Mercer has sounded a further warning about allocations to global bonds and global credit in its latest dynamic asset allocation (DAA) report, putting both in the “overvalued” category.
The report, published yesterday, refers to proposed asset allocations for a two-year time horizon as at October 2010. It includes an “unattractive” label for the $A versus the $US at 0.986, for instance, which is presumably even more unattractive at 1.00 and above.
While the global bonds categorisation of overvalued was the same as for the previous quarter, the report notes that the current yields are unsustainable if the world returns to its normal growth environment.
“Although in the past we have suggested that clients should move underweight cautiously because government bonds were providing ‘insurance’ against an adverse economic outcome, we believe the cost of this insurance is becoming prohibitive, and would now suggest a more significant underweight position.”
Global credit, where yields have fallen another 64bps since the last DAA report, has been reclassified from ‘fair value’ to ‘overvalued’.
David Stuart, head of the Mercer DAA team in Australia, said global corporate bond yields were now at levels last seen in 2003 and were beginning to look a little expensive. “Nonetheless, compared to government bonds, they still have a relatively attractive spread,” he said.
Unlike their global counterparts, Australian bonds and credit remain at ‘fair value’.
The story for equities, while more favourable than global bonds and credit, is not as clear cut.
Stuart said: “Ultimately, we see the outlook for global equities as finely balanced: positive valuation signals, particularly the wide gap between equity and bond yields, are offset by macroeconomic risks. Given the relatively poor performance of defensive assets, however, we have come down on the side of growth and recommended going overweight in equities and other growth assets.”
Emerging markets remain “attractive” and, in summary, overseas and Australian shares remain at ‘fair value’.