Strong supply-demand dynamics warrant a larger exposure to commodities

 

Cash / Fixed income

 

We continue to view cash and government bonds as a hedge against an adverse economic outcome - i.e. if our central scenario turns out to be too optimistic on the macro front.

Although our cautious duration bias was not appropriate over the last few weeks, we still find the risk-reward ratio in long duration unattractive - sentiment is very optimistic, with strong Federal Reserve (Fed) easing and European Central Bank status quo already priced in. We thus further reduce our government bonds exposure in favor of cash (and commodities - as discussed below).

We have no exposure to credit, where opportunities are limited by prevailing uncertainties and the widening spread gap between the financials and industrial sectors.

 

Equities

 

The relative valuation appeal of equities remains compelling, even in our slowing - but not collapsing - earnings scenario. As is typical of maturing bull markets, however, leadership is narrowing. Going forward, visible growth stocks should lead indices, with large capitalization, emerging market exposure and strong free cash flow generation being the key selection attributes. Regionally, we continue to favor emerging markets although valuation levels, particularly in China, do warrant greater selectivity.

Further short-term vulnerability is possible following equities’ rapid bounce off summer lows and given the lack of visibility still plaguing the banking sector.

 

Alternatives

 

Attractive supply-demand trends due notably to decoupling emerging economic growth, together with global liquidity and dollar depreciation, justify a larger commodity exposure. We see further upside in the prices of oil, gold and soft commodities - only industrial metals should be avoided due to their exposure to the US construction cycle.

 

 

We maintain our long-term bearish view on the dollar, due to the gradual shift from a dollar-centric to a multi-polar forex world, the current relative weakness in US economic growth, and the narrowing interest rate differential vs. Europe.