Luca Paolini, Chief Strategist, outlines the factors behind momentum in equity markets and the driving forces that are helping emerging market stocks pull away from their peers.
Asset allocation: outlook for equities remains positive
Equity markets continued their strong start to the year, supported by favourable liquidity conditions, expanding public spending across major economies and solid global growth. At the same time, risks persist: stretched valuations in some developed markets, particularly the US, and the potential for inflationary pressures or a sudden shift in investor sentiment could dampen progress. Nevertheless, strong earnings momentum and favourable liquidity conditions provide a constructive environment for equities in the near term: we remain overweight equities and underweight bonds.
Equities regions and sectors: The best opportunities are in EM
Ongoing monetary policy and fiscal spending make global equities an attractive asset class, with emerging markets offering the most compelling opportunities. As the AI rally broadens beyond a narrow group of US tech heavyweights, EM technology and communication services, in markets such as Korea, Taiwan and China, stand to gain from strong demand for AI hardware and semiconductors. Earnings growth in emerging markets is expected to outpace that of developed peers, all leading to an overweight position for emerging market stocks. Beyond EM, some selective exposure to high-quality developed markets, such as Switzerland, and cyclical sectors like industrials and financials all provide opportunities. A defensive position in healthcare also helps to insulate against potential market retrenchment.
Fixed income and currencies: JGBs beginning to look cheap
Fixed income markets are adjusting to shifting growth and policy dynamics, with Japanese government bonds appearing attractive following their recent sell off. In currencies, the US dollar remains vulnerable, supporting a constructive outlook for non-dollar assets. Dollar weakness, combined with resilient domestic growth across emerging economies and improving fundamentals in parts of Asia, underpin our overweight local-currency emerging market debt. Despite recent volatility, we remain constructive gold given that it’s a critical hedge against inflation, debasement and USD weaponisation fears for balanced portfolios
