Apart from the easing of the credit squeeze and the abating euro debt crisis, the main impetus to growth is coming from the improving global economy. The falling level of risk has triggered a strong rally on financial markets. Equity markets should continue to rise, albeit at a slightly slower pace. Equities should therefore once again outperform bonds in the second quarter. The equity market scenario shows potential for Euroland and for emerging market countries. Within the Eurozone, the main beneficiary will be the German stock market. Switzerland’s defensive equity market is likely to underperform.
With the reversal in global economic indicators and the central banks’ generous liquidity provision, the downside risks to the global economy and the financial markets have scaled back dramatically. Bank Sarasin expects growth to accelerate over the coming months and continue into the third quarter of 2012. Across Euroland there are significant differences between the more robust core nations and the peripheral states. But the worst of the European debt crisis is now over. Bank Sarasin expects the Euroland economy to revert to a growth path from the second quarter of 2012 onwards. Not least, the global economy is providing a strong stimulus: in the USA and emerging markets the pace of economic growth is starting to accelerate again. The emerging upswing is pulling Europe along in its wake with the usual time lag of one to two quarters.
“We expect the Euroland economy to revert to a growth path from the second quarter of 2012 onwards. The US jobless rate is rapidly diminishing, which has also resulted in a powerful recovery in US consumer sentiment and will develop into an international growth driver,” Jan Amrit Poser, Head of Research and Chief Economist at Bank Sarasin said.
“Global leading indicators have trended favourably in recent months with the majority of them delivering positive surprises. The steep price increase has fuelled a rising risk appetite among investors. Whereas many hedge funds have increased their exposure to equities, it appears that both institutional and private investors do not yet fully trust the upswing, despite the upbeat mood,” Philipp E. Baertschi, Chief Strategist at Bank Sarasin, said.
Central banks in the industrialised countries relaxed their monetary policy even further in the first quarter of 2012, despite better than expected macroeconomic data. However, central banks are unlikely to let a further upswing pass by: they are likely to apply the brakes in the second quarter and not allow the money supply to expand any further. As the economy starts to slow again towards the end of the year, central banks will once again discuss new measures to stimulate economic growth. A third quantitative easing programme (QE3) for buying US Treasuries could therefore once again become the dominant theme for capital markets.
Now that the situation on the money and capital markets has eased, the euro can continue its upward path over the coming quarters. Another reason for the euro’s continuous rise is its relative appeal compared to the dollar. This is because real interest rates make an investment in dollars unattractive, due to the low level of interest rates and higher inflation rate. As the recovery gathers momentum, safe-haven currencies such as the Japanese yen or Swiss franc are likely to weaken again. On the other hand Bank Sarasin has an upbeat stance on cyclical currencies such as the Swedish krona or British pound sterling. As business confidence is steadily restored, an investment in SEK-CHF should prove to be the most rewarding trading strategy.
For sovereign bonds, the main driver of yields will be the health of the global economy. While the first signs of slower growth will be evident as early as the third quarter in the USA, Europe’s economy should start to gather momentum around the same time. This suggests a relatively sharp rise in German and Swiss yields during the third quarter. The yields of the large EU peripheral economies Italy and Spain should continue to fall and emerging economies are unlikely to be able to escape the trend towards higher yields entirely. Nevertheless, the prices of sovereign bonds are expected to perform better in emerging market countries than in industrialised nations. It is also worth keeping an eye on developments on corporate bond markets, which staged a remarkable recovery during the first quarter. The attractive yields of corporate as opposed to government bonds remain a strong incentive. They also offer the chance of price gains as credit spreads fall – an entirely realistic prospect in view of stable macroeconomic and fundamental data.
The equity market rally in the first quarter exceeded existing positive expectations. The switch from bonds into equities could provide additional stimulus to the equities market. Since no reversal is expected in economic indicators until the third quarter of 2012, the rally is likely to continue, although higher than average returns are no longer anticipated. The friendly equity market scenario shows further catch-up potential for Euroland and emerging markets. Within Euroland, the focus is still on the German equity market, which profits from positive fundamental trends. The defensive Swiss equity market should continue to record a below-average performance. Investor sentiment towards US equities also appears to be overly optimistic.
One of the most important sentiment indicators for equity markets is the ISM Index (compiled by Institute of Supply Management), which provides information on economic activity. The ISM Index moves in a historical range between 30 and 70, whereby an index level below 45 indicates recession and a reading above 60 denotes an economic boom. Currently, the ISM Index is above 50 on a rising trend. Based on this scenario, Bank Sarasin believes that the sectors of information technology and consumer discretionary offer above-average potential. In view of the declining risks in the financial sector and the potential for positive surprises, above-average returns are also possible for insurance stocks. Given the prospect of rising oil prices, Bank Sarasin advises clients to avoid investments in the energy sector. On the other hand, basic materials have appeared attractive since the beginning of March due to upward earnings revisions, the cycle and positive expectations for chemicals in the coming months.