Brexit, volatility/financial stability, negative rates/cost of capital for banks, deglobalisation, and the US elections are key drivers of the current market environment and asset allocation considerations. They remind us, in case we needed to be, that we shouldn’t lower our guard just because of the “aggressive” role that central banks are playing on the financial markets.
Without getting carried away and reversing our asset allocation positions (in which we restore risk in emerging asset classes, continue to overweight peripheral vs. core euro zone countries, and overweight corporate bonds in bond portfolios), we remain on a cautious footing. We are not complacent on risk, which is, in fact, far greater than what conventional metrics suggest, mainly because central banks are smoothing out volatility. The US elections, the Italian referendum, the Spanish political situation, the current and future discussions on whether (or not) the ECB will stick to QE, and, above all, the wait for the next Fed FOMC meeting all suggest how misleading the current low levels of volatility are and how dangerous it is to underestimate risk.
Being aware of the risks does not mean reversing positions, particularly on markets with low liquidity, as it would then be very hard to get back into these markets, when the time comes. Unless we believe that coming events are likely to trigger a complete reversal in trend, we don’t want to be locked out of these markets. Protecting and hedging looks wiser in the current environment.