Every week we send out an e-mail to our subscribers where we highlight the most interesting forward-looking signals coming out of our ClearENGINE platform, and explain the impact they have on global markets.
Below is the weekly e-mail published on 7th of August 2019.
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The Big Picture
Our short-term (0-6 month outlook) Global Risk Appetite Matrix is Moderately Risk-Off, and our medium-term (6-12+ months) is fully risk-off, suggesting that investors with a global risk outlook should be underweight benchmarks. Short-term economic activity, monetary, and technical outlooks are all risk-off.
Markets are going through one of their periodic wobbles, and active mutual fund investors still have to further reduce their risk positioning before we call the all-clear: our EPFR positioning signal below is still negative even after the sell-off to date, indicating investors are still overweight their benchmarks.
Central bankers have more work to do to calm markets: our central bank-speak signals (Prattle) remain insufficiently accommodative to support markets. This increases market risk in the short-term.
But is it time to throw in the towel, and establish bigger risk-off positions? We still think this is premature. It’s true that our cycle sustainability signal below, which evaluates the probability of an end to the current economic cycle, is flagging a large warning sign. Moreover, in March we also raised the conviction level of our Coming Recession theme to Very High (60%+ probability of market impact over next 12 months).
But, today we are lowering this conviction level back down to High (40-60% probability) to take into account the fall in yields and the likely support that this will provide to markets over the next 6-12 months. So, we will continue to actively trade risk tactically through this period until we see greater evidence of an imminent recession.
We also reiterate a cautious view on Emerging Markets. Investors have already been shedding risk, as shown by the EPFR flows signal below, but, as we highlight in the Thematics section underneath, whilst we are reducing the recession risk flag, we are raising our Protectionism theme conviction from High to Very High. In our opinion, this will keep EM assets under pressure. We prefer to hold any EM exposures in credit against opportunistic equity shorts (we dislike South Korea).
Charts Of The Week
A month ago we started shorting govt bonds as investors had piled back in. But we were very tentative with position sizes as our short-term ratings were not negative. That is still the case, and given the size of the rally, we have already hit our stop loss. However, we choose to use one of our few allowed annual “over-rides” to run the US Treasury short. In fact, we may look to increase the position size: both of our key positioning signals are very negative: the first chart below shows that long-term investors are overextended.
Next, active mutual funds have now reverted back to previously stretched overweight levels.
What’s Going On In Our “Thematics” Portfolio?
Our Thematics framework and accompanying model portfolio was set up in April 2018 with a very defensive basket containing 13 live themes (a mix of late-cycle, overvaluation, liquidity, and political risk plays). Having had very strong performance (relative to a 60/40 benchmark) in 2018, the portfolio has under-performed this year due to the strong rally in financial markets.
We remain very comfortable with the portfolio. Net-net there remains a bias towards late-cycle plays and away from EM and fixed-income asset. And whilst reducing the conviction level today of our recession theme from Very High to High, we simultaneously raise the conviction of our Protectionism theme from High to Very High.
Should Your Portfolio Be “Risk On” Or “Risk Off”?
Overall, moderately risk-off. Expect the sell-off to extend further in the short-term. Keep an eye on the communication response function of central banks.
What TAA Opportunities Should You Focus On?
We highlight a key change in FX views where we have been bullish on the USD for the longest time and now revert to a neutral rating. Similarly, we have moved our recent bullish ratings on certain EMFX to neutral.
Credit: O/W EM sovereign hard currency credit and corporates relative to UST.
Equities: Neutral to Moderately U/W.
Regions:U/W EM vs DM
Countries:U/W Switzerland, Ireland, S. Korea; O/W Italy, UK.
Sectors/Styles: O/W Global Healthcare vs U/W Global Materials.
Government bonds/Linkers: U/W
Commodities: U/W (Softs/Energy)
Long SGD vs NZD; long JPY
TAA Portfolio Performance
Our tactical trade portfolio is down -0.11% over the last month – with a realized Information Ratio of 0.70 since inception – and overall underweight to global equity risk sensitivity.