Base case views from our last cyclical forum can be summarized as peak pandemic, peak policy, and peak growth. Those have, for the most part, played out and priced in the market accordingly. So where are the opportunities from this point on? We focus on three dimensions: First, whether the Delta variant is peaking; second, whether the Fed is going to taper or not; and thirdly, while China has been tightening policy and slowing down this year, will the PBOC start to ease and is China’s economy going to recover?
There is—at least based on historical experience—a major disconnect in the market in terms of the mid-cycle expansion, but late cycle asset prices. Although we don’t know whether it’s just the new normal because there is so much central bank liquidity, asset prices are potentially going to remain at these relatively rich levels by historical standards.
In the low volatility mid-cycle market, investors should think about portfolio construction a lot more thoughtfully: for example, constructing a portfolio that can perform under a variety of scenarios, to use global resources to undertake both directional and relative value strategies in single assets and across asset classes, and to think about long convexity positions balanced by risk premium harvesting strategies.
For now, most of our focus is developed market interest rates. Volatility in the market is quite low, so we want to use the market opportunity to construct positive convexity positions that give us exposure to higher interest rates in the market.
Last year we took advantage of the market dislocation to get long mortgages against different types of interest rate hedges. And in March and April, we flattened out the position as mortgages reached historically rich levels. If the Fed begins to taper, we think the mortgages are going to start to widen from historically rich levels.
And thirdly in corporate credit, in partnership with our global credit team, we are selectively adding exposure in potential COVID recovery sectors and also some companies that we think can benefit from secular disruption and sustainability initiatives. And in mid-cycle, when volatility is low, one should also focus on systematic strategies to try to harvest some short-term market dislocation and the risk premium.