Let’s get straight to the point: we are adopting a more cautious stance towards our global risk assessment, which has been downgraded to mild disinclination in our portfolios. While the economic backdrop, earnings-per-share growth and sentiment remain supportive, asset prices have now more or less priced in the current goldilocks scenario. So, the questions we are asking ourselves are: how much upside remains on equities and credit markets? Not so much. Can economic growth continue to surprise the consensus on the upside? Not likely. Will inflation fall further in the next few months? It seems very unlikely. Will central banks’ ultra-loose monetary policy continue to resist the rational exuberance in the financial markets? We doubt it.
In other words, the safety margin is expected to shrink going forward as the goldilocks scenario should at some point start to deteriorate. Volatility may then pick up as the massive "central banks’ put" fades away with the odds of a (healthy) correction, or at least a consolidation, picking up. Don’t misinterpret our view: we aren’t calling a bear market but just keeping some of our chips selectively out of the markets as the expected risk-adjusted returns of some assets such as credit and US equities (specifically technology stocks) aren’t appealing. As the continuation of the markets’ rational exuberance cannot be totally excluded, it makes sense to focus our risk budget on the laggards of the current bull markets, namely European and Japan equities, which have the advantages of better valuations, more "cyclicality" and higher visibility on their economic and political situations. That’s the best way to hedge ourselves against a powerful human emotion, i.e. the fear of missing out… because as usual, it ain’t over till it’s over!
On the other hand, the duration stance was kept in disinclination as the path of least resistance for rates remains currently on an uptrend. Inflation is bottoming out, some kind of central banks’ monetary policy normalisation, led by the Federal Reserve, is expected down the road and Trump’s fiscal plan is now back on the table. A spike in rates due to exaggerated concerns about inflation or clumsy central banks normalisation remains our biggest concern. If it happens, it will certainly provide a more interesting entry point to both reload some equity risks into our portfolio and adopt a more constructive view on governments bonds.