Be fearful when others are greedy

Indeed until now, the tug of war between the political risk and better fundamentals has been dominated by the latter. The economic recovery continues and corporate earnings are better than expected. Add to that some M&A-rumours and real M&A-activity and rising commodity prices and you obtain a tasty cocktail favouring risky assets. Also, outside the US, equity risk premiums are still attractive and around 100bp above their long-term average.

In addition, one must never forget that in politics, just like for any other event, risk is often two-sided. Simply compare the performance of markets post Brexit and post the election of Donald Trump with the ex-ante expectations. The difference could not have been bigger. Imagine what could happen if the outcome of the upcoming elections in the Netherlands but especially in France is not the negative risk outcome but the positive or at least a less negative one.

Of course, Greece has also come back to the table although in reality it has never left.

Up until now, markets do not seem to overly worry about Greece, US politics and European elections and continue their climb of the wall of worry. This is not to say that investors completely ignore the risk. This is witnessed by the widening of peripheral spreads and of countries facing elections in the short term. The political risk factor as captured by news and social media is real. We observe that since a couple of weeks this indicator has improved.

However, with the words of one of the most successful investors in mind: Be fearful when others are greedy and be greedy only when others are fearful, we thought it was wise to scale back some of our equity risk.

Indeed, looking at our short term technical momentum indicators, signs have popped up that equities are in clear overbought territory. From this point of view, the positive qualitative overlay that was in place does no longer seem justified. Also in the other risky asset classes like real estate and spreads we have moderated our views relative to our signals. This underscores one of the cornerstones of our investment process namely combining quantitative fundamental and behavioural measures with a qualitative overlay.

This does by no means imply that we turned cautious on risky assets. Overall, in our current TAA stance we keep a preference for risky assets. We have a small overweight in equities and spreads and have a medium overweight in real estate and commodities. Bunds are a medium underweight. So, in short we are counting on a continuation of the reflation trade fed by macro, earnings and fiscal measures in the US. Finally, also investor positioning is not extreme as witnessed by the high cash levels indicated in the latest institutional investor survey.