The risks for equities are limited

Self-interest and fear: These factors are the
main driving forces of stock markets. Self- interest, the economist Adam Smith’s great
motivator, is currently running scared. Right
now, fear is the dominant sentiment. In the
first months of 2014, the fear that the severe
winter in the United States could choke off the
economic recovery throttled stock markets.
At present, the conflict surrounding the future
of Ukraine and fears of
deflation in the Eurozone are weighing on
markets. Fortunately,
though, political markets
still have short legs. And
in the Eurozone, remember that declining inflation does not necessarily mean deflation.

The Eurozone
is still far from
deflation.

The fear that these factors could cause growth
to slump is likely to prove unfounded. On the
contrary: Leading indicators point to accelerating economic momentum in the Eurozone
and in the United States. The U.S. Federal
Reserve Board (Fed) is likely to continue its
tapering policy and end its bond purchases
by fall. At this point, low interest rates could
come into focus. If they rise, bond yields should
continue to increase. As a result, 2013 and
2014 could go down in history as the end of the
30-plus-year bull market in bonds.

More and more investors are starting to anticipate this and are moving out of bonds and into
stocks. This has already caused stock valuations to climb. A look at past valuation ratios,
however, reveals one thing: Equities are not
overvalued yet. Moreover, higher growth is likely to trigger an increase in corporate earnings.
The so-called “smart money” should underweight bonds that offer lower yields at higher
risk—and place its
bets on stocks.

The old stock market
saying “sell in May
and go away” could
thus prove wrong this
year. Indeed, stock
markets could be in for a bumpy climb up in
light of the expected rise in interest rates. But
market dips could be good buying opportunities. In addition, capital flows indicate that
the first investors are resetting their sights on
emerging markets. We, however, will remain
selective and favor emerging markets that
demonstrate little dependency on commodity
prices and boast strong fundamentals—self-interest still needs to be balanced with a little
caution here.