Be cautious on Stocks

Be cautious on Stocks

Shriram Garde

The longer the seemingly unstoppable reflation rally continues, the more warning signs start to flash — especially in stocks.

The bank’s strategists have lowered their three-month outlook for global stocks to neutral, while staying overweight cash and underweight bonds given the recent shift by central banks to a “slightly more hawkish” stance. The Federal Reserve is forecast to raise its benchmark interest rate Wednesday in an environment where markets are demonstrating historic calm.

With growth momentum nearing its peak and rates increasing further with a hawkish Fed, the asymmetry for equities is turning increasingly negative. A slowing cycle makes equities more vulnerable to higher rates and also shocks, e.g. from European politics, U.S. policy, commodities or China.

After a blip to start the year, strong macroeconomic data including U.S. jobless claims at a 44-year low have given investors renewed confidence to buy stocks. Valuations have been supported by “very low” bond yields, but a negative rate shock “looms large” as inflation accelerates.

At some point, rising bond yields will become a constraint on equities. Bond yields are still some way away from normal levels in Europe and Japan, but in the U.S. you are getting much closer to that.

Also be aware about trading dynamics in equities. Historically low volatility has pulled in “risk parity funds” that take their cue from risk levels. “Commodity trading advisors” who gauge trends or momentum and use futures also tend to pile in to markets with low volatility and established trends.

In the event of a reversal of the trend, these systematic investors are likely to reduce equity exposure quickly, which could exacerbate an equity drawdown and result in a faster and larger volatility spike.

Investors should bear these points in mind:

  • The analysts suggest investors replace their equity positions with calls, including shorter-dated calls on the S&P 500 and longer-dated Euro Stoxx 50 and Nikkei 225 calls
  • They are still positive on equity returns longer term, with a 12-month overweight rating for all regions except the S&P 500, which stays underweight
  • Rising U.S. rates should benefit Europe and Japan even as they become a headwind to the U.S., and there is also potential for a relief rally in the event of a “market-friendly outcome” to the French elections

Trump protectionism, rising rates and slowing China data are risks but strong growth in the region should be able to digest these.

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About The Author: Shriram Garde

My mission is just to share the events in my life sincerely with you; as I have experienced them, not necessarily in that order. I write on various topics. Whether that means - advice, tips, tools, scriptures, or instructions on budgeting, getting out of debt, making some extra cash, investing or anything else, I intend to provide it. I was 18 years old when I started working as a labourer. I had no savings. I had no money left in my bank accounts. I know life through lot of unpleasant incidences occurring day in and day out. But what I realised is that it doesn't have to be always like that. We are not doomed to how we are currently living – we all can change! I know, because over last couple of years my family and me have paid off a huge amount of debt. I have a passion to help people come to this realisation and get started on their own journey to financial freedom. I had owned 2 Companies before moving to Finance Sector about 9 years back. Spending more than 30 years in various capacities taught me quite a lot. I have a diploma in Engineering completed in part time while I was working. I have learned a good chunk from my working background in various fields. But, like most people who are eager to learn, the bulk of what I have learned thus far is from reading magazines, books, blogs, pod cast or whatever else I can get my hands on about Personal Finance, investing, business, personal development, and time management.

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