Asset Allocation Update: Cash Gains from Recession Shock

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June was a brutal month for the markets. Stocks fell 9%, commodities 8%, corporate bonds 3%-7%, emerging market bonds 5% and cryptos 40%-50%. Government bonds did the least harm, falling just 1%. It’s unusual for every asset to drop in a month, but June was that month. Worryingly, July also started on a weak footing.

What caused this? Admittedly, a surprise hike of 75 basis points by the Fed, which raised key rates to 1.75%, hurt risky markets. Then there was a steady stream of weak activity data, which saw recession fears rise dramatically. Our recession model has been citing this risk for several months, and the broader markets appear to have caught up with the view.

June was a brutal month for the markets. Stocks fell 9%, commodities 8%, corporate bonds 3%-7%, emerging market bonds 5% and cryptos 40%-50%. Government bonds did the least harm, falling just 1%. It’s unusual for every asset to drop in a month, but June was that month. Worryingly, July also started on a weak footing.

What caused this? Admittedly, a surprise hike of 75 basis points by the Fed, which raised key rates to 1.75%, hurt risky markets. Then there was a steady stream of weak activity data, which saw recession fears rise dramatically. Our recession model has been citing this risk for several months, and the broader markets appear to have caught up with the view.

When it comes to our view of asset allocation, our consistent refusal to seek refuge in cash proved prescient. It may have delivered only a tiny positive return in June, but it escaped the large losses seen elsewhere. As we have written before, the markets are undergoing a regime shift, with central banks raising their key rates. This means more instability, more risk of losses and more uncertainty. In such an environment, capital preservation is essential, so an overweight to cash is a prudent strategy. We stick to this point of view.

As with other markets, we reduced our overweight in commodities last month and are now moving to neutral (Chart 1). We still believe energy and commodities have structural supply issues, but market volatility and recession fears could limit near-term gains.

We were heavily underweight government bonds. But given the growing specter of a recession, we think it makes sense to reduce the size of the underweight. We still think the market is undervaluing the magnitude of the Fed hikes, so we prefer to underweight shorter term bonds (say up to five years).

On equities, we prefer to remain underweight. Most of the weakness in equities is due to devaluation, ie falling valuations (price/earnings ratios). But earnings forecasts have not yet been revised downwards. We believe that the macroeconomic situation is such that earnings will have to be revised downwards. When that happens, stocks could experience further weakness. And on crypto, we remain neutral – it remains a risky market and will likely face downside risks.

Finally, in terms of equity sectors, here are our favorite views:

  • In the United States we like to be Overweight financials, homebuilders, large-cap value, reopening trades, semiconductors, traditional infrastructure and underweight large cap growth, consumer discretionary, materials and technology.
  • In Europe we like to be Overweight finance and renewable energy.

Good luck!

Bilal Hafeez is the CEO and Editor-in-Chief of Macro Hive. He spent over twenty years doing research at major banks – JPMorgan, Deutsche Bank and Nomura, where he held various “global head” positions and researched currencies, rates and cross-markets.

(The commentary in the above article does not constitute an offer or solicitation, or a recommendation to implement or liquidate any investment or to engage in any other transaction. It should not be relied upon as the basis for any decision investment or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)

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