Valuations
Maintain an above-benchmark portfolio duration since, favoring markets with the highest real yields that stand out in a world where 65% of Developed Market government bonds trade with a negative yield.
Spread product performance has been foreshadowing changes in market rate hike expectations since early last year, and the recent bout of weakness means it is probably time for the Fed to temper its hawkishness.
The oversold bounce is not supported by policy or profits, and should be treated as countertrend. Lift machinery to neutral and differentiate between pharmaceuticals and the unwinding of the biotech mania.
Last month, the model outperformed both global and U.S. equities in local-currency and U.S.-dollar terms. For February, the model is aggressively increasing its risk exposure and has included a bet on commodities for the first time since 2012. For equities, the largest overweight remains Europe, but EM and Canada enjoyed significant upgrades. For bonds, the model favors the European periphery.
The setback in global financial markets has not been enough to persuade the FOMC to alter its stance. Although the Fed is signaling that the tightening cycle has further to run, the U.S. dollar is showing signs of fraying at the edges.
The Fed will upset the rebalancing of oil markets if it misreads the current sell-off as weakness in oil demand.
The U.S. corporate re-leveraging cycle is far more advanced than is widely believed. Corporate health looks only mildly better excluding the troubled energy and materials sectors. Mushrooming leverage ratios are not restricted to junk issuers either.
Corporate profits are more sensitive to selling prices than to volumes. Falling prices even amid mildly rising volumes could produce a meaningful profit contraction. Stay with deflation trades. In particular, maintain the short EM stocks / long U.S. 30-year Treasurys position. Indian stocks are still pricey and will deflate further in absolute terms.
There are no signs of broader financial stress in the Chinese corporate sector. The most recent financial market turmoil has had no systemic damage to corporate sector balance sheets. We are leaning against being overly bearish. Current valuation readings, particularly for Chinese H shares and Hong Kong stocks, on a historical basis have never been sustainable.
The declining correlation between risk assets and Treasury yields suggests that the market perceives monetary policy to be overly restrictive. Historically, this has led the FOMC to adopt a more dovish policy stance.