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Time to sell equities?

Chief analyst Bo Bejstrup Christensen sees potential challenges ahead for the equity market.

Should we sell equities now? Our answer is not yet, but... maybe. Read below and you will understand our less than unequivocal response. But first let’s set the scene: Global equities have risen more than 10% from their lows in early February and are fast approaching end-2015 levels. At the time of writing, oil is again trading above USD 40 a barrel, which is a rise of close to 50%. Concerns about a potential Chinese collapse, European bank crisis and a US recession appear to have gone. Emerging market equities are even outperforming equities in the US, Europe and Japan. How have markets managed to shift direction so quickly? And is the turnaround justified?

We will start at the end this time and explain our “maybe” above. If you have a lot of equities in your portfolio and had a bad gut feeling in the dark days of January and February, it may be – depending on your investment profile – time to sell and thus reduce your overweight. While our view is that global equities will rise further and we are maintaining our overweight, more risks have appeared on the horizon that could easily increase market jitters again. We consider our own overweight of risk assets – equities, corporate bonds, etc – as appropriate at this time. Our current overweight is roughly 50% of the maximum overweight we are permitted.

Why we are holding onto our equities for a little longer
When we increased our overweight in January, our view was that markets were unduly worried about China, the negative fallout from sliding oil prices and US growth. Since then the Chinese currency (yuan) has been very stable, the authorities have eased economic policy, oil prices have risen and the US economy has generally performed well. The US labour market has long been a source of positive surprises, and recently even the hard-pressed manufacturing sector has begun to pick up. In short – once again the world did not go under.

And we expect more of the same. A healthy banking sector and the strong housing market – new home starts in the US have just hit a post-crisis (2008) high – will lend support to the labour market, while the negative impact of the stronger dollar, in particular, is slowly easing. Hence, we look forward to rising growth rates in the US in the coming months – generally a positive scenario for equities. The softer tone from the US central bank in the past week will also be a boon, while the situation in Europe, too, looks reasonable after the European Central Bank (ECB) once again eased monetary policy and underlined its support for bank lending activity. So no economic problems from the US or Europe in the short term.

Short-term outlook for China is positive
China’s story is a little different. The latest figures show manufacturing growth has been falling since the end of 2015. However, the housing market has proved considerably more robust than expected, with very impressive increases in sales activity, strong house price appreciation and even signs of construction beginning to pick up after a long period of pronounced weakness.  In our view, the reason is a significant easing of economic policy. In particular, down-payments for first- and second-time homebuyers have been reduced and credit growth is again relatively high. Both should help support growth in the coming months, while the record high trade surplus will ensure ample foreign currency liquidity with which to defend the yuan.

All in all, the picture is of a global economy that should not deliver any great negative shocks in the coming months and which should – led by the US – be able to push global equities higher. We therefore maintain our modest overweight.

Lurking threats
Unfortunately this blog does not end here. Looking ahead to the summer, we begin to see the outline of a global picture that could present considerable challenges to risk assets.

We begin with the most obvious of risks – the political. The UK is set to vote on EU membership, the refugee crisis could well flare up again as the weather warms, and the US presidential election is not far off. These readily apparent but difficult to quantify risks cannot form the basis of an investment strategy, but the more positive financial market sentiment is, the more vulnerable the markets are to negative headlines.

As always, however, our greatest concerns centre on the global economy.

China’s policy easing will not last forever. It is a temporary boost that will evaporate later. Debt growth is again excessive, and the easing of home down-payment requirements entices buyers today who will be absent tomorrow. The more growth increases in the coming months, the more it risks falling later – and we remain sceptical on the housing market in particular. The stock of unsold homes is still far too high, and a new upsurge in construction is simply unsustainable. Hence, China could well be the source of negative surprises later in the year.

We are preparing to sell – when the time is right
This is very important, as nascent positive sentiment on China has very much been the driver of higher commodity prices. Hence we do not see rising commodity prices as sustainable – and that includes significantly higher oil prices, as they hinder necessary production adjustments. As well as commodity prices, emerging markets have also been helped by lower US interest rates and by both ECB easing and the more dovish tones of the US Federal Reserve.

The Fed situation, in particular, will change, in our opinion. In contrast to Janet Yellen, we see clear signs of rising wage inflation, and if our economic growth forecast holds, the labour market will tighten even further. That is why we expect the Fed will continue to hike interest rates this year. And while that will happen within a context of improved US growth, the combination of a potentially slowing Chinese economy, declining commodity prices and rising US interest rates will be a difficult cocktail for global equities to swallow.

Hence, our message is – hold onto equities for now, if the overweight is appropriate. However, we are preparing to sell some of ours, and we will of course tell you when we do!

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