Johann Jooste, Chief Investment Officer, Bank of Singapore, Member of OCBC Wealth Panel

June was another tough month for global equities, as fears of escalating trade confrontation and slowing economic growth broadened.

While the solid economic outlook and healthy earnings growth continue to be supportive, deteriorating balance of risk is expected to continue to curb investor risk appetite. Valuations are less demanding following the pullback in recent months. However, with rising interest rates, we do not expected earnings multiples to retest the recent peak in January and further upside for the markets would be driven primarily by earnings growth.

Hence we maintain a slight underweight stance for equities.

Damage from a trade war
The reason for the word “war” in “trade war” is becoming obvious: it can cause noticeable damage. It is the dominant feature of market news flow at present, drowning out much else that may prove to be relevant later.

Positioning of portfolios in this environment is an obvious challenge. As we have mentioned several times by now, both the actual outcome in terms of actual trade barriers as well as their impact are unclear right now. It has been obvious that winners will be few and far between, and that there will be plenty of losers in quite a few industries.

Winners and losers
We see China and Asia as potentially bigger losers than the US. The equity market has priced the risk accordingly, with Asian stocks across the board showing signs of stress as risk appetite wanes in the face of growing uncertainty over trade.

Investors should also guard against assuming that the US will back down from its harsh line soon. Donald Trump is driven as much by approval ratings and market reaction, and the relatively muted US market reaction, coupled with little negative impact on his poll ratings, suggests he may be willing to hold the line for a while still. Between now and July 6, when the tariffs are due to take effect, strong nerves will be required given that the rhetoric between the various parties will remain shrill.

No surprise then that we have left our asset allocation on the defensive side. The mild underweight to equity has served us well, especially given Japan has suffered more than the US or Europe of late, and on a year to date basis is now lagging other developed markets.

It is also worth pointing to the overweight allocation to hedge funds. In turbulent times, the reduced volatility offered by a well-selected portfolio of hedge funds is exactly what is required to steady the ship. This remains a key call, and we re-iterate it as a good way to attain diversification in a balanced portfolio.

Find shelter from rising trade risk: Trade risk is becoming much higher at this stage. With US tariffs due to come into effect on 6 July, the room for a quick turnaround looks limited. There is a need to manage risk from an investment strategy perspective. Investors should adopt the following actions: (1) a cautious asset allocation stance; (2) hedges for more trade uncertainty from now till 6th July; and (3) switch out of companies that are highly exposed to trade risk and into companies with a higher domestic exposure.

Look for shorter duration bonds: In the midst of all this, Emerging Markets debt has had a poor start to 2018 by its own high standards, down nearly 2% YTD. The headwinds of a stronger dollar and higher rates may remain for a while, but the underlying credit quality is not a concern at this point, certainly not for our coverage universe. We re-iterate our view that the best place to be in credit bonds at this juncture is in the shorter-dated end of the spectrum.

EM FX – storm clouds with silver linings: Wrong to extrapolate the problems of Argentina and Turkey to other Emerging Markets, although stress from intermittent rise in US yields will likely linger. EM FX sell-off in late stage. Generalised pressure should give way to greater differentiation.

Limited upside for oil: We doubt the durability of the OPEC-led supply constraints. As a result of the US shale supply response, we doubt recent price levels can be sustained, and see WTI at US$60/bbl over the coming year, with Brent at US$65/bbl in 12 months.