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Pictet’s Luca Paolini: “Buying the dip as China revives in the year of the tiger”

“Equities’ prospects are encouraging in the wake of a sharp sell-off as global economic growth is set to reaccelerate” says Luca Paolini, chief strategist at Pictet Asset Management.

“It’s been a gloomy start to the year. Economic growth has disappointed, Covid cases have spiked, and stocks and bonds sold off sharply. But we believe the world economy and equity markets might be through the worst – at least for the short term.

“Taking advantage of attractive valuations, we have chosen to upgrade equities to overweight on a tactical basis, conditional on the speed of US monetary tightening and on a successful resolution of the crisis in Ukraine.

“Chinese stocks endured a challenging 2021. As the Year of Tiger approaches, their prospects are improving. The volume of credit flowing into the economy as a proportion of GDP is increasing, which tends to precede an increase in economic growth.

“Meanwhile, the People’s Bank of China (PBoC) has shifted its monetary policy stance decisively to easing, supporting the economy with reductions in both official and loan reference rates.

“What’s more, Beijing’s regulatory clampdown last year on its most powerful corporations, which wiped out billions of dollars in value, appears to have paused for now.

“So, Chinese equities could recoup last year’s declines and narrow the valuation gap with their counterparts in the coming months.

“Chinese stocks could also work as an effective hedge if the Russia-Ukraine crisis escalates into a full-blown military conflict. We therefore upgrade Chinese stocks from neutral to positive.

“We are also more optimistic on the prospects for emerging markets more generally. We expect emerging market companies to deliver earnings growth of more than 15 per cent in 2022, above the global average and more than twice the consensus view.

“We also think the dollar – whose appreciation has tended to weigh on emerging market stock returns – is likely to peak in the coming months, given that we see US economic growth lagging that of the rest of the world as the year progresses.

“The dollar tends to depreciate with the first interest rate hike of the business cycle, which the Fed will likely deliver in March. Hence, we raise our emerging market ex-China to a benchmark weighting.

“We do, however, need confirmation on disinflation, stabilisation or improvement in earnings revisions and more clarity on the Ukraine crisis before we move to overweight.

“Our view on the Chinese economy means we are also more optimistic on materials stocks, which we upgrade to overweight. The sector is one of the cheapest on our valuation framework. A weak dollar should also be a boon for material stocks.

“Bond investors are having to negotiate a complex landscape. The Fed’s hawkishness in response to rising inflation and signs the US is close to full employment puts upward pressure on bond yields.

“We are underweight on fixed income generally, US credit and high yield, but on balance we remain neutral on US Treasury bonds.

“If, as we expect, inflation starts to drop with a relaxation of supply constraints and a stabilisation in oil prices, emerging economies – and their currencies and asset markets – should benefit.

“Among emerging markets, the recent underperformance of dollar-denominated debt compared to local currency bonds has left the two broadly in balance in terms of valuation.

“We remain overweight Chinese government bonds as the country’s policy is increasingly set on a diametrically opposite path to the US’s. The Chinese central bank is turning more accommodative as the Fed stamps on the brakes.”

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