Risk on, but preparing for riskier markets

Deeper dive

The US is about to follow an unprecedented experiment in monetary policy with an unprecedented experiment in fiscal policy. We remain pro-risk and are overweight global equities, but uncertainty is likely to rise and we need to consider how to position ourselves in this changing environment.

After the recent budget announcement, the US fiscal deficit looks set to rise to more than 5% of GDP, while the unemployment rate is likely to fall below 4% – a never-before-tested combination. The risk that inflation rises more quickly and the Fed is forced to turn more hawkish than markets currently expect is therefore not negligible. The market cycle may enter a new phase, in which fears of higher interest rates begin to compete with, or even outweigh, hopes for higher growth.

This new environment could challenge investors, as traditional asset class relationships may be less stable. Ordinarily, for example, investors can expect stocks and bonds to trade in opposite directions. But these sold off together during February’s stock market correction, and the 13-week rolling correlation between the S&P 500 and 10-year US Treasuries is now positive. Recently, bonds haven't fulfilled their usual role as a diversifier against falling stock prices. At inflection points in monetary policy, this kind of change in market dynamics is not unusual. In recent history, these episodes typically only last for short periods between two and 12 weeks, although during the 2013 taper tantrum the correlation was positive for 31 weeks from June 2013 to January 2014. But that doesn't make it easier for investors facing more volatile portfolios.

To help reduce portfolio volatility, we're looking beyond traditional bond-equity diversification. We retain a pro-risk stance to benefit from still-strong global economic and earnings growth, but have also opened positions that should help stabilize portfolios during periods when markets focus on fears of higher inflation and/or tighter policy. We have bought a 10% out-of-the-money put option on the S&P 500, which provides some insurance against sharp equity market falls, and have also added an overweight on the Japanese yen against the New Zealand dollar, a position that should benefit in the event of a market downturn driven by fears of higher US yields. The yen has traditionally been a safe haven in times of market stress, while the New Zealand dollar would lose its relative yield appeal.

Over our five to seven year strategic asset allocation time horizon, we are confident that bonds will continue acting as diversifiers for equities. Over the last 10 years, the 13-week correlation between the S&P 500 and US 10-year Treasuries has only been positive 16% of the time, and the impact of growth across business cycles ultimately dominates shorter-term shifts in monetary policy expectations. So we keep our strategic asset allocations diversified across equities, bonds, and alternatives. But to manage a new, more volatile, time for markets, we have also added a counter-cyclical position to help stabilize portfolios.

Mark Haefele

Global Chief Investment Officer WM

Bottom line

As the US begins an unprecedented fiscal experiment, traditional asset class relationships may be less stable. Bonds and equities have moved intandem recently, which can occur for short periods; we still believe the long-term correlation is negative. We remain overweight global equities,but have also opened positions that should help stabilize portfolios when markets focus on fears of higher inflation and/or tighter policy.



United Kingdom


Emerging Markets


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