Upside down

Bye-bye summer, hello deep negative yields. ‘The law of diminishing return’ continues to wreck the global economy and markets. Yields have plunged further over the past three months, particularly so when the US -China trade war erupted again.

Highlights:

  • The negative yield disease is spreading in a way that radically alters portfolio considerations. We argue that the economic pain threshold justifying a switch away from risky assets is higher than it used to be. Investors have been punished for rushing away from equities into bonds.
  • The million dollar question is whether the global economy, now on a dangerous slope, will fall into recession. This is not our core scenario, but policy support – not just monetary – is required. We assume none of the three major risks (Brexit, US/China trade war, Middle East tensions) will materialize in the worst way.
  • In the upside-down world of negative yields, IG Credit is a new safe haven – symbolized by the outright and relative low IG yield volatility. Equities remain cheap relative to bonds, and the Fed will remain supportive (we do not believe in the FOMC’s hawkish dot plot).
  • We reduce our long duration following sharp EUR 10-30y flattening. Credit duration offers more value. We stay underweight short-dated EUR Govies. With the USD looking toppish, EM equities and bonds offer selective opportunities.

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