Fund managers should be looking to reduce cash balances, and move into equities to leverage into the economic recovery in the next 18 months, says analyst Richard Schellbach, Citi Investment Research. “Funds need to prepare for a Chinese renminbi revaluation or devaluation, and identify the asset classes globally that have been distorted by this excess money coming out of China and Asia,” he warns. Local fund managers have to pay attention to which asset classes are being “pushed out of whack”, such as emerging market equities, and some specific commodities – for example, energy. For 2010, Citi prefers overseas shares to Australian equities because the locals are trading at a rare PE premium, says Schellbach, “and we face currency headwinds for earnings”. This overearning, due to the commodity super-cycle, is abnormal relative to local equities’ history and to global companies.

With an estimated $100 billion over-allocation to cash, according to Citi’s calculations, and with cash rates currently around record lows, Schellbach says this “war-chest” would now be better deployed in equity and bond markets. Schellbach tips the S&P/ASX200 market PE to peak at around 17.5 by the middle of this year, and the PE multiple on Australian equities could eventually settle at above average levels. In international equities, Citi is favouring the cheap and higher-beta European markets, which are the cheapest in the world. While UK economic performance is a concern, says Schellbach, 70 per cent of its market revenues come from overseas. “If you’re worried about the UK economy, then sell sterling, but not necessarily the UK stock market.

The US remains underweight, valuations don’t look particularly attractive, and earnings momentum is better elsewhere. “We’re Underweight Developed Asia, mostly Australia, where strong performance now leaves relative valuations looking unattractive, Japan remains an enigma.” Schellbach continues to prefer value over growth equities during this early cycle environment. Citi’s value bias also concurs with other key multi-asset decisions such as its continued preference for banks over resources, and for large companies over small. “Our leaning towards financial stocks over resource stocks argues in favour of large cap indices as does our concern that the A$ could mean that [it] reverts from its current overvalued levels,” says Schellbach. Financials continue to have more upside potential than resources, he adds.

“Although we subscribe to the resource super-cycle and Chinese industrialisation,” he says, “these would appear to be largely priced-in already.” In the local bonds pool, Australia’s entry into the recovery stage of the investment clock prompts a deduction of Aussie bond positions back to a neutral portfolio holding. However, Schellbach prefers Aussie bonds over internationals due to their relative quality, supply, volatility and yield. Australian semi-government bonds stay enticing and warrant an overweight holding, says Schellbach. A-dollar corporate bond valuations are attractive and “spreads should grind tighter over the next six to 12 months, thanks to inflows to global credit funds”. Citi is staying neutral on international bonds.

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