»A real and abrupt turn in the credit cycle poses a major tactical risk to global equities and hence to our allocation. However, we do not expect this to occur just yet.«
That was how we ended the last edition of this publication – and we were wrong. On the timing at least! The question now is 1) is this a real turn in the credit cycle? “no” is the answer in our opinion 2) how much damage has been caused and 3) where do we go from here? We think that what has happened so far in the credit space is manageable and constitutes a healthy correction in an asset class that has long been mispriced. On the other hand, we do not yet think this poses a major buying opportunity for either credit or equities (though sentiment in the credit space is close to panic, which normally constitutes a tactical buying opportunity). As such we continue to recommend a modest equity overweight of 5 percentage points and a neutral weight to high yield.
We are still of the opinion that US subprime and its underlying cause, i.e. the US housing recession, will not derail either the US economy or the global economy. Right now we think that what is causing the turbulence is basically that very few people, if any, understand what is going on and everybody is throwing numbers around. As we wrote in the last edition of this publication, we do not pretend to understand the risks stemming from credit either. However, we do think we have a proper understanding of the magnitude of the losses we are facing in US subprime – and these are manageable.
Hence, even with the gearing on top, we think the total losses that our industry is facing from the debacle in US housing are manageable. In that respect, consider the following. The Fed has said that losses stemming from US subprime will be in the range of USD 100bn. With a very pessimistic scenario, we arrive at USD 200bn. Indeed, that is a lot of money and this is by no means insignificant. Some people have already lost - and more will lose – significant sums of money. However, we need to put things into perspective. From the peak of the dot.com bubble to the bottom, the S&P500 lost around USD 6000bn in market capitalisation and the value of US household holdings of equity-related financial assets declined by almost USD 6500bn. In comparison we think the value destruction that the US economy is facing right now is rather insignificant and we are, quite frankly, tired of hearing about US subprime.
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