>>> Cross-asset risk premia & yields; downgrade commodities & credit
Risky assets are likely to digest higher yields eventually
Recent increases in yields have led to drawdowns in some equity markets.
After the intense search for yield drove down required returns across
assets, they are getting upward pressure from higher yields. We expect
yields to increase further towards the end of the year. Risky assets should
be able to digest higher yields as risk premia fall. But, if rates increase
without a pick-up in growth, such a ‘rate shock’ can drive drawdowns
across assets. This has resulted in a negative bond yield/equity correlation,
similar to during the ‘taper tantrum’ period. We think a pick-up in growth
will lower risk premia and, in turn, stabilise valuations.
Equity drawdown risk remains; credit sentiment linked to oil
Until US growth picks up, equity drawdown risk still appears elevated in
the near term. Also, there are increased risks from Greece during the
summer. We think equity puts are attractive. To minimise negative carry,
we recommend EURO STOXX 50 puts at least partially financed by S&P
500 puts. For credit, we think the carry-friendly environment will stay, but
we see risks to credit sentiment from a lower oil price. In addition, rate
volatility might spill over to credit spreads – US HY puts appear attractive
OW equities, UW bonds; downgrade commodities and credit
We remain Overweight equities but continue to recommend selective
hedging strategies, owing to elevated drawdown risk. We also remain
Underweight government bonds, and our fixed-income team upgraded its
bond yield forecasts. We downgrade credit to Neutral on a 3-month basis,
as spreads should narrow and yields increase more gradually; we stay
Underweight on a 12-month horizon. Also, US HY credit sentiment might
suffer from a lower oil price near term. We downgrade commodities to
Underweight on a 12-month basis and stay Underweight on a 3-month.