Key Themes – The Battle Between U and V
· We expect a U-Shaped economic recovery with the US recession ending in summer 2009. Recovery will likely
be gradual as cyclical headwinds have not fully disappeared, rising mortgage rates can dampen affordability,
and the doubling of energy prices can impact consumer discretionary spending power.
· Risky assets are supposed to be forwarding looking, and 2009 price behavior is more V-shaped as the
healing of systemic risk post financials stress-tests and capital raises. The de-risking post Lehman, following
by the re-risking since early March is a significant driver of this V-shaped phenomenon.
· Equity view: Our team believes that equity markets need a V-shaped economic recovery to sustain
significant further gains, and believe the next move is more likely to be down than up. They do not believe
this is the beginning of the next bull market, but do believe the market has put in its lows.
· Equity Derivatives view: There is a better than even chance volatility will decline (low 20% for longer-dated,
20% or high teens for short-dated) as fundamentals turn and markets heal, but the risk / reward for positioning
that way is poor. Instead, we advocate owning options and selling steepeners to protect against potential
spikes / curve inversion.
· Credit view: We remain constructive on IG credit globally, based mainly on continued cheaper valuations and
a market that is open to issuers. HY and loans are a tougher call, but despite peak default rates now, new
issue markets are open.
· Credit Derivatives view: We are in the last leg of our sequencing theme, and we like mezzanine tranche
risk, tranche steepeners, distressed forms of legacy bespokes, and credit gamma as a good hedge.