JP Morgan continues to favor the risk trade. They see the recovery continuing into 2010, jobs recovering and the reflation trade continuing to work well. Their outlook is little changed over the last few weeks. They see the short dollar/long beta trade performing well:
- Fixed income: Open short in 2-year USTs. Within EMU, we overweight Ireland and Italy but we prefer to position for this through CDS.
- Equities: Asset reflation favors the high-risk, high-beta parts of the equity market.
- Credit: European credit 2010 outlook—stay overweight Financials focusing on Lower Tier II, Tier I issued in 2009, and distressed Financials within HY.
- FX: We stay short USD medium term and focus on crossrates where interest rate markets looked mispriced.
- Alternatives: Stay short oil, but long base metals and agricultural products.
With economic data coming broadly in line with expectations, asset reflation and risk premia compression have become more important forces for equity markets. Asset reflation favors the high-risk, high-beta parts of the equity market, i.e., small caps versus large caps, cyclicals versus non-cyclicals, and EM versus developed markets.
In addition, money flows are beginning to favor the equity trade as hedge fund flows and mutual fund flows increase:
Retail flows into equity funds picked up this week. We need to wait for a few more weeks to see if a new trend is emerging. Retail investors have been reluctant buyers of equities so far and have deployed most of their excess cash into bonds. In contrast, the tactical flow remains supportive for equities as equity hedge funds appear to have been steadily increasing their equity exposure since April. The 21-day rolling beta of equity long-short hedge funds with respect to the equity market reached its highest level since January 2008.
Within the beta trade, they like energy and technology to outperform:
We stay long Energy and Technology across sectors. An analysis of US sector performance following seven major market bottoms since 1974 shows that the best two performing sectors were Energy and Technology in the 6th to 12th month following the market bottom. Indeed, since Sep 9, six months following the equity market bottom, both Energy and Technology have outperformed MSCI World
with Energy being the best performing sector.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.