Note Précis May 23,2018: Risk Premiums, Inconsistencies and Weak Links – In any market, risk premiums need monitoring, not just in overall terms but also at weak links for creaks and inconsistencies. Many rationalizations are tardy, after the fact of breaks. Currently all more so than in the past, global links do matter. Politicians prefer to run on promises rather than on having to justify actual delivery – which means that issues could linger, ranged from trade to nuclear regulations. In the swirl of volatility amid higher levels of algorithmic activity than in previous market cycles, changes in risk premiums are evident in some but not in other market segments. On the rationalization of chasing yield, the risks of weak link dislocation are already emerging in emerging market debt denominated in foreign currencies, severely so for Argentina, Turkey and Venezuela but also among G-7 members Britain and Italy. Even as U.S. Treasury yields rise markedly, they have not yet done so for sovereign equivalents German Bunds and Japanese JGB, nor oddly in CCC corporate bond markets. We believe risk premium assessments could irregularly ratchet up worldwide, especially if 10 year U.S. Treasury note yields were to be 4.50% and Fed Funds at 3.50% in a year, as is our expectation. Equity valuations appear elevated and many market levels subject to large point moves – which indicates more fragility in confidence than earlier in this cycle on quantitative ease as support. The just released FOMC minutes for May1-2,2018 corroborate evolution. These aspects are contributory to our Energy and Materials equity overweight and at the asset mix level, to precious metals as alternate asset overweight. Furthermore, in our otherwise Fixed Income underweight, we favor shorter duration as well as for diversification, smaller sovereign nations that are fiscally conservative and flexible. Similarly in equities across sectors and geographies, strength of balance sheets and quality of operational delivery may be especially attractive in the mid capitalization investment space, such as $1.5-5 billion in a U.S. context.
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