Risk-on sentiment has dominated markets in a post-Brexit world characterized by expectations for lower-for-longer interest rates. The result: Certain investments have become very popular, and investors should tread carefully.
Chart of the week
Positioning across asset classes, August 2016
The chart above shows where the crowds are, based on our analysis of fund flows, fund positioning and price momentum. We see positions with scores between 1 and 2 (and -1 and -2) as popular, and those with scores above 2 (and below -2) as very popular. The most popular investments today: overweights to UK government bonds (gilts), emerging market (EM) sovereign debt, developed market credit and gold, and an underweight to eurozone equities.
Investment popularity does not tell us much about the direction of returns over the long run (i.e., the next 12 months). In fact, we expect that many of today’s consensus trades could be long-term winners as low economic growth and low interest rates persist.
Yet some popular positions are approaching extreme levels (scores above 2 and below -2), which we see as an important signal of short-term risk. These positions may be vulnerable to a market shock or rising volatility, especially when combined with high valuations. It’s important to manage this risk by being selective.
We advocate reducing popular positions where prices have moved beyond fundamentals (examples are gilts and bond-proxies such as utility stocks). We also would resist taking contrarian positions in sectors facing big structural challenges (e.g., European banks). But popular overweights with supportive fundamentals and valuations (such as EM debt and U.S. credit) are still worth considering, and gold can offer portfolio diversification benefits.
More than $8 billion has entered dividend equities since the Brexit vote, according to EPFR Global. We prefer dividend growth over dividend yield. Our overweight EM equity position doesn’t appear popular despite recent flows into the asset class. Bottom line: Be mindful of the short-term risks in consensus trades, and look for potential opportunities the crowds haven’t yet reached.
|Aug. 29||U.S. core personal consumption expenditures (PCE) price index|
|Aug. 30||Germany inflation|
|Aug. 31||Japan industrial production; UK housing price data|
|Sept. 1||U.S. ISM manufacturing index, PMI manufacturing; UK PMI manufacturing; China PMIs|
|Sept. 2||U.S. employment report|
The main event this week: the U.S. employment report on Friday. Payroll growth numbers have beaten expectations for two months straight. A continuation of that trend, along with further evidence of recovering wage growth and core PCE inflation near 2%, could raise the odds of a 2016 rate rise. Recent remarks from Yellen and Vice Chair Stanley Fischer appear to confirm this. Elsewhere, we expect UK housing price data to show how the Brexit vote has affected the local housing market. We see downside risk to UK growth estimates. Finally, China’s August PMI report may show whether softness in July data is spilling over.
Weekly and 12-month performance of selected assets
|Equities||Week||YTD||12 Months||Div. Yield|
|U.S. Large Caps||-0.7%||6.1%||11.8%||2.1%|
|U.S. Small Caps||0.1%||10.0%||11.0%||1.4%|
|U.S. Investment Grade||-0.1%||9.0%||9.4%||2.8%|
|U.S. High Yield||0.3%||14.3%||9.9%||6.3%|
|Emerging Market $ Bonds||0.0%||14.4%||16.1%||5.0%|
|Brent Crude Oil||-1.9%||33.9%||15.7%||$49.92|
Source: Bloomberg. As of August 26, 2016. Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Barclays U.S. Corporate Index; U.S. high yield by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Barclays Municipal Bond Index; non-U.S. developed bonds by the Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.
Views from a U.S. dollar perspective over a three-month horizon
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