Oil prices to benefit from increased geopolitical risk

2014-10-13

Luca Paolini (pictured), chief strategist at Pictet Asset Management, outlines the firm’s positive view on oil…

With geopolitical risks remaining high, the oil price at the low end of recent trading ranges and the sector looking relatively cheap, we have been building our position in energy stocks. This reflects our more positive view on oil. 
 
Similarly, we also like materials, financials and industrials.  We maintain a pro-cyclical bias as global growth is expected to improve.
 
Regionally, we have raised our European equity position to neutral whilst decreasing our overall US stock weighting.  We remain positive on emerging market stocks
 
European stocks have been upgraded as liquidity conditions are improving and positioning has turned lighter as investors have shunned the asset class for the past few months. Valuations look less extended after the region’s underperformance.
 
Although growth has been disappointing in the euro zone and the escalating crisis between Russia and Ukraine casts a shadow over markets, weak economic data increases the chance that the ECB will embark on more monetary policy stimulus over the coming months to re-ignite the recovery.
 
US fundamentals remain solid but momentum is beginning to weaken. Stocks have rallied to all time-highs following strong GDP growth in Q2, and valuations are beginning to look rich. An eventual rise in US interest rates, after the Fed wraps up its bond buying programme later this year, is another negative that hangs over US stocks.
 
We maintain neutral on Japan. Valuations look reasonable but indications are that the Japanese economy is stalling. While the Bank of Japan has indicated that it would add to its massive stimulus programme, the timing is still unclear. In addition, the third arrow of structural reforms that forms part of Prime Minister Shinzo Abe’s progrowth plan has so far failed to deliver the expected results.
 
In spite of this, the case for Japan is positive over the medium term thanks to the combination of a weaker yen, improving corporate governance and prospects for an institutional rotation into stocks.  Thus, we await a catalyst to turn tactically more positive.
 
Emerging markets’ fundamentals remain strong but we have trimmed our exposure following strong outperformance versus developed markets since March, and sentiment has become more neutral. We remain positive in the medium term because emerging economies are likely to recover as global activity picks up.
 
We expect the People’s Bank of China to leave interest rates on hold, but it may roll out additional steps to boost growth. Any flare-up in the geopolitical tensions between Ukraine and Russia could weigh on a modest recovery in the developing world. Inflation remains moderate in the very short term at a global level, but in some countries like Turkey and Brazil it is overshooting policy targets.
 
We continue to favour emerging hard currency and corporate debt, which are are attractive as investors intensify their search for yield in an environment of low interest rates and volatility.
 
We are still cautious on local emerging currency debt, mainly because we expect emerging currencies to remain under pressure against the USD. We are also underweight in European government bonds with yields hitting fresh record lows.
 
As monetary policy paths begin to decouple among the major economies to a greater extent, we may be entering a period of higher volatility in fixed income and currency markets.