Central banks' loose monetary policy is the main reason behind the equity market's sharp rally started in mid-2012, Bank of America (Other OTC: BACYL - news) -Merrill Lynch strategists say, but they warned that the equity market's performance in the second quarter will depend on real signs of improvement on the macro front.
"While policy and flows have allowed stocks to rock in Q1, Q2 will likely be a 'show-me' quarter. Equity performance will depend on whether European and Chinese growth expectations recover before reflation in the U.S. and Japan disappoints," the strategists write in a note.
"The ECB must ease or European growth must improve if further capital flight from southern European banks and markets to what is perceived as 'safe haven' bonds and 'Nifty 50' European stocks is to cease in Q2."
Asset returns in the first quarter have been dominated by the 'Great Rotation' theme, with global bonds on course for their worst quarterly performance since the first quarter of 2009 while equities have enjoyed double-digit gains in the United States and Japan, the strategists say.
"The good news is that the liquidity story will remain in place in the second quarter, and there's scope to see a positive policy surprise from the ECB. The bad news is that sentiment remains overly bullish. And while a correction in global equity markets has thus far been conspicuous in its absence the recent rally has had very defensive undertones," they write.
"Something's got to give. Either the world's reflationary policy works and Europe and China join the U.S. and Japan in surprising to the upside. This would be very negative for bonds. Or real estate, bank stocks and Treasuries signal that reflation is failing in the U.S., which would cause an equity correction. Either way, volatility is likely to rise in Q2."
Setbacks in equities should be viewed as entry points for longer-term investors as the secular case for stocks remains strong, write the strategists, who remain 'overweight' stocks, 'underweight' bonds and cash and 'neutral' commodities.
Reuters Messaging: blaise.robinson.thomsonreuters.com@reuters.net
Reuters Messaging: blaise.robinson.thomsonreuters.com@reuters.net
