Asset Allocation

Most financial assets are trading within the confines of the feedback loop between markets and Fed policy. Investors should avoid expensive assets such as spread product, and hold positions with attractive long-term value such as U.S. TIPS over nominal Treasuries and U.S. Treasuries over German bunds.

Like the economy, banks show no major imbalances. But the "glide path" for credit is slower than in previous cycles.

The dollar countertrend move has more downside, but beyond the next few months, the dollar remains in a cyclical bull market. Improvements in global growth, even if temporary, are likely to lift non-U.S. rates more than U.S. ones. The euro will benefit from that move as investors still have deep negative feelings toward EUR/USD, exactly as economic momentum has moved in favor of Europe. The SEK should outperform.

Saudi oil policy, like its defense policy, will be more aggressive and less predictable, following Deputy Crown Prince Mohammed bin Salman's apparent nullification of a production "freeze" deal at Doha.

The euro area's nominal GDP and wage bill are growing at 3%, suggesting that fears of deflation are overdone. But a higher wage bill has implications for profits growth.

EM/China growth improvements and the associated rally will falter on their own without tightening by policymakers. The short duration of these mini-cycles and a lack of observable catalysts make it impossible to precisely time selling out of EM positions. This makes us reluctant to chase the rally. Regardless how the impeachment process proceeds, Brazil is heading into a fiscal/public debt crisis.

The balance of risks favors accelerating wages and stable core inflation during the next few months. This will result in a move higher in rate hike expectations, benefitting Treasury curve flatteners.

Bearish sentiment is a red herring, as most other measures of investor positioning point to a strong undercurrent of bullishness. That is contrarily worrying.

The equity bear case is obvious. Prices are approaching overhead resistance and face fundamental headwinds.

This week <i>Global Alpha Sector Strategy</i> in conjunction with <i>Emerging Markets Strategy</i> is sending out a <i>Special Report</i> on EM deep cyclical sectors, discussing debt and cash flow dynamics, identifying how far advanced the capital expenditure down cycle is, and determining if recent EM deep cyclical strength should be bought or faded.