Risk is no Four-Letter Fantasy but Reality Crosscheck

This article was last updated on May 19, 2022

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Now close to three years after the last peak of euphoria and the intervening credit crisis, risk for investors is no four-letter fantasy but is instead a reality cross check. Weak U.S. employment numbers and other releases have already raised political temperature for markets in 2010 by, well ahead of the traditional post Labor Day focus during U.S. election years. As well as political considerations are expanding in Asia (such as cooling asset pressures in China) and Europe(such as deficit reduction). Arguably since late 2007 there has for investors been yin/yang over expansion/recession. Now, the focus on short term developments needs to evolve to corporate requirements for the long run. We expect equities to be in the trading ranges established in 2010 to date Hi- Low (S&P 500 1217-1022; MSCI World 1228-1033) ranges until more clarity emerges, likely around mid 2011. The breadth of recent bond rallies from sovereign debt to junk contrasts with potential cash flow pressures if deflation or economic weakness were to spread.

Assumptions of nimble behavior in current fixed income represent risk even if the Federal Reserve has signaled via its August 10, 2010 statement maintaining a large $2.3 trillion balance sheet and low rates. Even with faster Asian growth, we are skeptical about the notion of faster corporate revenue growth without corporate leadership. We do not expect equity valuation expansion in major markets like the S&P 500. In some markets like India, P/E ratios appear high versus inflation pressures on the central bank. One source of bifurcation in favor of quality for the investor today lies in differentiating in favor of companies re-investing for the future and stressing stable ROE over those stretching for amplitude. Within a quality overlay, we favor information technology and energy as well as in healthcare, anticipating further restructuring. Gold remains our favored hedge against uncertainty. Yen levels remain of concern to us as a potential unrecognized global risk factor.

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