• Asset allocation: Keeping risk tight, we’re avoiding consensus trades where feasible, but not giving up on medium-term bullish view on risky assets.
• Economics: Slightly softer data may unnerve markets but are not enough to change our growth forecasts.
• Fixed income: Bond yields to move higher medium term, but remain hostage to market volatility near term.
• Equities: Position squaring favors Europe, large versus small caps, and defensive versus cyclical sectors in the near term.
• Credit: Flows out of high yield mutual funds have been occurring for three consecutive weeks, pointing to further spread widening near term.
• FX: The recovery in commodity currencies looks to be on hold until after G-20.
• Commodities: The medium-term direction is still positive.
Guys at J.P.Morgan have made also a great Q&A session, with some most relevant, in my opinion, questions and answers as follows:
How bad can it get? If we are right that the underlying cyclical rebound remains in place, that banks will not be a source of contagion, and that policymakers will be generally supportive, then risky markets should bottom over the next month or so. But this argument does not tell us how far the knife can fall.
What will stop the sell-off? Three signals are most important: (1) confirmation that the nonfinancial sector—companies and households—are not panicking and remain in expansion mode; (2) coordination among policymakers to support markets rather than punish them; and (3) markets cease reacting to bad news and start reacting to good news, something that was clearly not present this week. One can understand the frustration of policymakers in the midst of renewed market panic, but the only solution for overstretched public balance sheets is growth, and that requires coordinated support to markets.
What to do in the meanwhile? Keeping tactical risk low is obvious. Investors with staying power should start buying oversold assets, though, without being in a hurry. Remaining positions should be focused on non-consensus exposures.
Then, there is a belief that employment will follow the corporate profit growth, as can be seen in the chart below. However, the gap has got extremely large this time, and the question for me is - whether the one is achieved at the expense of other ... and whether this is not exactly the cause of weakness in economy?
Click on chart to enlarge, courtesy of J.P.Morgan.
How long the cyclical upturn remains in place?