Equity will remain the preferred asset class, thanks to abundant liquidity, repressed interest rates and improved earnings prospects, notes Rothschild in its recent report.

In its recent report titled “Market Perspective”, Rothschild notes stronger global economic growth and plentiful liquidity offer supportive conditions for equity markets.

Plenty of liquidity

Rothschild believes despite the US Federal Reserve reducing its monthly asset purchases, liquidity would be plentiful in the coming months. It believes the Fed is likely to continue to increase liquidity until at least the third quarter of the year.

The report also points out that through an aggressive quantitative easing program, Japan is increasing its balance sheet significantly. Moreover, the European Central Bank too has suggested it will at least stop shrinking its balance sheet and could begin to expand it.

The Rothschild report also points out that the US Federal Reserve has emphasized that tapering is not tightening, which the bond markets have so far accepted. Moreover, the one-year forward Treasury curve assumes that losses will be avoided in 2014 all the way to 10-year maturities owing to subdued consensus curve steepening expectations. However the report cautions that this situation could change if rising GDP growth prompts a change in inflation and Fed policy expectations.

The following table highlights the key trends in the financial markets over the past 12 months:

Key trends Equity

Goldilocks scenario

The Rothschild report points out that the global economy is neither too hot to cause inflation nor too cold to cause recession. The majority of market view points to this ‘Goldilocks scenario’. Thus the report notes despite encouraging signs about the global economic recovery, there are some causes for concern. Moreover, many emerging countries remain vulnerable to various risks although there are select bottom-up investment opportunities.

Equity market performance

The report points out since September 2011 the big gains in equities have been caused by investors re-rating the markets, not due to profit fundamentals. The report notes valuations now look stretched, indicating that company earnings will have to rise from real sales growth to support further gains and not just from balance sheet transactions, such as share buybacks.

The report notes emerging market equities underperformed developed markets throughout 2013 and valuations now appear relatively attractive.

The following graph illustrates the equity market performance for the past 12 months:

12-month performance of Equity market

Fixed income

The Rothschild team are avoiding long-maturity nominal bonds as they would be negatively affected by a return to more normal monetary policy in the ‘economic renaissance’ scenario. However, they prefer shorter-maturity corporate bonds within fixed income.

The following chart highlights the 10-year bond yields across major markets:

10-year bond yields

The Rothschild team believes the strong performance from hedge funds is likely to continue, while oil prices remain in their trading ranges.

The report concludes that equities remain the most attractive asset class, as the conditions for equities look more attractive than for other assets, particularly government bonds which offer little value.