Barclays to Investors: Stay Liquid

Barclays stays cautious in its global outlook for December:

We are in the midst of the most severe global recession since at least the early 1980s, if not the Great Depression. It is difficult to find an economy anywhere in the world that is not being hit hard, and the downward momentum underway virtually ensures that activity will continue to fall significantly through Q1.

If fiscal stimulus plans and market supports do their job, Barclays says this contraction could bottom around mid-2009 but warns:

Plenty of nasty surprises lie ahead, as economic performance in the fourth and first quarters is set to be considerably worse than anything in the current cycle thus far. This will take its toll on income statements, balance sheets, and liquidity around the globe. We thus suggest keeping relatively sizeable portions of portfolios in liquid instruments to allow investors to take advantage of opportunities as they arise.

We could get an early 2009 rally off recent lows, but the rest of the year remains largely uncertain. So what to buy? Barclays recommends the following (bold is mine):

• Buy US investment grade credit and TIPS. Our valuation metrics suggest that corporate debt spreads are already close to the highs they reached in the Great Depression, and even if they remain elevated, the amount of carry suggests that decent profits are likely to be made by investing and holding these assets. Real yields on TIPS in the 5-7yr part of the curve are in excess of 3%, and are pricing in an extended period of deflation.
• Given the high degree of risk associated with any scenario in today’s environment, it is wise to hedge even these relatively cautious positions. Nominal European government bonds seem relatively cheap considering the likely economic weakness and associated monetary ease that we expect in Europe. A long position is likely to provide an effective hedge to significantly weaker economic growth or a more extended period of deflation than we expect.
• We are cautious on emerging market assets, commodities and equities. Emerging market debt and equity were hit relatively late in the de-leveraging cycle and it could well take some time before investor interest is rekindled. We thus recommend underweight positions in emerging market equities and non-investment grade credit. The downturn is having a devastating effect on demand for commodities, and it is hard to be confident that the bottom in prices has yet been reached. OPEC production cuts should help support oil prices, but similar supply management is not expected to benefit other commodities in the near term. Equity valuations are cheap compared to history, but not as cheap as credit. Over the long run, we believe equities offer excellent value, but we are concerned that the weakness in earnings that will follow the sharp contractions in economies in Q4 and Q1 is not yet fully appreciated. Consequently, we recommend a very cautious dip-buying approach, primarily in Europe, where valuations are the lowest. 
• Most of the position reduction in currency markets that has favored the dollar and the yen appears to have run its course, and we are not looking for further significant gains in these former funding currencies. The commodity currencies may have somewhat further to fall as the global downturn plays out, whereas sterling seems set to recover as the gloom surrounding UK prospects – particularly relative to the euro area – seems to be overdone.

The above, plus today's pull-back from Wednesday's Fed-inspired rally, should keep equity investors from becoming too optimistic.