Sometimes you can’t make it up, as they say. We’ve occasionally suggested that buying insurance against the US government defaulting on its debt is a little like betting that the world will end: if it happens, who do you think will be around to pay out? But as William Hill reportedly found to their profit last weekend, people will indeed place such bets. And now the market for CDS on US Treasuries is reportedly picking up as the fiscal stalemate continues.
We don’t favour bonds ourselves, but that’s not because we yet worry about the long-term creditworthiness of the US government. This is simply the wrong phase of the business cycle for bonds, and they look quite expensive (indeed, they’ve actually rallied further this week, despite predictions of fiscal doom).
Stock markets meanwhile are in the doldrums. A run of weaker data is damping risk appetite in the US. Continuing volatility in peripheral bond markets is playing a similar role in the euro area. In the UK, where fiscal policy has been decisive, the jury is still out on its impact. Emerging markets are paying a price for success, in the shape of higher inflation and interest rate risk.
We doubt that stocks will get much wind in their sails soon. If anything, a near-term setback feels a little more likely, especially given the distance already travelled since last summer. We advise that investors sit tight, and wait for the breeze to freshen.
We still think that the US economy is recovering, albeit patchily; that the wider impact of the euro area debt crisis will be limited; that the squeeze on UK households’ real incomes will not hit consumer spending hard; and that a “hard landing” in China is unlikely. Meanwhile, corporate profits globally are rising briskly, and keeping a lid on stock market price/earnings ratios.
This mix of recovery and inexpensive valuations suggests to us that we should look through the near-term loss of momentum, and continue to favour developed equities within balanced portfolios. For investors with lower equity holdings (and higher cash and bond weightings) than our recommended asset allocation suggests, a setback, and the rally in bond prices, may prove an opportunity to make the switch on slightly better terms.
Head of Global Investment Strategy