By Natsuko Waki
Financial markets, already looking shaky after a two-month green shoots rally stalled this month, face further hurdles next week with the release of leading economic data and a U.S. monetary policy decision.
World stocks, which are on track for the first weekly loss in five weeks, have been trading sideways after rising 40 percent since mid-March to hit a 7-1/2 month high early in June.
While the jury is still out as to whether it was a bear market rally or the start of a new bull market, much of the gain has stemmed from optimism that the global economy has hit bottom and corporate earnings will improve from here.
However, investors have so far had insufficient evidence of a recovery. Therefore, next week's euro zone purchasing manufacturing surveys, the German IFO investor sentiment survey and data on the U.S housing sector — key for consumer spending — must strongly beat expectations to kickstart the rally again.
"We don't think green shoots are the prediction of a great harvest in 2010. We might be in for a double dip," said Emiel van den Heiligenberg, head of asset allocation at Fortis Investments.
"It's not a good time at this moment to go into equities to chase the rally. We're looking for reasons to go short as we don't believe in the rally."
Fortis has found that during previous crises, bottoms in the S&P 500 index have lasted from 3.5 to 11 months.
"There's reason to believe that this bottoming process will be longer than average," van den Heiligenberg said.
Boston Consulting Group, which studied 61 leading economic indicators in the United States, Germany, France, Britain and Japan, found that only five are in the clearly positive territory. Another 15 are in the "positive trend but too early to confirm" category.
"We are neutral on equities. Central banks are still fighting monetary problems. People went too far in playing policy normalisation," said Sebastian Paris-Horvitz, head of investment strategy at AXA Investment Managers.
AXA is overweight bonds, with a preference for corporate bonds and nominal government bonds.
EXIT DEBATE
Investors are split on whether the Federal Reserve will expand its existing $300 billion plan to purchase Treasuries when it meets next week.
If the Fed announces a plan to expand this purchase programme, investors who had fled Treasuries in search of higher yields might return to the risk-free asset to lock in recently elevated Treasury yields.
In the U.S. bond market, which has been under pressure for three months, benchmark Treasury yields hit an eight-month high of 4 percent last week as speculation intensified over the timing of the Fed's exit strategy. Yields have since fallen towards 3.8 percent.
Banc of America Securities-Merrill Lynch found in its June fund managers survey that more than half of the respondents expected higher short-term rates in 12 months' time.
Its risk and liquidity composite indicator stood at 38 this month, below the average of 40 seen since 2002.
In this climate, Swedish bank SEB recommends a portfolio which has slightly more weighting on fixed income — including corporate bonds — than equities.
On its Modern Aggressive portfolio, it recommends investors allocate 28 percent to equities, 37.5 percent to bonds including high yields, and 22.5 percent to hedge funds.
"We do not want to expose ourselves to a rapid economic recovery, since this is not our main scenario, partly because it represents excessive risk taking," Hans Peterson, chief investment officer of private banking and head of investment strategy at SEB, said in a note to clients.
"We combine corporate bonds, with the potential for good returns if the economy rebounds, with assets that depend very little on the economic cycle."
