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- Potential treatments/vaccines for COVID-19, policy support, and gradually reopening economies make us more comfortable adding risk over our 12-month time frame.
- However, the market’s sharp rally and the prospect of a slow economic recovery leave us only moderately bullish on risk assets.
- Within surplus assets, we prefer high-yield credit, bank loans, US equities, and growth and quality factors, though we think some value-oriented sectors are attractive near term.
- Within reserve assets, we expect interest rates to stay low and find some areas of the securitized market attractive.
- Downside risks include a second wave of COVID-19, a deeper and longer recession than anticipated, worsening US-China relations, and Brexit. Upside risks include reflation and US-dollar weakness.
GLOBAL EQUITY MARKETS HAVE STAGED A REMARKABLE REBOUND OVER THE PAST FEW MONTHS, retracing 73% of their COVID-19 decline as of June 22. The speed and magnitude of the risk rally is unprecedented relative to past economic shocks, so it’s understandable that investors are asking whether there’s a disconnect between the market gains and the economic fundamentals. In the short term, we think the market recovery is justified: Treatments and vaccines for COVID-19 are likely on the horizon, monetary and fiscal policy support is strong, and economies are slowly reopening (Figure 1).
However, after the initial burst of economic improvement from ultra-depressed levels, we expect a slower pace of recovery. In addition, since the fundamentals are dependent on the course of and treatments for a disease, and recovery from a unique and drastic shock, it’s difficult to have a high degree of confidence about the path of the global economy. Taking all of this into account, we think volatility will remain elevated over the next 6 – 12 months and have tilted our views only modestly in favor of more aggressive exposures, leaving us fairly neutral across asset classes.
We expect interest rates to stay low and find many areas of credit attractive. We believe the COVID-19 shock is deflationary and, consequently, think commodities could be a source of funds going forward. We continue to prefer US equities, given our expectation that global growth will recover slowly and to a weak level. We are neutral on European, Japanese, and emerging markets (EM) equities, as we think less attractive fundamentals are offset by cheaper valuations.
Credit: Have spreads come too far?
Like equities, credit has had an extraordinary run this past quarter, with spreads narrowing hundreds of basis points in many cases. Despite that, we believe spreads remain cheap. The US Federal Reserve’s (Fed’s) credit-purchase programs give us confidence that spreads could…
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