Latest GOAL note.
Negative macro surprises and the global bond sell-off since n last week have driven a reversal of the ‘Goldilocks’ summer rally. Risk parity and balanced funds suffered in particular, with a sharp increase in equity/bond correlations. We think bond yields will increase more until year-end, and downgrade bonds to Underweight on a 3-month horizon (in line with 12-month). However, while rate volatility could pick up in the near term, we expect the most pressure in the back end and continued anchoring of the front end by central banks next week.
We remain defensive in our asset allocation and Overweight cash (3m) due to elevated valuations across assets and the risk of shocks. However, we upgrade equities back to Neutral on a 3m basis due to support from still low rates and optimism on fiscal easing stabilising LT growth expectations. We continue to expect ‘fat and flat’ returns but our equity strategists now forecast less negative returns. Risks are still skewed to the downside in the near term, in our view, owing to more bullish positioning and the fading ‘Goldilocks’ backdrop. However, we see a lack of catalysts for a material drawdown. We move S&P 500 (3m & 12m) and STOXX Europe 600 (3m) to Underweight within equities. Japan is Neutral 3m, Overweight 12m. Asia is our preferred equity region – we are Overweight MSCI Asia ex Japan for both 3m and 12m.
We still prefer credit to equity due to better asymmetry of returns. More positive asymmetry for equities would require a better growth/rates mix, with rates volatility easing.We have a stable growth outlook until year-end and macro volatility has been low. With central banks anchoring rates and a pick-up in macro data, we would expect equities to stabilise. The sensitivity to US 10-year yields across assets is close to the highest level since the 1990s. And risky assets tend to benefit from higher rates as long as they come alongside better growth; the correlation of risky assets with US breakeven inflation is more positive than with real yields. But, elevated rate volatility often results in a negative correlation of equities with higher yields initially.