Conditions remain favourable for equity markets overall but we trim exposure to tech stocks following their stellar run.

Asset allocation: Conditions still favourable for stocks

How high can the market go? With global equities having rallied some 26 per cent over the past eight months, that is the question investors are grappling with.

Supporting stocks, the economic outlook remains solid as fears of sticky inflation appear to have faded.

However, this positive fundamental backdrop has to be set against two potentially negative developments. First, there’s a fraught political backdrop in Europe. Snap parliamentary elections in France appear likely to leave the country in uncharted waters, with the hard right having decisively won the first round of the two-round ballot. A second countervailing force is investor positioning in stocks, which our indicators show is extremely bullish.

For all this, we still believe the balance of risks remains in favour of remaining overweight stocks, neutral bonds and underweight in cash.

Our business cycle indicators are in positive territory. The economic outlook is brightest for emerging markets, which are benefitting from higher commodity prices and improved global trade.

Things look more mixed for Europe, not least due to France’s parliamentary elections. The vagaries of the country's two-round voting system mean the outcome is difficult to call, raising questions over the outlook for economic growth and fiscal spending.

Politics aside, our leading indicator for the region continues to improve, as does the inflation picture. We expect these trends to continue as the European Central Bank proceeds with gradual rate cuts.

In the US, meanwhile, recent data has been softer. We expect growth in the world’s largest economy to decelerate to around 1 per cent annualised by year end – around half its potential – thanks to weaker consumption and residential investment.

Our global liquidity scores are neutral for riskier asset classes. Half of the central banks we monitor are on hold, 37 per cent are in easing mode and 13 per cent are tightening (most notably Japan). Should the proportion of central banks easing monetary policy continue to rise, this could translate into an improvement in economic conditions. Our analysis shows a fall in central bank interest rates tends to be followed by a rise in leading indicators with a lag of nine months.

The liquidity backdrop thus supports our broadly positive stance on global equities.

Within equities, our valuation models support our preference for European stocks over US ones. While Europe is the second cheapest region in our model, the US is by far the most expensive one.

Overall, some 80 per cent of the asset classes in our valuation model are trading above trend – something that has only happened three other times in the last decade. This potentially suggests a high level of market complacency, supporting the case for holding safe havens as the Swiss franc, gold and US Treasuries.

Technical indicators suggest that momentum remains positive for stocks and the market is not yet overbought. Equity inflows continue to be strong, (at some US44 billion over the last four weeks, defying weak seasonality.