EC HH Update: Global Asset Allocation

The risk budgets this month are again unchanged. For the moderate risk investor, the allocation between risk assets and bonds remains at 40/60 versus the benchmark of 60/40. The changes in our indicators since last month’s update have not been sufficient to warrant a change. Credit spreads did narrow significantly over the last month but the widening trend is still intact.

The economic data improved somewhat over the last month and oil prices firmed. This firming of oil prices, more than anything, was the catalyst for the improvement in credit spreads. That improvement in credit spreads was accompanied by a pretty nice rally in stocks but like the trend in spreads, the trend in stocks hasn’t changed, the downtrend threatened but still intact. The improvement in the economic mood also affected the long end of the bond market. Our move last month to sell duration turned out nearly perfect as the update was published the day TLT and TLH peaked.

Credit Spreads: The HY spread in last month’s update turned out to be the peak so far for this cycle, 8.87%. Since then spreads have narrowed to 7.15%, a very large move for one month. Spreads narrowed across the spectrum of ratings.

Valuations have not improved as earnings for Q4 2015 were once again negative, the third quarter in a row. In addition, estimates for Q1 are falling and right now are expected to make it four in a row. Stock prices have not fallen far enough to reduce valuations meaningfully.

All but the shortest momentum indicators are still negative.

The yield curve continued to flatten but the 10/2 spread is still not flat or inverted. Real rates also continued to fall with the 5 year TIPS going negative briefly (currently at 0.01%). Falling real rates have been a positive for gold and other commodities.

Credit Spreads

The panic I noted in credit spreads last month abated throughout the month and spreads narrowed significantly. The narrowing, however, was not by my reckoning sufficient to change the trend nor to make a change in allocation. A narrowing like this even before recession is not unusual. As you can see similar moves were seen prior to previous recessions. The economic damage of wider spreads is hard to quantify but high yield issuance is down considerably from last year. So far in 2016, $16.4 billion in junk bonds have been issued versus $51.5 billion in the first two months of last year.