This year's profusion of snow and near-perfect weather delivered pristine conditions for skiers. But like the current state of the market, pistes may not be as smooth as they first appear - and the ever-present danger of avalanches threatens a serene exterior.
Valuations improved at the end of last year, finally giving investors some fresh powder to traverse treacherous slopes. Weather conditions were cleared by the Federal Reserve's U-turn and reinforced by dovish stances in other developed markets. With no inflationary clouds on the horizon, investors have had a smooth ride through financial markets year-to-date.
All downhill from here?
However, for investors regretting they might have profited more from the last two months, now is not the time to try and extend the experience. This would only increase the risks, as potential difficulties loom ahead; avalanche hazards are mounting as the snow crust becomes less stable.
Valuations are less appealing because central bank reassurances have led to momentum-driven investment and crowded trades. How can $8-9trn of government debt with negative yield be justified, if not through financial repression by the central banks?
Our view is the current market rally has gone too far too fast. Investors need to be aware of rising risks and the chances of the market snow-balling. Thus, we are keeping a cautiously neutral stance in our portfolios. We maintained our relative preference for US over eurozone equities, even though the equity risk premium for the US became less attractive and earnings revisions are slowing. In a fragile environment, we still favour their resilience and defensive characteristics compared to eurozone equities.
We also prefer the United Kingdom and Switzerland over the eurozone - despite ‘very cheap' valuations in Germany - in the absence of sufficient ‘buy' triggers and with ongoing trade tariff risk weighing on the European automobile industry. In the case of a general election in the United Kingdom, we would immediately consider downgrading UK equities.
Avoid catching an edge
While the central bank put is back in place, following the Federal Reserve's U-turn, the current situation cannot last forever. Either global growth will bounce back, in which case we may start increasing our risk stance and lowering duration, or if the opposite happens, with growth decelerating further, we would look to increase duration and lower our risk exposure.
We believe the rally in equity markets will soon be capped - on one hand by Fed hikes, if activity improves, and on the other hand by worries over growth, even if the Fed resumes cutting rates.
Given the strong gains we have made so far, it is time to implement ‘cheap' and asymmetric protections to start consolidating our year-to-date positive performance. We still have no sectoral bias, but we continue to favour high quality dividend stocks that offer attractive carry. They should be less volatile than the rest of the equity market and we also prefer them to credit.
On the duration front, we kept our stance unchanged from last month at a mild disinclination. Bonds now have limited upside, as rates have reached historically low levels again - especially in Europe, where valuations are expensive. However, it is worth having some duration in the portfolios, to balance risk.
In addition, the macro dynamic is still losing strength and the pause in monetary policy normalisation does not support a significant increase in rates. Tactically, rates could spike towards 3% for the US 10-year treasury and to 0.5% for the German 10-year bund if economic growth momentum rebounds rapidly, but this is not our base case at the moment.
We took some profits and implemented hedges through options strategies on the equity side, as well as on the fixed income side. Even gold's appeal now seems tactically less shiny. It's definitely time to take pause from the slopes and step out to a sunny terrace.