Asset allocation, balance inclined towards equities

According to Nossek (WisdomTree Europe), asset allocation is tilted towards overweighting equities relative to credit and bonds, with Europe presenting itself as having the broadest appeal in equity style strategies

Against the suppressed sovereign bond yields, rising rates expectations in the US, and an upbeat economic outlook for Europe and the US, what asset allocation shall we choose? Lmf International asked Viktor Nossek, Director of Research, WisdomTree Europe, to illustrate the 2016 market outlook and the main factors to consider.

Nossek, could you please illustrate your 2016 general outlook?
Domestic demand led economic activity, underpinned by a more competitive labour market and a late arrival of easing credit conditions to small businesses is solidifying Europe’s recovery. The revival of consumer spending should trigger a virtuous cycle of higher tax revenues and improving investment needs, broadening out Europe’s structurally-led recovery in the process. Against a tightening Fed and weak commodities backdrop for 2016, the weakening export outlook is countered by Europe’s rebalancing act that at the start of 2016, is still at an early inflection point.

About corporate bond, what is your view considering the Fed’s decision to raise interest rates?
The widening of credit yield spreads since H2 2015 is expected to continue in 2016, on the back of concerns over growing levels of indebtedness as Fed tightening expectations build up. Investors will discriminate corporate issuers more against heightened default fears, driving the yield wedge between investment-grade and below, and between corporate sectors within quality tranches wider. Sentiment in junk bonds, as well as smaller Energy and Base Metals issuers is expected to sour further, adding pressure to bond prices of borderline investment-grade credit and further gravitate investors into the crowded trade of prime credit issuers in Europe.

What will happen on high grade corporates and government debt yields for Eurozone?
High grade corporates and government debt yields are seen as likely to fall further, sustaining the negative yield environment of shorter dated maturities of government debt, while the expanded QE program by the ECB and the mild inflation outlook will further suppress yields of longer dated peripheral government debt. The ECB’s indiscriminate support for Eurozone sovereign debt means further erosion of the yield premium of peripheral sovereigns over German Bunds.

What are your expectations for the euro-dollar exchange? Weak euro, Strong dollar
Dovish rhetoric, more so than further policy easing is expected by the ECB in its effort to continue to suppress the euro. Given the upbeat economic outlook for the Eurozone, weak inflation will be of secondary concern as opposed to keeping a lid on the euro, boost exports and buy enough time for domestic demand led growth to sustain itself. Persisting expectations of rising US rates against a robust US economy will furthermore keep the euro fundamentally weak and reduce the pressure on the ECB to having to provide for more stimulus to do so.
Moderate US wage growth pressures are expected to fuel Fed rate hike expectations, and coupled with tightening conditions in credit markets is allowing the Fed to postpone the rate hike into the summer of 2016. Rhetoric, not policy action by the Fed that strengthens or diminishes the divergence of monetary policy expectations with the ECB is therefore expected to also keep the euro-dollar volatile.

What will be the impact on emerging markets and commodities in 2016?
China’s economic slowdown will pose limited risks to sentiment in global financial markets in 2016. China’s potential to further lower policy rates, intervene in FX markets to control yuan deviation and increase public spending will work to cushion any accelerated downtrend in manufacturing.
Gold is expected to remain weak, with a high likelihood of falling below 1000 USD/oz as real interest rates are expected to rise in the US
Crude oil, along with copper will continue to succumb to weakness and volatility, as the outlook for global energy and metals consumption remains deeply uncertain.

Given this market environment, what asset allocation do you suggest?
Against the suppressed sovereign bond yields, rising rates expectations in the US, and an upbeat economic outlook for Europe and the US, asset allocation is tilted towards overweighting equities relative to credit and bonds, with Europe presenting itself as having the broadest appeal in equity style strategies. In positioning strategically around Europe’s domestic demand-led recovery, a small-cap equity exposure overlaid with a quality screen is seen as an efficient means to play the theme, minimizing downside risk while maximising potential rewards.
Large-cap equities also remain a viable play, though a cyclical, export biased portfolio is seen tactically positioning around the downside risks to the euro and the outlook on overseas trade. Non-Eurozone investors should consider a hedged exposure to Eurozone equities in that regard. For income seeking investors, high dividend yielding Eurozone equities remain an appealing alternative to corporate credits amidst rising indebtedness and default fears, even while government debt yields will stay artificially depressed. The disproportionate high yield premium equities offer over fixed income compared to its historic trading range means equities will retain their attractive value proposition for investors.