From Goldman today:
- We recently highlighted correction risk, in part due to bullish positioning – our risk appetite indicator was at the highest level on record. The S&P 500 pulled back c.8% since January 26th, other equity markets followed and bonds have not hedged well. The S&P 500 has underperformed relative to its MSCI World beta.
- This S&P 500 correction has been faster and harder to diversify than previous ones. We find many equity markets and sectors have not performed in line with their betas. We think technical factors have contributed to the recent sharp correction with equity selling/buying pressure from systematic investors.
- Risk appetite has now normalised to more neutral levels due to the spike in the VIX, but remains supported outside the volatility components, suggesting little spillover so far. From these levels, both our Risk Appetite Indicator and the VIX signal positive returns over the medium term.
- While we have pushed above previous vol highs in the current low vol regime, we are not yet ready to call the end of it, which could change the balance of risks. Whether volatility settles into a higher regime is critical to asset allocation from here and could still affect allocations from systematic investors.
- Balanced portfolios have suffered in particular. The recent rapid repricing of bond yields has been difficult for equity to digest. As we highlighted before, with equities, bonds and credit expensive at the same time, the potential for diversification is more limited, both in case of growth and rate shocks.
- We view this as more a technical than fundamental sell-off, and still see bear market risk as low – our economists still see a low probability of recession and while our bear market risk indicator is at elevated levels it has remained range-bound, in part due to anchored inflation. Equity valuations have reset to the lower end of their range and current equity flows and equity-bond rotation are not yet consistent with levels before bear markets.
- We remain pro-risk in our asset allocation – Overweight equities and commodities, Neutral credit and Underweight government bonds for 12m. We continue to prefer EM to DM equity, where the macro cycle has further to run.
Makes sense to me except in one crucial aspect, if the USD does not keep rising then bond yields will and stocks will keep falling. Therefore I think the USD will rise and commodities fall to contain yields.
