The latest market views from BCA Research and MWCM
Following a meeting with BCA Research, one of the better-known research groups globally, I thought it would be useful to document some of their key views. I also use the opportunity to provide our view and, where useful, provide some color on this.
BCA: potentially weaker short term (3-6m), but stronger thereafter; up-leg has simply been delayed. Expect Euro to weaken due to weak economy and little pressure on ECB to raise.
MWCM: Agreed on both.
BCA: expect the Fed to be more aggressive, raising rates more than the market currently expects. Market expects one more rate hike. BCA expects one this year and two next.
MWCM: I think the Fed will continue to lag the inflation impulse, similar to 2005/6. Risk assets may continue to perform well, however, until inflation comes through and the market sees the need to tighten. We are not there yet.
BCA: expected to pick up as unemployment goes below 4%.
MWCM: would agree. Earlier this year, my trade call was that the long bond was oversold due to inflation expectations being too high. The market has since shifted on this, with our long bond exposure up over 10% YTD. My expectation was/is that China could provide a deflationary shock before we hit bottom, but the US is now increasingly insulated from this, given potential trade tariffs etc. The deflationary shock though, would weaken Asian currencies, which in part drives my expectation of a stronger dollar.
BCA: expectations for recession in the US pushed out to mid 2019; earlier the forecast was for mid 2018. Expect a mild recession driven by rising rates, rather than external shock.
MWCM: Our view is slightly different. Expect the market to turn, due to the expectation of higher inflation and higher rates. Asset prices are based off the risk-free rate, so as inflation increases and the 10yr bond yield picks up, assets prices should be revised down. As the Fed starts to catch up, this will induce secondary effects.
The recession could impact financial markets far more than the underlying economy, given the amount of leverage in the financial system. In terms of personal leverage, this has reduced in the US since the GFC but has picked up everywhere else. It’s thus likely we will see more of a global impact.
One bond manager I recently met with had the view that personal leverage was not yet high enough to trigger a major systemic collapse. I would have to agree with him on this. Leverage is increasing though, so it is only a matter of time until it could.
BCA: mixed view – likely a mild recession.
MWCM; China’s Central Bank has been very aggressive in supporting the financial and real estate markets. I see this impulse starting to fray at the edges. NPLs are far higher than the banks report and market prices in. There is a reason the large China banks trade at low multiples.
I would not bet against China’s CB, but it is unlikely they will be able to maintain the level of new liquidity seen over the last decade. GDP growth will, through natural market forces, start to decline from current levels. Like the tide going out, this will highlight some of the vulnerabilities in the economy, where debt levels are excessive, most notably the State Owned Enterprises (SOEs). China longer term is fine though, and well run private companies are the only place to be.
BCA: Bullish Oil – this is a key call; expecting $60 by year end
MWCM: We do expect higher oil going forward. There is though, an excessive amount of shale still in the system and any price increases above around $60 will be capped by increased shale production.
BCA: Bullish high risk assets: equities, High Yield; Equities: Prefer EU and Japan to US. Bearish bonds and the US long bond (due to inflation and higher yields)
MWCM: we are not as bullish and are increasingly allocating to managers that have demonstrated their ability to protect the portfolio in a down market. The rally in risk assets is long in the tooth and valuations are rich.
Far better to reduce risk exposure and look to ride through a change in the cycle – better to have the dry powder, necessary when valuations become more attractive.
With this mind, in addition to traditional asset classes, we allocate to several long-short equity, multi-strat, macro, event and bond managers that we feel are well suited to the current environment. MWCM’s focus is on sourcing managers that can provide strong returns, regardless of the market’s direction and have excellent drawdown control. With a low correlation to other exposures, these allocations also reduce volatility at the portfolio level.
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