High beta sectors, such as financials, have outperformed, while low beta and interest-rate sensitive sectors, such as industrials, have underperformed.
End of beta rally
With a strengthening US economy and European deflation risk appearing under control, developed market macroeconomic risks are starting to take a back seat. As a result, investors are increasingly focusing on relative value.
This may well signal the end of the beta rally and the start of a less friendly credit environment. This is supported by our equity versus credit relative value models which indicate a preference for equity, alongside our macroeconomic analysis which also points to a more favourable environment for equity than credit.
Looking forward, the risks of deteriorating corporate fundamentals and corporate activity are coming to the forefront. The US is more advanced in the credit cycle, with companies increasingly willing to spend their cash on merger & acquisitions and shareholder-friendly activities such as share buybacks and dividends.
Credit support
This can be a double-edged sword: increasing leverage ratios for investment grade companies increases uncertainty and puts pressure on their debt financing, however smaller companies that are subject to buyouts tend to have their high yield debt paid down, decreasing their leverage.
Overall we remain neutral towards credit. Despite the risks outlined above, the cyclical backdrop is still supportive for credit, if not as supportive as for equities, central banks continue to take a cautious approach towards tightening interest rates and technicals remain supportive for now.
However, we recognise 2014 is unlikely to see same risk-adjusted returns as 2013.
