Economic Growth
Developed Market bond yields are too low relative to improving global growth and the strong recovery in risk assets post-Brexit. Reduce portfolio duration to below-benchmark.
Long-time subscriber Mr. X recently visited our office to discuss three issues: Brexit, the outlook for China and the seeming contraction between the performance of equity and bond markets. This <i>Special Report</i> is a transcript of our conversation and, not surprisingly, the broad conclusions supported a cautious investment strategy.
Today, on a tactical basis, we are moving our allocation on EM hard currency bonds to neutral from underweight. In this <i>Special Report</i>, we elaborate on the reasons leading to this decision.
A number of divergences have emerged in global financial markets. These gaps are unsustainable. The recent improvement in Asian trade/manufacturing has been largely due to firming demand for electronics/semiconductors. Meanwhile, demand/output for industrial goods and basic materials - the areas leveraged to Chinese capital spending - remain weak. Fixed-income traders should bet on yield curve steepening in India: receive 1-year/pay 10-year swap rates.
A benchmark overall duration stance is still warranted, as central banks will maintain exceptionally accommodative monetary policies to offset potential Brexit-related shocks to confidence.
Rising policy uncertainty is negative for global equity multiples.
Equity and Treasury market positioning support the notion of a bounce in risk assets, possibly egged on by dollar weakness.
EM/China oil demand is not as strong as some reputable energy sources have indicated. As and when the oil market shifts its attention from supply cutbacks to subdued EM/China oil demand, oil prices will relapse. Renewed drop in commodities prices and poor growth in EM will weigh on EM risk assets going forward.
The Chinese government is engaging in a difficult balancing act between the imperative of maintaining growth momentum and structural reforms. Policymakers have eased off the gas pedal, but the impact of previous stimulative measures should continue to filter through the economy. Investors should also curb their enthusiasm in assessing China's demand-side countercyclical initiatives.
