At the end of last year Source’s multi-asset research team was recommending Chinese and Japanese equities, European real estate, and US high yield bonds. While their overall macro view hasn’t changed, the firm is less optimistic about returns over the next few years and is recommending that investors shift more of the portfolio into cash, dollars and British pounds in particular.

“Most assets have become more expensive since we last published in December, with the obvious exception of commodities. With little change in the global economic outlook, expected returns are now lower and we are boosting our recommended cash position to Overweight,” write Source head of research Paul Jackson (and ex SocGen analyst) and research associate Andras Vig.

Source MAP weights QE

Macro changes since Source’s December letter

The biggest surprise since the Source’s December letter is the collapse in oil prices. They had expected Brent crude to end 2015 at $70, but now that it has fallen to $50 they don’t see any reason for prices to perk back up by the end of the year. Other commodities have also fared poorly so far this year, but Source expects them to fall further and recommends 0% weight to commodities (n.b. Source considers 2% to be a neutral weight for commodities). This had two knock-on effects: US high-yield indices lagged Treasuries since November, and lower than expected inflation figures in the Eurozone translated into the ECB starting a larger than expected QE program.

Of course Source didn’t anticipate the Swiss National Bank to remove the EUR/CHF floor (did anybody?) or a Syriza win in Greece in their December letter, but neither event seems to have significantly changed its view on which assets investors should be holding.

Finally, the 40% rise in the FTSE A50 index means that Source no longer sees Chinese stocks as a “no-brainer” like they did three months ago, though it’s multi-asset portfolio (MAP) is still overweight Chinese equities.

Changes to the Source’s multi-asset portfolio

The Source argues that liquidity from the “QE5” (the Fed, BoE, BoJ, PBOC, and ECB) has already propped up Since valuations, making it difficult to find attractive risk-weighted returns, but the divergence among central bank policies means that USD and British pounds should continue to gain against the euro. To account for this Source has increased allocation to cash from 3% in December to 7% in the latest report. To make up the difference, the firm has reduced its weight for government bonds from 18% to 15% and real estate (which has performed well recently) from 4% to 3%.

The Source MAP is still tilted toward equity-like assets, including things like high yield corporate bonds, but it notes that the US appears to be well into its economic recession. Since a stronger dollar will export growth to other regions that are at an earlier stage in the economic cycle, Source recommends investing more heavily in Europe ex-UK and Japan. The report also notes that equity prices in the US are the only ones that really look stretched.

economic roller coaster Source QE

global yields and CAPE Source QE

Source’s top picks for March

While Source still likes Chinese equities and European real estate, it no longer counts them among its top picks because of recent outperformance. It’s clear that tailwinds from central bank easing is playing a big role in the Source’s analysis, since three of the top four picks are Japanese equities, Japanese real estate, and eurozone equities. Eurozone equities could experience a QE-driven multiple expansion similar to the one that drove the US equity market in 2013, if not to the same degree.

The outlier is US high-yield, which the Source report calls “the best among a poor fixed income universe,” though it sounds like the firm might just be reaching for yield in its recommended weights.