21 June 2017
Author: Johan Jooste, Chief Investment Officer, Bank of Singapore, Member of OCBC Wealth Panel
Our overall allocation to equities has been underweight, despite upgrading Europe to Neutral from Underweight after the French elections. The call has been largely driven by our skeptical view of earnings expectations embedded in the market. Lately, our view of a moderating economy has added to the strength of our conviction and hence, we have not added to risk.
However, that did not preclude us from being quite active throughout the first half of the year. For example, we have been rotating actively in Singapore and Chinese equities, global technology (downgraded to neutral) and energy (upgraded). And of course, we remain positively disposed to high yield bonds.
In all cases, we continue to advocate selectivity. Markets have been largely range-bound since February so, sector and regional opportunities can be fleeting and a nimble response can be required to take advantage. Some other strategies that we advocate are far more long-term in nature and require patience not speed.
The Trump Trade is over: Returning to Mr Trump, the “Ugly” outcome that we painted as a possibility in January looks like one we can now discard. The risk of a trade war with the East will not likely happen soon except, perhaps verbally on Twitter but not in the real world. The actual policy outcomes of the Trump presidency cannot be predicted in full – the man is just too temperamental for that – but we can make a good guess that mostly, it will fail to live up to the promises he made for bold changes.
Infrastructure spending will likely prove to be the biggest disappointment to his support base. He has been slow to move on proposals, and it has become clear that the path to much higher infrastructure spend will be a tortuous one. It is entirely likely that he will give up on the notion entirely once the scope of the problem becomes clear.
We differentiate between tax reform and tax cuts. Tax reform is a structural issue that drives not just the rate of tax paid but a myriad of other things including where the burden falls (who pays) and what it is used for. Tax cuts are a far narrower issue: how much to pay. It is easier to achieve some tax cuts, but full-blown tax reform will be far more difficult.
Looking at the macro-backdrop and overlaying it with the stock market, we find that the current episode of moderation is not out of sync with history: we have seen this before. It is not out of the ordinary to see a growth moderation of the current magnitude.
More to the point is whether or not, as equity investors, we should be fearful of significant downside risk from here on in. The numbers are reassuring to some extent: past history does not contain too many instances where the market drops appreciably, apart for the summer of 2010 when it declined sharply.
Otherwise, the broad conclusion is that carry strategies perform better than a blanket exposure to US stocks. The comparison is with HY bonds and US high dividend equities. The message: stay cautious, but don’t panic. A period of moderation is different from a recession, and we are not calling for a recession.
Sensible carry: Finding value in a fully-valued market is a challenge. To ensure a safe outcome in the long run, diversification is much more important than timing the market. By holding too much cash as a defensive strategy, investors risk long-term harm by being under-invested.
It is true that in turbulent times, extra caution can yield positive results. However, this assumes one has the ability to know when to increase cash levels and when to stay invested. Over time, this is difficult to achieve consistently.
This does not mean that we are advocating a blind insistence on staying in the market at all cost. Risk appetite and tolerance plays a role, as does liquidity – the ability to draw on investments on a rainy day. A better investment philosophy is to look for additional sources of diversification in portfolios. Long term returns will be enhanced, without necessarily taking uncomfortably high levels of risk.
This material is not intended to constitute research analysis or recommendation and should not be treated as such.
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