For the past month, despite the biggest quarterly bounce back from its lows in Dow Jones history, the market skepticism has not only remained but intensified: JPMorgan, Morgan Stanley, Deutsche Bank, SocGen, all have warned that this is a sucker’s “bear market” squeeze, not the start of a real rally. Techniclans have been just as vocal in their skepticism, while the smart money has been selling relentlessly (not in its 8 consecutive week – more shortly). One would say this is your plain vaniilla wall of worry phenomenon, and it would be true if we didn’t know who it is that was buying: another burst of record corporate buybacks, which however are now over for the next 6 weeks as we enter buyback blackout period.
And overnight, the latest to join in the skepticism rally is none other than Goldman Sachs strategist Christian Mueller-Glissmann who in the latest “Global Opportunity Asset Locator” report, writes that the “relief rally across risky assets might fade over the near term”, warns that “sharp declines in oil prices are likely to weigh on risky assets again”, suggests to go to “reduce risk allocation”, warns against holding US HY bonds as “the risk/reward is least favourable if oil prices reverse course” and “go to cash” ahead of “expected elevated volatility.“
Key highlights below:
Since February 11, oil prices have rallied together with risky assets, supported by better sentiment on global growth, increasing indication of future supply rationalization, and declines in US oil production. At the same time, bond yields have picked up and US breakeven inflation has started to recover, indicating the market is starting to price US reflation. While we see potential for reflation to gain steam in 2H, in particular in the US, the current relief rally across risky assets might fade over the near term. We remain Underweight commodities over 3 months and Neutral over 12 months. As supply adjustments take place, we believe commodities will become more attractive. Until then there is risk of a self-defeating rally as supply cuts might be delayed. We expect volatile oil prices in a US$25-45/bl range, which coupled with negative roll yields should result in poor risk-adjusted returns. Sharp declines in oil prices are likely to weigh on risky assets again. In addition, we see several additional risks entering 2Q (e.g. Brexit, migration concerns, US elections, China, rate shocks), which are likely to drive higher volatility across assets. As a result, we reduce risk in our 3-month asset allocation as we enter 2Q.
We upgrade cash to Overweight over 3 months to position for and take advantage of more volatility. With the potential for cross-asset correlations with oil to increase again should oil prices decline sharply, the potential for diversification is limited. Similarly, rate-shock risk is difficult to diversify. Within cash we have a preference for the USD. We remain Underweight government bonds over 3- and 12-month horizons as inflation continues to pull yields higher and we still expect three Fed rate hikes this year. Over the near term, central bank easing, the dovish Fed, and lower oil prices might support bonds but we do not think US 10-year yields will trade below 1.75% for long.
Our key Overweight remains credit as we believe credit valuations are already pricing a worse growth environment. We continue to prefer EUR IG (and HY) due to a combination of better technicals (especially with ECB credit easing), fundamentals and valuations. Following the strong relief rally in USD HY, over the near term, we think the risk/reward is least favourable if oil prices reverse course. We prefer USD IG to HY near-term. While we expect equities to rebound within a ‘fat and flat’ range once reflation gains the upper hand and as oil prices stabilise, we remain Neutral over 3 months. Until then, equities are likely to remain volatile. Also, equity valuations are not attractive, in our view, having increased further in the rally, with negative earnings revisions. Without a sustained pick-up in growth and inflation, we think equities are unlikely to turn decisively. We retain our preference for Japan and Europe over 12 months, for which we believe valuations are not as stretched and policy remains supportive. However, near term, we are Neutral across equity regions; we like the low US beta and Brexit/migration concerns might weigh on Europe
This is Goldman’s latest tactical asset allocation:
Finally, Goldman points out traders have been all too aware off: everything trades with oil: “Correlations across assets and with oil prices have been high this year to date. The oil price recovery since February 11 (due in large part to China relief and the dovish March FOMC meeting) has come with a broad relief rally across assets.”
And since Goldman believes that the oil “relief rally might lose momentum from here” and “since oil prices will remain volatile, ranging US$25- 45/bbl in 2Q16”, it notes that “with oil prices back to the upper end of our forecast range, we are concerned that declines could again drive elevated volatility for risky assets.”
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Perhaps just this once Goldman will be right?
via Zero Hedge http://ift.tt/1Rgo9N0 Tyler Durden