A sharp sell-off in government bonds encouraged us to raise European bonds from underweight to neutral and close our short position. With sizeable moves in US bonds too, we took profits on our short positions, while remaining cautious. Overall, our short government bond positions have now been broadly halved.
We have upgraded Japanese government bonds to neutral. As for European investment-grade bonds, we built on our constructive positions with many IG rated companies boasting solid balance sheets and being long cash. As for European high-yield bonds, companies are generally (far) less protected from the deepening economic and energy-related woes, so we have shifted to a neutral position.
On equities, we are cautious. Growth and earnings look unlikely to improve. High inflation should ultimately eat into margins, particularly in Europe, while rising interest rates are increasing the cost of capital. Finally, forward equity valuations are still at or above the 15-year median, running counter to moves in fixed income markets that are consistent with mounting recession risk.
The disparate pricing between bonds and equities likely reflects the distinct probabilities of how successful central banks and economies will be in taming inflation without cratering growth. With (US) business inflation expectations sticky, and rental inflation high, the outlook for prices is far from clear. It is notable that the interest rate expectations of the investment community lag behind their inflation expectations.
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