zone equities should maintain their solid trend

We favour euro zone over US equities

Our scenario in relation to euro zone equities remains intact:

• In the euro zone, equities have a more attractive valuation when compared to bonds than do US equities. European yields are still at low levels, with returns near zero or negative, due to the ECB actions. In this context, despite having performed well since the beginning of the year, euro zone equities still offer a relative attractive valuation.
• Euro zone equities are benefiting from improved momentum. Year-on-year earnings growth has been positive since the second half of 2014 and should continue to deliver in 2015, while US earnings are being penalised by a strong USD and the energy sector.
• The euro and oil price depreciation should continue to be favourable to euro zone equities.

Preference for Chinese equities within emerging markets

Emerging market equities seem to be quite cheap (PE at 12.13, slightly above the median) but, relative to their earnings growth, this inexpensiveness is less obvious. Furthermore, there is a lot of dispersion among the various emerging countries, sectors and individual stocks. Various macroeconomic forces are at play here, such as the commodity price decline, the increase in the USD and economic policy divergences. We have a preference for Chinese equities. After the surge in mainland Chinese equity markets over the past 12 months, and having reached their highest valuation discount since 2011, Hong Kong stocks should continue to benefit from the improved conditions for using the cross-border link between the Shanghai and Hong Kong stock exchanges. We expect the valuation gap to continue to shrink.

Positive on Japan

We have maintained our positive stance on Japan. The arguments for this remain intact.

• Valuations are attractive and the BoJ’s additional measures should trigger a potential increase in earnings.
• Investors expect a substantial future increase in shareholder returns, helped by solid earnings growth and strong cash holdings.
• The change in the asset allocation of the GPIF, Japan’s leading pension fund, is indicative of the sustainable support for Japanese equities.

FIXED INCOME STRATEGY

We prefer high yield and emerging debt

We are still underweight in government bonds as there is less of a cushion to absorb any increase in rates, especially in a context where during its last meeting the Fed opened the door wider to a possible first rate hike this year. Therefore we are maintaining a preference for diversification into riskier, higher-yielding bonds, which continue to be supported by the combined actions of the ECB and the BoJ which are easing financial conditions, and the more cautious approach which the Fed can adopt in its management of the interest rate increase.

Moreover, as high-yield and emerging debt still offer the best carry-to-risk ratio (risk-return measure: yield-to-maturity divided by 1-year volatility), we have kept our overweight position in these asset classes.

COMMODITIES STRATEGY

Still too early to be positive on commodities

Although probably a lot of the bad news on excess supply and lower global economic growth has already been discounted, it is still too early to turn positive.

Oil: while the fall in the US oil rig count slowed, oil prices seemed to have bottomed out, but the price recovery will be longer term. US crude oil inventories are still at a high level and hopes of a deal between Iran and the six world powers (UN Security Council plus Germany) have increased fears that Tehran crude oil could exacerbate the current oversupply. Moreover, after having cut drilling capacities over recent months, US companies could increase their production capacity if oil prices are maintained at a higher level.

Base metals are being penalised by disappointing activity in the US and Chinese manufacturing sectors during the first months of the year. Nonetheless, the oversupply problem is going to be resolved for some base metals such as copper, zinc and nickel, with supply shortages from 2016-2017. We consider it too early to invest in this asset class.

Finally, gold prices are negatively correlated with US real interest rates, which should finally start to increase in 2015