Time to ditch bonds for stocks?

Since the lows in February, a number of negative market drivers have improved. We see opportunities in the U.S. and Europe.

U.S. high-yield bonds have rallied to a point where we think investors who were overweight the asset class should now consider switching money into U.S. stocks. The downturn in U.S. manufacturing and subsequent weakness in services sentiment generated concern last month that the U.S. could be heading for recession. Yet better data has improved the outlook.

Traders work on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters

The U.S. manufacturing sector appears to be stabilizing. The ISM manufacturing index has shown signs of stabilizing. Jobs growth is strong. U.S. high-yield bond prices are up by 5 percent since the beginning of March, with some weeks recording the strongest inflows into the asset class on record.

It will be important to monitor the rise in U.S. core inflation. The Federal Reserve leaned to the dovish side at its last meeting due to its own concerns about a variety of global risks.

In Europe, financials were under considerable scrutiny earlier this year, but this pressure has eased. The European Central Bank's targeted long-term refinancing operations have addressed concerns about bank creditworthiness and monetary policy transmission, providing a clear means by which negative interest rates can translate into lower borrowing costs for banks, consumers, and businesses.

Confidence in Europe's growth has held up, too. Industrial production surpassed expectations this month. Retail sales growth remains robust. And Germany in particular still looks strong — consumption is expanding, backed by wage growth of more than 4 percent per annum.

Muted profit growth keeps us from being more bullish on the region, but we still maintain an overweight position in euro-zone equities against emerging market equities, along with an overweight position in European high-yield credit relative to high-grade bonds.

Against this improving backdrop in the U.S. and Europe, we have also witnessed a decline in global risks emanating from China. Early this year, China's falling foreign-exchange reserves were a key risk for markets. The country's capital account has since stabilized, with $28.5 billion flowing out in February, about one-third of the declines registered in December and January. The Chinese currency has strengthened by around 1 percent versus the U.S. dollar since the start of March and, unlike last year, there are clearer signs that China's policy makers are getting their way with the economy. The uptick in fiscal spending, the surge in new lending, rising property starts, and a stabilizing yuan all indicate that policy measures are, for now, having their desired effect.

We can question whether some of the effects of this intervention (for example, property prices in Shenzhen rising 50 percent in a year) are in China's long-term interest. But for global markets, the latest data provides a welcome respite.

Most of these global developments offer cause for hope. Yet sentiment among clients I have spoken with remains cautious, often because they are fearful about local events, including political risks in the likes of Brazil, the U.S., and the UK. If addressed incorrectly, these fears could significantly hamper portfolio performance. The investment principles used to manage such situations apply across the board: hedge what you cannot know, limit exposure to specific risks, and don't overreact to potential tail risks.

The outlook has brightened for well-diversified investors, and the same factors that spooked markets at the start of the year have turned more supportive in the past month. The rally in U.S. high-yield bonds and improving conditions in the world's largest economy argue for a rotation out of U.S. high yield and into U.S. stocks.

Yet, in spite of improved economic data and further central bank accommodation over the past month, investors must remain vigilant and continue to diversify their portfolios. Profit growth is muted, and individual risks still have the potential to undermine markets. We still prefer to wait for clearer evidence of accelerating growth and earnings before adding significantly to risk.

Commentary by Mark Haefele, global chief investment officer at UBS Wealth Management, overseeing the investment strategy for $2 trillion in invested assets. Follow UBS on Twitter @UBSamericas.

For the latest commentary on the markets in the U.S. and around the world, follow @cnbcopinion on Twitter.