(Refiles to change date to March 27)
By Natsuko Waki
LONDON, March 27 (Reuters) - Investors will look to rebuild risk portfolios next week as an expected euro zone interest rate cut and a G20 summit are likely to buoy world stocks which are on track for their best monthly gain ever.
World stocks, measured by MSCI, have risen nearly 5 percent this week, gaining 21 percent since hitting a 5-1/2 year low earlier this month and on track for one of their strongest monthly performances on record. The cost of insuring sovereign and corporate bond debt against default has also eased sharply.
Quantitative monetary policy easing by the world's major central banks, Washington's latest bank bailout plan and tentative improvement in forward-looking economic data have all contributed to increasing investor risk appetite.
In what investor George Soros said is a "make or break event", Group of 20 leaders are expected to discuss detailed measures to combat the worst economic crisis since the 1930s with financial regulation and fiscal stimulus set to be on the top agenda.
Also next week, the European Central Bank is expected to cut interest rates by half a percentage point to a record low of one percent. The region's policymakers have said the central bank could start buying corporate bonds in an unorthodox measure to support the economy.
The MSCI world equity index has gained three weeks in a row as the first quarter comes to an end. However, year-to-date it is down more than 8 percent, reflecting broad underweight positions held by investors.
"With the stabilisation of several leading indicators, stable volatility and investors strongly underweight, the equity rally can develop further into Q2," said Cyril Beuzit, global head of interest rate strategy at BNP Paribas.
"Quantitative easing and attempts to ring-fence toxic assets currently held in the financial sector balance sheet have improved the chances of the economy rebounding, and the combination of these two measures may unblock credit flows."
Central banks in the United States, Japan, Britain and Switzerland have all moved to adopt unconventional monetary easing measures, which prompted government bond yields to fall.
INCOME STRATEGY
Falling government bond yields have made the relative valuation of equities more attractive than that of bonds.
According to UBS, the trailing dividend yield on the European equity market, excluding financials, stands at 5.2 percent. This compares with a 10-year euro zone government bond yield of 3.1 percent.
Even if dividends were cut by 30 percent, these stocks still yield more than government bonds.
And dividends are gaining more investor interest at a time when interest rates and bond yields are hitting rock bottom.
Credit Suisse says its long-term data shows that reinvested dividends are the main driver of total returns. Seventy-two percent of total returns in the United States and 92 percent in Britain have come from reinvested dividends.
The Swiss bank estimates that for the first time in more than 50 years the dividend yield of the U.S. stock market is higher than the 10-year Treasury yield and more than two thirds of European stocks and nearly half of U.S. stocks have a dividend yield above their government bond yields.
The risk for pursuing investment income via holding stocks with higher dividends is that companies could slash dividends to bolster balance sheets.
Credit Suisse says dividends have fallen so far by 20 percent in Europe and the United States. Assuming earnings fall to as far below trend as in previous downturns and an average payout ratio, the bank expects U.S. dividends to have a further 15 percent downside, with 25 percent in Europe.
U.S. companies with a dividend yield above 3 percent with what Credit Suisse reckons as having a sustainable dividend included Duke Energy, Pfizer, Intel and Microsoft.
"Not only do high dividend yield stocks tend to outperform when markets are falling, they also outperformed in the first year of the last bull market," the bank said in a note to clients.
Pan-European stocks yielding more than 4 percent, rated "buy" by UBS, include BP, RWE, Novartis and Rio Tinto.
Barclays Capital also recommends buying energy, materials and industrial sector stocks, which also work as hedges against inflation.
It also recommend overweight investment grade credit. Within this sector, the bank favours overweighting senior financial debt, particularly in Europe.
"We believe that an increase in portfolio risk exposure is warranted," Tim Bond, head of asset allocation strategy at Barclays, said in a note to clients.
"The underlying fundamental trend in the credit cycle has swung towards a slow easing of conditions, a trend that government fiscal and monetary policies are likely to amplify. Credit easing regimes are invariably associated with improving risk appetite."