Time to Reduce Risk Exposure: Barclays Analysts

As investors increasingly shun risk, concerned over developments in the Middle East and Japan, which they fear could derail the recovery, analysts at Barclays Capital are also turning more bearish, advising investors to take positions that are more risk neutral.

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“The biggest surprise in the past few months has been the rise in inflation, with data coming in higher than either we or policymakers expected," Larry Kantor, Global Head of Research at Barclays Capital said in a note.

"Bond yields have moved up since last fall – when fears of a double-dip recession were rampant – but not high enough in our view to fully reflect the risks of inflationand future policy tightening.” After two years of economic recovery and strong gains in risky asset prices, we are no longer in an environment where confirmation of the sustainability of economic recovery reduces risk premiums and generates a revaluation of cheaply priced assets, Kantor wrote.

Barclays favors stocks over bonds, and developed markets – especially those in the US - over emerging-market stocks.

He said asset prices were now closer to fair value and stronger growth was now accompanied by signs of higher inflation and an increased probability of policy tightening.

Barclays Capital favors developed market stocks because there was more room for economic growth there without triggering significant policy tightening.

“That is particularly true in the US, where policy is still more supportive of growth than almost anywhere else, and where the Fed has a greater focus on core than headline inflation and is more inclined to look past short-term inflation developments,” Kantor wrote.

He added that the corrections following the dramatic events of recent weeks have created attractive entry points.

“Markets have been dominated by news surrounding the earthquake, tsunami and nuclear risk in Japan, as well as the political unrest and military action in the Middle East and North Africa and the associated rise in oil prices.

These events are still unravelling and it is difficult to be confident of final outcomes,” he said.

He does not expect however that events in Japan and the Middle East will be significant drivers of markets in the coming months.

“Growth in Japan is likely to suffer a sharp decline in the near term, but we expect reconstruction later in the year to bring the overall level of activity back to roughly where it would have been otherwise by the end of the year,” he said.

"While oil prices may rise somewhat over the next few months, there is still some spare capacity and Barclays’ base case is that supplies will not be curtailed significantly further." “At this point, we do not see the rise in oil prices as putting the recoveries in economies or markets seriously at risk,” Barclays said.