Thursday, March 11, 2010

The J.P. Morgan View: Markets Uncertainty is receding— add to risky assets $SPY

• Asset allocation: Confidence in the sustainability of the rally is growing as major threats from jobs and policies
are receding. We have moved from small to normal overweights of risky assets.

• Economics: No change in forecasts of recovery, but increased confidence as the risks to sustainability are
gradually receding.

• Fixed income: Close shorts in US 2s, but stay short in the UK. Buy Greek government debt.

• Equities: Stay long, focused on small caps and cyclical sectors. We are reluctant to overweight EM equities despite their higher beta.

• Credit: Investors are becoming more bullish US HG spreads but have yet to adjust their positions. Stay long

• FX: Take profit on long USD positions against EUR, GBP, and commodity currencies.

• Commodities: Stay long commodities, favoring base and precious metals near term.

Equities are up 3% on the week. Flows have turned more supportive, driven by a rise in share buyback and M&A activity as well as retail buying. Retail investors bought equity funds for a third straight week following six straight weeks of outflows.

Credit markets rallied across the board this week. We see the spread tightening trend restarting once again and stay overweight credit, especially higher-yielding debt such as high yield, super-senior CMBS, and EM corporates

Fixed income

Bonds fell slightly this week, on stronger activity data and increased confidence that Greece will be able to fund its fiscal deficit. The lack of major surprises from central banks has been another contributor to diminishing market uncertainty. This week, the ECB announced that it would make its liquidity provision slightly less generous, in keeping with our expectation that G-4 central banks will unwind their extraordinary stimulus very gradually. Those central banks that are tightening, such as the RBA this week, are doing so in response to strengthening economies, a benign outcome.

We maintain a medium-term bearish view, as demand for bonds should fall much more than supply this year, largely due to the end of QE. But we have been playing shorts tactically, to benefit from the lack of clear direction in bond markets, and close our US short duration position in response to this week’s sell-off. However, we stay underweight in the UK, where many shorts have been covered over the past few weeks, leaving positions more conducive to higher yields.

Greece took two significant steps toward bolstering market confidence this week, announcing further fiscal consolidation measures and issuing a 10-year bond. Greek debt is likely to remain volatile, not least because of the difficulty in implementing austerity measures. But spreads of close to 400bp provide ample compensation, and we go long Greece. Ireland provides a less volatile way to position for intra-EMU convergence—we stay long.


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