Markets have digested the higher move in bond yields and any further rise in yields will occur because of firmer economic data.
Central banks globally are almost unanimously dovish which should translate into asset reflation and easy financial conditions. The Bank of England and European Central Bank were the latest banks to use “lower for longer” language to drive down interest rates. Chairman
Bernanke has also indicated that the Fed will hold rates at the current 0% level for the foreseeable future.
At the same time, economic data is improving. High velocity indicators in Europe such as PMI are increasing from a dip in 1Q and broad data in the US such as jobs, spending and production are also suggesting the economy is improving.
The volatility spike and risk aversion in June presents
an attractive entry point and opportunity going forward.
Risk premium increased because of higher rates and
concerns about emerging markets. Both of these issues
have stabilized. Bond yields in the US have repriced
sharply since May but the pace of the increase will likely
slow going forward. China concerns have also dissipated as the authorities introduced more liquidity into the
market. We expect risk premium normalization to
continue which translates into higher asset prices.
Equities are our favorite asset class and a key
beneficiary of asset reflation. Based on our metrics,
equities are significantly more attractively valued than
other assets at this stage in the cycle. Within equities,
Japan is our most overweight region because it offers the
best upside given the size of central bank stimulus and
attractive valuation.
In our Alternative Strategies ranking, we have an
overweight bias to directional strategies in the equity
space. L/S Equity discretionary and systematic neutral
strategies should benefit from a high dispersion, low
volatility environment. We upgraded Long term CTAs to
slight overweight after a challenging 2Q because we
believe the factors responsible for the soft performance,
such as a spike in rates, will be more benign going
forward. On the credit side, the market appears richly
valued and we downgraded L/S credit to neutral. We
advocate focusing on relative value funds in the credit
space with limited interest rate risk.
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