Central bank action and low valuations make a compelling investment story

Favourable valuations and negative sentiment are also supportive.

Writing in SIG's monthly asset allocation report for December CIO James Millard says:

"Although we acknowledge that significant risks remain we think that equities could rise into year-end boosted by favourable valuations.

"With sentiment so low, even modest improvements in the Eurozone could lead to a better financial market performance."

In his report, Millard says that despite all the problems associated with the Eurozone, the area as a whole was not uncompetitive as its current account was roughly in balance.

Furthermore, the deficits and debts of the Eurozone as a whole are not "alarmingly high" with the deficit much lower than in the US, UK or Japan.

As far as the current crisis in the Eurozone is concerned he says that while Germany is committed to the Euro, it wants to keep the pressure on the peripheral economies in order to bring about fundamental change, as this is easier during times of crisis rather than calm.

However, he notes that Germany's hands might be forced if markets continue to deteriorate and in the face of up coming elections.

Millard says:

"If these observations are correct, then it is likely that Germany will continue to resist calls to issue Eurobonds (or turn the European Financial Stability Facility into a bank), until as much progress as possible has been made in terms of a) structural reform in the peripherals and b) new rules to punish those countries that break the rules."

As far as China is concerned, Millard notes that the People's Bank of China cut bank reserve requirements by 0.5% following 12 consecutive increases to boost the economy and to avoid a hard landing.

He believes that with inflation falling further reserve requirement cuts could take place over the next few months with interest rate cuts also possible next year.

He says:

"We agree with consensus that global growth is likely to be very weak next year. We remain very optimistic on the outlook for Chinese markets and think that the economy will avoid a hard landing.

"While the consensus has become less bearish on China, it is less optimistic than we are."

Impact on SIG's model portfolios

SIG has made few changes to the December model portfolios. It continues to run a small overweight to equities and small underweight to bonds.

SIG further increased its exposure to emerging Asian equities which it thinks will outperform other equity markets as Chinese inflation falls and interest rates are cut.

SIG has further increased its exposure to high yield bonds and increased exposure to the Japanese Yen from negative to neutral.