The economic cycle has reached its peak following a strong first quarter and there will soon be fewer positive surprises, said Bank Sarasin in its latest economic outlook.

'In the second half of 2009 and the first quarter of 2010 the global economy recovered well from the preceding financial crisis. While the developed economies managed to successfully kick-start production and investment again, China had to take steps to stop its economy from overheating,' according to the “Global View”, published by Bank Sarasin’s Research team.

The sentiment indicators for second quarter of 2010 such as the purchasing managers’ indices show that the economic cycle has already reached its peak and growth is not expected to pick up again until 2011 at the earliest, it added.

One particular cause for concern at the moment is the potentially deflationary environment in the peripheral European economies, which could act as a brake on the long-term growth of the global economy going forwards.

Shifting the focus on defensive sectors, the bank said, 'When it comes to asset allocation, investors are advised to significantly scale back their investment risks. The default rate for corporate bonds is likely to ease in the second quarter.'

'The global economy continued to recover in the first quarter of 2010. In the US and in the emerging markets of Asia, gross domestic product (GDP) in the fourth quarter of 2009 was already higher than a year ago, and Europe and Japan were now expected to follow suit.'

One clear sign of this is the fall in the jobless rate and short-time working in response to increased investment activity, the bank pointed out.

The recovery is being led by China, which is showing very few traces of the global economic crisis. Bold intervention by the Chinese government has helped to shore up domestic demand, boosting consumption and investment activity in the process, it added.

Jan Amrit Poser, head of research and chief economist at Bank Sarasin, said, 'The worst economic crisis in 80 years has given way to a spectacular recovery. Following the powerful upturn in production in Q3 2009, investment activity also started to pick up in Q4.'

'Consumption will ultimately determine whether or not the recovery will become sustainable. There is some doubt whether final demand, which is being curtailed by negative wealth effects and stricter lending standards, really will pick up,' Poser said.

'The need to repair public finances will also act as a drag on economic growth. The cycle should become self-sustaining only at the beginning of 2011, when the majority of imbalances have been corrected,' he added.

Philipp E. Baertschi, chief strategist at Bank Sarasin, said, 'The peak of the cycle has been reached, as expected, following the strong first quarter and there will soon be fewer positive surprises.'

'The risk of a significant setback in equity markets will therefore increase significantly. The time has come to take profits and significantly reduce risk positions. We are therefore switching from an overweight to an underweight position in equities.'

'The impending slowdown in economic growth in the second quarter should stimulate bonds. Basically we favour high-quality corporate bonds over government bonds, Baertschi added.

The inventory cycle made a sizeable contribution to growth in Q4 2009, but the purchasing manager indices show that the cyclical inventory upswing has now more or less reached or even passed its peak. This is particularly true for the US, China and Japan, while the European economy will peak with the usual time lag in Q2 2010.

'Based on an analysis of economic cycles for the last 50 years, it is therefore likely that the current dynamic pace of growth will tail off during the course of the second quarter and will not pick up again until the start of 2011 at the earliest,' the bank said.

'Consumption will ultimately determine whether or not the recovery will become sustainable, and this is in turn affected by the labour market and income growth,' it added.

The cocktail of weaker lending, households’ lower net assets and increased unemployment (despite a slightly improved labour market) has a deflationary impact.

Especially if the pace of growth is slow up to the end of the year, governments will therefore be compelled to resort to further financial stimuli in order to prevent negative multiplier effects.

But states in Europe’s periphery such as Greece, Ireland, Portugal and Spain need to consolidate their public finances as quickly as possible and cannot tolerate additional fiscal burdens.

'More financially strong countries would need to step in to support global growth. As well as sorting out their public finances, governments also need to tackle their structural budget and current account deficits by strengthening their export sector.'

'They will only succeed in this by making painful cuts to prices and wages, boosting productivity or devaluing their currency. Experience shows, however, that most countries are capable of adapting their public finances to meet the challenges.'

'Once the process of correcting the global imbalances has been successfully completed, the cycle should become self-sustaining again in 2011,' the Bank added.-TradeArabia News Service