Global economic prospects are bright whilst valuations for equity markets are reasonable, with corporate profitability looking healthy.
With bonds having received the bulk of investment flows in recent months, investor positioning in stocks does not appear excessively bullish.
That’s not to say there are no red flags – such as a potential tightening of liquidity, particularly from the US Federal Reserve.
We are comfortable holding an overweight position in equities and an underweight stance on bonds. We have shifted currency positioning to be overweight the US dollar. Supportive price pressures are likely to build in the US as transitory dis-inflationary factors fade.
Japanese stocks are supported by continued purchases from the Bank of Japan, the reassuring status quo of Shinzo Abe’s election victory, good valuations and solid economic data. Euro zone economic growth is also above the long-term trend - encouragingly, the recovery looks sure-footed in the euro zone’s periphery, particularly Italy.
Indeed, when comparing economic fundamentals and asset class valuations, there is little to justify the valuation premium US stocks enjoy over euro zone counterparts, and we expect that differential to narrow.
The future performance of emerging market stocks, meanwhile, is likely to be depressed by a stronger dollar and excessively bullish investor positioning.
At a sector level, technology has enjoyed a strong 2017, and there is still more short-term upside before a potential wave of year-end profit-taking. We retain an overweight on financials – the only cyclical sector that looks cheap - but we are monitoring this position closely over the next few months for signs of weakness.
Conventional wisdom dictates that the mix of faster inflation, higher interest rates and rising bond yields is a boon for financials. That is all well and good, but with one key caveat – banks should do well as long as there is no sharp flattening of the yield curve.
Hence we are on high alert for any sudden shifts in expectations for Fed monetary policy, following the US administration’s nominations for the US fed board.
The dollar looks set for a fresh rally towards the year end - we see more upside, especially as market positioning remains stubbornly short on the dollar index.
Following a recent sell-off, there's scope for US Treasuries to outperform. They should act as a good hedge against any sudden correction in stocks and they look cheap relative to European bonds. In the short-term, emerging debt looks vulnerable to a US dollar rebound, as does gold.
Luca Paolini is chief strategist at Pictet Asset Management.
Keep up to date with all the latest personal finance news and investment tips by signing up to our newsletter. Email subscribers will also receive a free print copy of Money Observer magazine.
Subscribe to Money Observer Magazine
Be the first to receive expert investment news and analysis of shares, funds, regions and strategies we expect to deliver top returns, plus free access to the digital issues on your desktop or via the Money Observer App.Subscribe now