Perplexing complacency in credit markets
The world is full of imbalances. It does not matter if one looks at the disruptive activities of central banks or at unprecedented emerging markets credit growth. At the same time, valuations of risky assets are high. That is how markets work, though.
Markets can be complacent for years. We realize imbalances can burst or deflate at any time, for any reason and thus unexpectedly. By the way, the most perplexing complacency we find is in China, comparing real growth and credit creation. The risk of a major deflationary growth slowdown is increasing.
Economically we still have a bit of time. Europe is in full expansion mode and even the US soft patch period might well be transitory. The most important variable to watch is the change in (US) credit creation, the so-called credit flux. Commercial & Industrial (corporate) lending is weakening and is a very good indicator of future economic activity.
Risky assets are increasingly mispriced. We believe we need to be more careful and make sure we invest in credit market segments that do offer value for the risks we take.
Technicals are relatively stable now. Central banks are very predictable, election stress is gone for now and a wall of cash is looking to be invested.
We manage betas close to index level and try to take advantage of tactical sector or corporate positioning. We increase underwriting standards as much as possible.