Markets are at their most fascinating — and most challenging — when price action diverges from what an objective assessment of the relevant news might suggest. By and large, economic data and corporate announcements in June were consistent with continued improvement in global economic conditions. And yet world equities declined nine percent peak-to-trough, the first notable correction in the rally that began in early March.

Several factors provided an excuse for nervous investors to take equity risk off the table it seems — a weak US jobs report, the looming second quarter corporate reporting season and the prospect of a dull market during the summer months.

The lack of confidence in the current rally is illustrated by the increasing reliance within the investment community on 'technical analysis' (following stock price chart patterns), which provoked some commentators in early July to forecast further significant declines in major stock markets. There is nothing wrong with technical analysis (indeed, it is a tool we regularly use at Ashburton), but when the consensus market view among previously 'fundamental' investors is all of a sudden based on a spurious chart pattern (in this case the 'head and shoulders top') it is often advantageous to move in the opposite direction.

Equity weighting highest in years

Accordingly, we increased equity weightings for our multi-asset funds during the weakness in late June and early July. At 45 percent, the equity weighting in our Asset Management funds is the highest it has been for several years. As in recent months, we continue to favour Asian markets, which including Japan account for roughly 50 percent of our equity exposure currently. The remaining exposure is split evenly between Europe and the US. We believe the Asian region will benefit disproportionately from low global interest rates and the economic rebound that is taking shape, as well as offering high domestic growth potential in China and India.

While we are confident that GDP growth in Asia will outpace that in the developed world, the risk to our current equity allocation concerns valuations and what they say about relative profits growth expectations. Following their impressive rally, emerging markets are now trading at a valuation premium to developed markets. This no doubt reflects a consensus expectation that growth in emerging market profits will outpace western profits, in spite of the productivity gains and cost-cutting so evident among US corporations in particular, many of which will benefit from exposure to Asia anyway. Our current regional allocation reflects a belief that the trend of Asia-ex Japan equity out-performance will continue, but we must recognise that the scope for out-performance is not as great as it was at the start of the year. Should the valuation gap between developed and emerging markets widen materially we will have to revisit our regional equity strategy.

Attractive opportunities in bonds

Away from equities, we also see a number of attractive opportunities in the bond market. We maintain significant weightings in long-dated German bunds and 20-year US TIPS (inflation-linked treasuries) and we have recently added a position in Australian bonds. Despite the country’s relative economic resilience, we believe the interest rate hikes priced into the Australian bond market are excessive and therefore view today’s yields as highly attractive.

We continue to hold a variety of investment grade corporate bonds (seven percent weighting) and supranational bonds (issued by the likes of the World Bank, Inter-American Development Bank or European Investment Bank). Following weakness in May and early June, we added a position in US 10-year treasuries although we closed out the position earlier this month for a gain of over four percent.

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