2H outlook: Riskier recovery; near-term relief but risks remain
* Remain pro-risk as tail risks are easing
Following a very risk-friendly 1Q15, the second quarter was characterised by large drawdowns in risky assets and high volatility in equities, rates and credit. With an improving global growth outlook, improved prospects for the approval of the Greek bailout deal, and better China data, we remain pro-risk in our asset allocation. We upgrade our 3-month European equities view to Overweight, in line with our 12-month view. Valuations and fundamentals look more attractive with tail risks fading, at least near-term.
* Elevated volatility and less stable bond/equity correlation
Cross-asset volatility has been higher with the bond sell-off in May and risks from Greece and China. While Greek risks are fading, some Euro area political risks remain. And we expect rate volatility to remain elevated. This
is likely to result in a less stable equity/bond yield correlation. As a result, bonds are unlikely to be good risk-off hedges. We like shorts in US rates and long the US dollar against both the euro and yen as hedges for rate
shocks. Implied equity volatility has declined materially – we like puts on MSCI EM (in US$), for which implied volatility is comparably low.
* Four key macro drivers in 2H
(1) Europe, balancing better growth against political risks; (2) US growth recovery driving the first Fed rate hike; (3) commodity prices declining further; and (4) China macro and market volatility and broad EM pressures.