The performance of the global financial markets in recent months can be described as a risk-on rally.Risk-on assets include commodities, real estate and emerging markets. Risk-off assets include US Treasuries, the US dollar, and German Bunds.
Believe it or not, Richard Bernstein actually considers U.S. stocks to be a risk-off asset.
Bernstein is the founder of Richard Bernstein Advisors. He was previously the Chief Investment strategist for Bank of America Merrill Lynch.
In a new piece he wrote for the Financial Times, Bernstein argues that the rally in risk-on assets won’t last. He believes that these assets rally when global credit is expanding. But that it isn’t exactly what’s going on right now. From his piece:
“Our research shows that risk-on assets’ outperformance during the 2000s was directly related to the inflation of the global credit bubble. The most popular investments during the decade were all credit-related investments. When one buys risk-on assets, therefore, one assumes that the deflation of the global credit bubble will subside and that credit will again expand. The implied forecast of a risk-off trade is the exact opposite, ie, that the credit bubble will continue to deflate.“
Bernstein believes that the current natural course of the global credit market is deflation. So, what’s going right now?
“Accordingly, we expect risk-on assets’ outperformance to be periodic when policymakers attempt to reinflate the global credit bubble. Risk-on assets outperformed subsequent to the Federal Reserve’s attempts to stymie US financial sector consolidation, and they have been outperforming more recently as the European Central Bank made moves to thwart European bank consolidation. “
And Bernstein isn’t willing to bet on policymakers in the long run.
“But economic history is also full of stark reminders that bubbles cannot be reinflated despite best attempts of politicians to soften the blows of consolidation and deflation. When these economic realities prove more powerful than policy, the risk-off trade outperforms.”
In this environment, Bernstein recommends U.S. stocks and bonds.