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Key Themes – The Battle Between U and V
· U that feels like a V: We expect a U-shaped economic recovery beginning in 3Q 2009, but surging
production will make the data feel V-like. Significant economic headwinds (financial conditions, eventual
cooling production and cautious consumers) mean that the surge is unlikely to spill over into a stronger overall
recovery. Tighter monetary policy is unlikely soon.
· Risky assets are supposed to be forward looking, and 2009 price behavior is more V-shaped as the healing of
systemic risk post financial stress-tests and capital raises. The de-risking post Lehman, followed by the rerisking
since early March is a significant driver of this V-shaped phenomenon.
· Equity view: Remain constructive and believe S&P 500 at 1,100 would be a level to consider taking profits.
We won’t get bearish until we see one or more of 1) policy tightening; 2) material macro data disappointment;
3) excessive valuation.
· Equity Derivatives view: There is a better than even chance volatility will decline (low 20% for longerdated,
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 near-dated options and selling steepeners to
protect against potential spikes / curve inversion. We like selling correlation generally across market
opportunities and focus much of our effort at the single-name and sector level.
· Credit view: We remain constructive on IG credit globally, based mainly on continued healing in the market.
· 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 are leaning toward selling correlation.
Within HY and Loans, we like super senior hedges as OTM downside protection.
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