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World Stocks Laced With ‘Huge Bond Risk’ Put Wall Street On Edge

World Stocks Laced With ‘Huge Bond Risk’ Put Wall Street On Edge

(Bloomberg) -- A U.S.-China rapprochement on trade or bust. Goldilocks-like expansion or a brewing downturn. An “everything bubble” versus the bullet-proof bull.

For all the existential doubts wracking investors, they’re dead sure of one thing: Cheap-money policies will power anew the 2019 cross-asset rally.

Consider this. The biggest winners from low yields have recently surged to the priciest-ever versus the losers since at least 2003, according to global stock portfolios compiled by Societe Generale SA based on their five-year link with U.S. Treasuries.

Put another way, money managers are front-loading dovish monetary bets with echoes of the QE heyday. A classic portfolio that allocates 60% to equities and 40% to fixed income is poised to notch its best half-year performance since 2010.

All told, billions are riding on interest-rate cuts in a one-sided wager -- spurring angst in some corners of Wall Street that global markets are moving toward the danger zone.

World Stocks Laced With ‘Huge Bond Risk’ Put Wall Street On Edge

“This is a slippery slope when we’re talking about Fed policy right now,” Jack Manley, global strategist at JP Morgan Asset Management Inc, said on Bloomberg TV. “The market is actually setting itself up for disappointment.”

No one is saying this is dumb money. Investors are hedging an economic downturn and paying hefty premiums for companies posting reliable earnings growth and dividends -- the likes of real estate, utilities and consumer staples.

All that has naturally ramped up the valuation gap between defensives and cyclicals to near a six-year high over in the U.S.

And why not? With nearly $13 trillion of negative-yielding obligations, the developed world is bereft of safe assets. Thanks to the epic debt rally, non-bank investors are already holding the biggest stockpile of bonds in three years, JPMorgan Chase & Co. calculates.

No surprise then that more investors are relying on dividend-paying equities as a form of income, according to Guy Haselmann, chief executive officer at FETI Group LLC.

World Stocks Laced With ‘Huge Bond Risk’ Put Wall Street On Edge

For now, bonds are the equity market’s best friend. For example, the jump in the value of fixed-income holdings is spurring money managers to up their stock weightings in order to match exposure targets to the asset class, according to JPMorgan.

But the bearish case is easy to construct. The risk is that high-flying income stocks will be at the mercy of gyrations in Treasuries, while demand stays muted for cyclicals hitched to economic growth. Quick-fire shifts in sector rotations could inflict pain for quants and traditional traders alike.

“This inner polarisation of valuation is not only introducing huge bond risk into equity portfolios, but also driving significant month-on-month factor volatility,” SocGen strategists led by Andrew Lapthorne wrote in a note.

There are incipient signs of a shift. Payout sectors such as utilities and real estate have lagged the broader market of late. Meanwhile, shares acutely sensitive to the business cycle known as value are set for their best week in nearly three months, according to a portfolio compiled by Bloomberg.

It could all prove eminently benign of course: Lower rates keep developed growth on a solid footing, the yield curve steepens to boost cyclicals, and steady demand for income juices bond proxies.

But given crowded positioning in bond-like assets, it’s looking dangerous out there.

“There is a risk markets may be expecting a little too much in terms of what the central banks are trying to deliver,” said Abi Oladimeji, chief investment officer at Thomas Miller Investment Ltd. in London.

--With assistance from Cecile Gutscher, Vivien Lou Chen and Lisa Abramowicz.

To contact the reporter on this story: Justina Lee in London at jlee1489@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Sid Verma

©2019 Bloomberg L.P.