Bonds as portfolio hedge? JPM AM thinks they're a "key risk"

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BONDS AS PORTFOLIO HEDGE JPM AM THINKS THEY'RE A "KEY RISK" (1137 GMT)

The reflation trade may have slowed in pace but a wave of pent-up household savings yet to be spent is one of the factors J.P. Morgan Asset Management (JPM AM) feels will help growth stay strong and inflation prove "persistently troublesome". That leads to the firm recommending investors look away from bonds in the third quarter when they seek portfolio hedges.

"...bonds – which are supposed to be a key source of portfolio ballast – are actually a key risk," says JPM AM in its Q3 markets guide released today, recommending investors look at alternatives, like macro funds and core infrastructure assets to trim risk. 

Karen Ward - the firm's chief market strategist for the EMEA region - thinks talk of tapering by the U.S. Federal Reserve will surely louden over the summer, resulting in sustained bond volatility. 

"Ultimately, I think central banks will, at the very least, ease off the accelerator pedal, and this will encourage bond yields to nudge higher," says Ward.

She and her colleagues think strong growth and the modest inflation backdrop will aid corporate earnings and thereby stocks, with some sections of the equity market yet to price this in.

"Despite the strong outperformance in the first half of the year we still see the most attractive opportunities in the value segments of the market, such as financials," they say, adding that industrials and energy stocks generally outperform at times of rising yields.

Geographically, JPM AM finds European and Japanese equities outperform the global benchmark MSCI ACWI  when yields rise, while U.S. and developing world stocks underperform.

(Aaron Saldanha)

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Q2 EARNINGS: HOW MUCH BETTER IS MUCH BETTER (0937 GMT)

As underlined in the last post, there's a strong feeling across investment houses that European stock markets are priced close to perfection and as a result there's not much upside left, even in a best case scenario.

Take Q2 earnings, expectations were already sky-high but the latest data from Refinitiv IBES shows the expected earnings surge has been revised to 108.6% from 104.3% last week.

See it here:

For Neil Wilson at Markets.com, even "monster numbers" for Europe Inc might fail to impress.

"Earnings season is coming up but it's well known we are going to see some monster numbers and it is less obvious how Q2 reporting will drive the market higher – if anything it could lead to a round of profit taking and recalibration", Wilson wrote in his morning note.

(Julien Ponthus)

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"PAST THE REFLATION PEAK" (0917 GMT)

Another stunning reporting season is upon us with Europe Inc and Corporate America set to deliver Q2 profit growth of 109% and 65% respectively but equity investors are already starting to come to grips with the idea that the post-pandemic reflation boom may not run ad aeternum.

For Barclays we are "past the reflation peak" and in terms of sector allocation this means it's time to add some tech as a hedge even though it still likes commodities and banks and says it would be premature to turn overly defensive.

"We expect equities to grind higher in Q3, but risk-reward is less compelling and upside potential more limited, as catalysts have largely played out," says the UK bank.

"Growth is peaking, Fed is moving closer to tapering, inflation may prove sticky and COVID variants could result in more supply bottlenecks, particularly in EM. As we transition from recovery to expansion, risk-adjusted returns should be lower and sector/style leadership more balanced," they add.

(Danilo Masoni)

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VALUE, REFLATION STRIKE BACK AT THE OPEN (0732 GMT)

European markets at the open seem pretty determined to reverse yesterday's risk-off moves.

The STOXX 600 is up about 0.6% and on track to erase the losses of the previous session when reflation trades got a kick in the chin as government bond yields fell.

Value plays and cyclical sectors such as commodities, energy, construction and autos are leading gainers while defensive stocks, like pharma, are trailing behind.

The travel and leisure sector is the worst performing one, down 0.5% as worries about the spread of the Delta variant persist.

Of course with investors still waiting for the Fed's minutes, there's a lot of uncertainty moving forward but Wall Street futures are up, indicating there's broad optimism out there in comparison with yesterday.

(Julien Ponthus)

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"OK, WHO LEAKED THE FED MINUTES" (0645 GMT)

"Ok, who leaked the Fed minutes," Sven Henrich, founder of NorthmanTraderm, asked jokingly on twitter after markets suddenly switched to risk-off mode yesterday.

While one would typically expect investors to trade cautiously a day before getting a better sense of what caused the hawkish shift at the U.S. Federal Reserve's June meeting, the market price action was surprisingly decisive.

Government bond yields dropped, the dollar rose, the reflation trade and cyclical stocks got hammered and traders were suddenly ready to pay an extra premium for growth stocks, particularly tech, which sent the Nasdaq to new record highs.

Market participants were hard pressed to find a single catalyst for the mood swing but offered plenty of explanations.

COVID-19 fears (Delta variant surging), peak-growth fears (ISM showing a cooling in U.S. services), the Chinese crackdown on tech companies, falling oil prices (OPEC+ meeting): there was no shortage of possible triggers.

Another view is that the U.S. yield curve flattening, with U.S. 10-year notes US10YT=RR dropping to their lowest since February at 1.34%, meant some investors were betting the Fed would tighten its policy pre-emptively to head off inflation.

There's not much left to wait before the Fed minutes are published later on Wednesday. In the meantime, bond markets are calmer. Stock futures in Europe are slightly positive with no palpable sign of yesterday's stress.

That's good news for London's stock market, which faces a test of its capacity to be a hub for fintech post Brexit with the listing of cross-border payments firm Wise IPO.

Key developments that should provide more direction to markets on Wednesday:

- Samsung Electronics flags 53% jump in Q2 profit, tops estimates 

- German May industrial output -0.3% m/m in May

- Germany to sell 5 bln euros of 5-year bonds

- UK Halifax fall for first time since January

- Japan coincident index first fall in 3 months 

- France May current account

- U.S. May JOLTs job openings

- Thai central bank monetary policy report 

- Riksbank deputy governor Henry Ohlsson talk on e-krona

NO REBOUND ON THE HORIZON (0525 GMT)

European futures are up a modest 0.1% about two hours before the open and seem so far in no mood to rebound after their retreat yesterday.

It's still not 100% clear what caused Tuesday's risk-off episode which also hit Wall Street and Asia overnight.

COVID-19 fears, peak-growth fears, Fed policy fears, Chinese tech fears: there's a large choice of options at hand.

Whatever the cause however, the end result goes like this: government bond yields are lower, cyclical stocks are under pressure and investors are ready to pay an extra premium for growth stocks, particularly in the tech sector.

It's unlikely we'll a breakthrough in terms of direction of travel until investors get the minutes from the Fed's June meeting and get a better sense of what its recent hawkish shift is about.

(Julien Ponthus)

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