Pictet Asset Management Chief Strategist Luca Paolini shares his insights as to whether investors should be leaning heavier into bonds (^TYX, ^TNX, ^FVX) or equities (^DJI, ^IXIC, ^GSPC). "When you look at valuation alone, there is a clear and strong case for bonds now," Paolini explains, adding "unless you expect something really terrible to happen on the inflation side or a significant acceleration in growth, the current level of bond yields is very attractive." On investment opportunities, Paolini highlights European bonds, noting that the European Central Bank (ECB) is likely to cut interest rates more rapidly than the Federal Reserve while inflation remains under control. He believes "there is more value in Europe than the US when you look at the bond market." Additionally, he recommends emerging market bonds, explaining that the US dollar (DX=F, DX-Y.NYB) is approaching a secular peak. "We want to be exposed to emerging market debt as well," he adds Addressing the broader equity market, Paolini maintains it should "outperform in the next few months, but I think the case for equities is more difficult," noting that investors tend to be overweight in this sector. He expresses concern about profit margins, stating "I don't see how margins can expand from current levels."
It's time now for today's strategy session.
Options markets are pricing in the U.S.
ten-year treasury yield hitting five percent.
Currently, the bond market is actually offering a greater
return to investors compared to the dividend yield from the S&P 500.
So is now possibly the time to shift your portfolio
from stocks and buy into bonds?
Let's talk about that and more.
We want to bring in Luca Paolini.
He's Pictet Asset Management's chief strategist.
Luca, that's one of the questions maybe on investors minds here this morning,
whether or not the bond sell-off is nearing an end.
And it could be an opportunity here to buy in for investors.
What do you think?
Hi, Shannon.
Well, let me say that when you look at valuation alone,
there is a clear and strong case for bonds now.
You have even real bond yields, a level that we haven't seen in a long time.
Unless you expect something really terrible
to happen on the inflation side or a significant acceleration in growth,
the current level of bond yields is very attractive.
On the other side, you look at the equity side,
and I still believe the fundamentals are quite supportive.
Earnings are OK. Growth is OK.
At the same time, you have a significant share
of investor portfolios in equities right now.
And so I think some kind of diversification or reallocation into bonds
makes sense.
I don't know if now is the right time exactly now,
but I do believe in the next few months
there will be a great buying opportunity for bonds.
We are already increasing our duration exposure in our portfolios.
And so where are you kind of sitting on the duration
portion of your allocation right now?
Well, when you look at bonds, we see more value in European bonds,
to be honest, especially in the high yield space.
There are good yields.
The ECB is going to cut rates more aggressively than the Fed.
Inflation is more under control.
So we think that there is more value in Europe than the U.S.
when you look at the bond market.
But also in the U.S., I have to say again, we look at tips,
you know, 10 years tips or 30 years as well.
I mean, it's close to 2.6.
So I think there are levels where it starts to become actually quite attractive.
But for us, the preference is on European bonds.
And we also start to like emerging market bonds
because we feel that the dollar is getting very close to
maybe not only cyclical peak, but even a secular peak potentially.
So we want to be exposed to emerging market debt as well.
Well, let's talk about one of your thesis here, because you lay out
a maybe comfortable, but also potentially dangerous scenario
or situation for equities in the months ahead.
Explain your thesis and maybe what investors should be doing
or should not be doing at this point to be a little bit more proactive.
I think, you know, if you're sitting on a lot of profits
because you've been overweight equity in the past few years,
I think it makes sense to reduce exposure there.
We still believe that U.S.
equities should outperform in the next in the next few months.
But I think the case for equities is more difficult.
Everybody seems to be overweight.
Position are very, very, very extended.
When you look at the earnings season, we have an earnings season ahead of us.
Consensus seems to be quite on the bullish side.
I don't see how margins, for example, can expand from from current levels.
So I think some kind of, you know, maybe a reduction of equity
exposure may make sense.
No reason to panic, though, because, again, as long as the U.S.
economy is growing at two percent and inflation doesn't accelerate
significantly, the macro backdrop remains quite positive for equity markets.
So if you think that we're going to see an adjustment of some of the margin
expectations, how does that play into what is largely been expected
by many strategists for calendar year earnings growth of 15 percent?
I think it's far too high because, you know, when you look at the last year,
last year, the big surprise was U.S.
growth growing at almost three percent, where expectation was one.
So you have a delta of two percentage point, which is massive
in terms of earnings growth and also margins.
This year, we start from a really high level of growth.
I don't see how U.S.
growth can accelerate from the current level.
And you see that real wage growth is positive.
So effectively, wages are rising more than inflation, which it was not the case,
for example, one or two years ago.
So it's difficult for me to believe
that you're going to see a significant improvement in margins.
So this there is the kind of potential risk for disappointment
for especially for the U.S., but not only.
So I think there is a risk in the earnings season to, you know,
for investors to be slightly disappointed.
Luca, thanks so much for taking the time here with us
just after the opening bell. Appreciate it.
