High Yield Looks More Compelling, While Equities Face Risk Of Fed Policy Error

It may be time to reduce equity exposure in favour of other asset classes

Following three months of solid equity performance, and acknowledging the risk that the Fed could be making an error in tightening policy now, it may be time to reduce equity exposure in favour of other asset classes, including high yield credit and real estate. This is the view of the Multi-Asset Research team at Source, one of Europe’s largest providers of Exchange Traded Funds.

Paul Jackson, Managing Director, Head of Multi-Asset Research at Source, said: “We still prefer equity-like assets, but are reducing the extent of their overall weighting in our asset allocation model. At the same time, we believe it is worth shifting some of the regional focus within the equity exposure, in particular reducing weight in the US, the UK and emerging markets. We are still most positive on Japanese and Eurozone equities, but would hedge the currency in the latter.”

The Multi-Asset Research team’s latest quarterly publication, The Big Picture, also highlights the more compelling yields available in the high yield segment of the fixed income market. The report suggests the best opportunity may lie in the US, where the yield is currently 8.3%. Higher yields are reflecting the increased default risk within oil companies. Given the possibility for further interest rate hikes in the US, investors may wish to focus on the shorter end of the maturity curve, which would typically be less sensitive to rate movements.

Paul Jackson added: “The Fed’s decision to raise interest rates did not catch too many people by surprise, but, as we pointed out in a recent weekly note, the Fed is doing so at a time when some economic data would actually support loosening. Case in point is the US manufacturing sector, which after six years of economic expansion is starting to show signs of weakness. That said, we would also highlight that some other areas are still reasonably strong, namely the service sector.
“The Fed clearly feels the need to start normalising policy after maintaining a very loose stance for the last seven years. We think they can raise rates another three times during 2016 but the weakness of the manufacturing sector highlights the risks of such a path for the equity market. Investors must wait to see what impact such tightening will have on the economy.”