The upside potential for equity markets is limited in September without a cyclical upswing or a massive reallocation from bonds into equities in the short term, according to a report.

Since equities are fairly valued, investors can expect a normal return of about 6 per cent each year from dividends and growth, said Swiss banking giant Bank Sarasin in its equity strategy outlook for September.

The rally of the past few months should slow noticeably and the risk of a correction will gradually increase from a valuation perspective, it stated.

"After the rally in global markets, equity valuations are once again at the upper end of the historical post-crisis range," remarked Philipp Baertschi, the chief strategist at Bank Sarasin.

"Since we see little chance of cyclical upswing and do not expect a massive re-allocation from bonds into equities in the short term, the upside potential for equity markets is limited and the risk of a correction is rising gradually," he pointed out.

"The autumn of heated activity expected by us has so far turned out to be extremely mild. The first potential stumbling blocks for the equity markets have turned into positive catalysts," said the expert.

The European Central Bank (ECB) has delivered on its promise and at the beginning of September, it released details of a bond purchase programme to support peripheral bonds.

One week later, the US Federal Reserve Bank (Fed) surpassed investors’ expectations and delighted the financial markets with a monetary policy double strike.

"That said, only time will tell whether this act of liberation has worked and although the public debt burden has not decreased in size, many investors have taken heart. The burning question on the equity markets is no longer "How high is the risk of a setback?" but "How big is upside potential?," remarked Baertschi.
 
The ECB has fulfilled the most important condition from the financial markets’ standpoint by declaring its willingness to buy unlimited short-dated peripheral government bonds in the secondary market, and investors' fear that the European Union (EU) rescue plan might be too small subsequently evaporated.

The ECB has brought out the biggest weapon in its arsenal, said the report by Bank Sarasin.

Although it has not yet loaded this bazooka because countries first have to ask the EU for help, it is scaring off any would-be attackers. This is evident from the performance of credit default swaps in the peripheral bond market, it added.

"After the ECB’s pledge, taking a punt on a default on Spanish or Italian debt is no longer worthwhile. Although European banking stocks have also staged a strong recovery, they have risen considerably less sharply than credit default swaps."

In its forecast, Baertschi said,"We expect equities to generate a much higher return over five years than government bonds, which are likely to generate a negative total return."

"Despite these prospects, the past shows that investors generally tend to switch from one successful asset class to another only when the signs have changed," the expert said.

"A reallocation will take place only when investors actually stand to lose money on bonds. The best indicator for this would be rising central bank interest rates. As this will not happen on a large scale before 2015, the long-awaited reallocation is not likely take place either," Baertschi added.-TradeArabia News Service