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Risky assets cheap, safe assets expensive, says Lyxor

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Risky assets are cheap and safe assets are expensive but the situation is unlikely to change soon, says Lyxor Research.



Over the next several months, Lyxor sees no catalyst to drive risk assets substantially higher in a sustained fashion. Risky assets are cheap and safe assets are expensive, but it believes these conditions are likely to persist in the near term. The quest for safety in a persistently policy-driven, uncertain environment is likely to keep risk premiums on risky assets elevated.

While Lyxor is broadly constructive on the global economy, it sees modest growth at best. It also sees obviously deteriorating momentum and below potential prints of economic data across the globe. Markets will look to policy makers to do the right thing after all other options are exhausted. The result is likely to be rangebound markets with sentiment-driven reversals.

Lyxor believes that the slow-motion progress on the political front is insufficient to reverse the economic downturn in the Eurozone. Deleveraging by banks and self-defeating fiscal restraint will likely deepen the recession. The escalating euro debt crisis is taking its toll on the global economy. The current soft patch is severe and broad-based, hurting developed as well as emerging countries. 

On the positive side, inflation is receding, paving the way for policy easing, which should allow the expansion to regain some momentum before yearend. Looking forward, the major uncertainty for the world economy seems to lie with the US where, after a catch-up phase, businesses have put the brakes on hiring and investment. 

Within the US, however, the housing sector is giving signs of life while household purchasing power should benefit from the oil price decline. The credit impulse has softened, but banks signal looser credit standards and the Fed’s second “Operation Twist” will continue to put a lid on long interest rates, fostering the longed-for recovery in mortgage debt. The US soft patch should prove short lived, but the expansion will likely carry on at a sluggish pace. Moreover, fiscal retrenchment in the US will start in 2013, which constitutes a significant tail risk for the world economy.
 
Lyxor therefore views hedge funds as a crucial component for consideration in portfolio construction. We are still stuck in the middle of a structural deleveraging both on the private and public sector side. This weak growth environment is probably going to be with us for a prolonged time span, capping the upside to risky assets. This is not to say that markets do not offer – sometimes prolonged – tactical trading opportunities after sharp risk off selloffs. These are among the opportunities that we believe hedge funds can capture.  

“The most attractive portfolios right now include both alpha-generating, steady earner strategies to provide income, as well as managers who can swing their portfolio exposure to take advantage of short-term tactical opportunities,” says Jean-Marc Stenger, deputy head of alternative investments at Lyxor Asset Management.

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