According to the results of a survey conducted at the end of June of hedge fund managers on the Lyxor platform, there is a positive sentiment concerning risk assets. Equities are largely expected to continue to rally, both in the US and Europe, on the back of accommodative monetary conditions recently reiterated by Janet Yellen. However, on the negative side, Lyxor managers express caution regarding US credit and China.
The bullish stance on equities, both in Europe and in the US, was largely shared by the respondents to the survey. The level of agreement that US equities are not overvalued and European equities remain undervalued is very high. The respondents were more divided with regards to equity investment styles. 50% do not expect value continue to outperform growth stocks. Value stocks have underperformed growth stocks for several years, especially in the US. However, the underperformance of value stocks unexpectedly and abruptly reversed in March and April 2014.
According to a recent press report, this is the least- believed bull market in years. Most asset allocators remain bullish on equities because of the lack of opportunities in other asset classes. Equity investors believe that valuations are not overstretched globally. The bullish case generally assumes that earnings will take the lead after the expansion of multiples over recent years. “L/S equity funds continue to attract significant investor interest. However, style gyrations caused some damage earlier in Q2. As a result, investors must be aware of the biases implied by the investment style of a fund. We recommend a balance between growth and value oriented funds in a L/S equity portfolio”, says Lyxor. L/S Credit funds focused on Europe and L/S equity funds focused on Japan should do well if these expectations effectively materialise.
The majority of the respondents to the survey currently expect the central banks to remain extremely accommodative. According to Lyxor managers, the ECB and the BoJ should implement (or expand) quantitative easing programmes in the second half of 2014. At the same time, only 47% of respondents think that the Fed will lift rates in the first half of 2015. As a result, 10-year Treasuries are not expected to reach 3% over the next six months. Finally, the increasingly dovish stance of the ECB suggests that the EUR will fall versus the USD to below 1.35 according to 53% of the managers surveyed.
Other important finding of the survey is that hedge fund managers are increasingly cautious regarding US credit. This is being seen in the context of rising fears concerning financial stability following the extended period of near-zero interest rate policies implemented by the major central banks. According to the survey, 65% of the respondents do not expect the credit rally to continue.
“US fixed income and credit appear increasingly expensive as an asset class. Although long dated Treasury yields are not expected to move significantly higher, a long-only strategy on credit does not fit with current market conditions”, says the report. For this reason, unconstrained bond funds are much more adapted to current market conditions. At the same time, Global Macro funds should do well as a result of established short EURUSD positions.
Emerging markets
Emerging Markets remain a key investment theme given attractive equity valuations and carry positions in fixed income. However, downside risks for EM have increased as the Fed prepares its exit strategy. The EM asset price gyrations in May 2013 (when Bernanke first signalled tapering) were a good reminder of the emerging markets’ sensitivity to US monetary policy.
The vast majority of the respondents of the survey (74%) expect real GDP growth in China to fall below 7% over the next two years. In parallel, over the next six months, the WTI is not expected to fall below USD100/ bbl (USD105/ bbl as of 30 June). However, it is important to note that the survey was conducted at a time when geopolitical tensions were rising and the risk premium attached to oil prices had probably increased significantly.
“Deceleration in growth in China would have a significant impact on emerging markets, particularly Latin America (huge producer of base metals consumed by China) and Asia (supply manufacturing chains). Latin America is more exposed here given that the deceleration would tend to come from an adjustment of the real estate market, a commodity intensive market”, says the report.
In terms of strategies, L/S equity funds with a Chinese focus playing domestic consumption themes should be resilient due to the rebalancing of the economy. At the same time, the Chinese equity market is attractive from a valuation standpoint. Additionally, the deceleration in growth should already be priced in to a certain extent, as this forecast is quite consensual. Finally, CTAs provide a very good hedge against geopolitical factors due to their established long energy positions.