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No summer lull for investors – says Pictet’s Luca Paolini

“Even if China is flexing its regulatory muscles and Covid infection rates remain uncomfortably high, equities aren’t likely to suffer if the economic recovery continues,” says Luca Paolini, chief strategist at Pictet Asset Management.

“There is no summer lull for investors this year. The global economy is powering ahead despite the resurgence of Covid-19 infections while inflationary pressures continue to build, particularly in the US. Then there’s renewed upheaval in China.”

“The Chinese government’s surprise ban on for-profit after-school tutoring, essentially shutting down the circa USD100 billion edu-tech sector, has raised concerns about an intensification of Beijing’s regulatory crackdowns.”

“The latest intervention comes on the heels of cybersecurity investigations of the ride hailing app DiDi and other e-commerce companies, increased scrutiny of overseas IPOs and the imposition of fines and restrictions on some of China’s largest e-commerce firms.”

“Authorities have also moved to restrict the use of the variable interest entities (VIE) structure – holding companies based in tax haven jurisdictions and designed to allow foreign investors to invest in key sectors such as tech without giving them any operational control.”

“Even though such moves would in effect add a permanent ‘risk premium’ to Chinese stocks and bonds, they should not fundamentally change China’s growth model or the broader investment case for the country’s financial assets.”

“Balancing the economic resilience with the rising uncertainty, we retain an overall neutral allocation across equities, bonds and cash.”

“We remain neutral on equities in China and other emerging markets.”

“Leading indicators in the world’s second largest economy have fallen for 11 months in a row in the latest sign that the recovery is losing steam.”

“However, we don’t think a full-scale withdrawal from Chinese stocks is warranted.”

“Prospects for European stocks are improving as smooth vaccine rollout allows governments to lift lockdown measures.”

“The region is now taking the lead in the recovery from the Covid crisis from the US, with business activity across the region expanding at its fastest rate in 21 years and mobility indicators having already returned to pre-Covid levels.”

“At the same time, European stocks should also benefit from what we expect will be an upward move in real bond yields.”

“That’s because European equity indices contain a greater proportion of value stocks, such as financial, which tend to outperform when real rates rise.”

“For these reasons, we upgrade the euro zone to overweight.”

“We also upgrade Swiss equities to overweight. Swiss equity markets are home to a large number of quality stocks, which tend to perform well during the mid-cycle phase of a bull market.”

“The US remains our only underweight position. Our models suggest US stocks’ price-earnings ratio will decline by as much as 15 per cent over the next 12 months”

“Growth-orientated stocks far outperformed value on the month, so that returns from these two factors are now neck and neck: value has been a big winner in the first months of 2021.”

“A powerful bond market rally that drove yields sharply lower has prompted us to take profits on US Treasuries; we have reduced them to neutral from overweight.”

“We also take profits on Chinese government bonds, reducing our exposure slightly but still maintaining an overweight.”

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